CHAPTER 4 Commented [AA1]: PART OF THE EXAM

BASIC FINANCIAL STATEMENTS

Basic financial statements should meet the following accounting principles:

 Going concern – this implies that the business will continue to operate for a Commented [AA2]: This implies continuation

long time with no intention of stopping operation/ no intention of failing. When

looking at the financial information of the business that is presented before can

that, you need to see whether the business can operate into the future (the

going concern).

 Matching concept – revenue and expenses (costs) are recognised as they Commented [AA3]: First this is the principle that guide
the revenue /expenses.
are earned or incurred irrespective of the timing of the receipt of cash or its That means we earned revenue it must be recognised and
must be recorded that “we earned revenue”. So, it does n
payment and matched with one another, that is all revenue earned is matched matter “irrespective of timing of receipt of cash” meaning
when we earned revenue it must be recognised immediat
whether we received cash or not because earning revenu
with all expenses incurred in earning that revenue during the relevant account. does not mean obtaining cash but it could mean a positiv
transaction or a sell. Such as struck a deal or sell somethin
 Consistency concept – once a firm has a fixed method for the accounting big that is earning revenue.
Example: enter into a transaction with a client to buy R20
worth of the stock however don’t have money as of yet, w
treatment of an item, it will enter all future items in exactly the same way. Can’t pay later. That is says irrespective if cash received or not.
And that’s referred to as a credit sell as a business. And th
record this item by method a and record the next item by method b. client is called the credit purchase.
The same can be said for an expense for example buying
stock on credit.
 Prudence concept – an item that is dealt with in the most conservative option,
it would be prudent to select the option which has the least favourable effect Commented [AA4]: Secondly, we should be able to ma
the revenue with the expenses incurred with the earning
on the net income and financial position the revenue.
Commented [AA5]: Looking back the consistency meth
were there are a number of methods but you need to be
consistent. This method states that you should choose th
most conservative not most convenient method.
Formula on which each of the following financial statements are based:
Commented [AA6]: Example: method 1 final results is
 Statement of Comprehensive Income (Income statement) income of R500000 and financial position of 2.5 million. B
method 2 results in a net income of R200 000 and financi
o Profit = Income – Expenses
position of 1.5 million. The conservative method would be
So even be conservative with the estimates meaning it
 Statement of Financial Position (Balance sheet) o should be less that what you expect.

Assets = Owner’s Equity + Liabilities

Tutorial exercise solutions (Chapter 1) 1

 Key notes to remember when compiling financial statements

 Financial information relating to profit, income and expenses should

appear on the statement of comprehensive income (income

statement)

 Financial information relating to assets, liability and owner’s equity

should appear on the statement of financial position

(balance sheet)

 Financial information relating to profit, capital and drawings should

appear on the statement of changes in equity

 Statement of Changes in Equity o Owner’s Equity =

Capital + Profit – Drawings

Example 1

The following information was taken from the books of Texas Dealers as at 28
February 2017.
Bank R15 000

Debtors R31500
Furniture R18000
Loan R45000
Creditors R28500
Equipment R18000
Buildings R105000
Inventory R24000

Page | 2
REQUIRED

Prepare the Statement of Financial Position. (The owner started this business a
year ago with a contribution of R75 000). Indicate on the statement the profit for
the year.

STATEMENT OF FINANCIAL POSITION OF TEXAS DEALERS AS AT 28

FEBRUARY 2017

Assets: R

Non-current assets 141 000

Buildings 105 000

Furniture 18 000 Equipment 18 000

Current assets 70 500

Inventory 24 000

Accounts receivable 31 500

Bank 15 000

TOTAL ASSETS 211 500

Equity and liabilities:

Owner’s equity 138 000

Capital 75 000 Profit 63 000

Non-current liabilities

Loan 45 000

Current liabilities

Accounts payable 28 500

Page | 3
TOTAL EQUITY AND LIABILITIES 211 500

Example 2

Prepare the Statement of Financial Position for Sangiwe Traders as at 28 February

2017.

Account: R

Capital at 1 March 2016 51 000

Creditors 15 000
Bank (overdraft) 12 000
Buildings 36 000
Drawings 21 000
Debtors 18 000
Equipment 18 000
Motor Vehicles 3 000
Inventory 18 000
Profit for the year 24 000
Loan 24 000
Fixed deposit 12 000

STATEMENT OF FINANCIAL POSITION OF SANGIWE AS AT

28 FEBRUARY 2017

Assets: R
Non-current assets 57 000
Buildings 36 000
Motor vehicles 3 000
Equipment 18 000

Financial assets
Fixed deposit 12 000

Current assets 36 000

Inventory 18 000

Page | 4
 Accounts receivable 18 000

TOTAL ASSETS 105 000

Equity and liabilities:

Owner’s equity 54 000
Capital 51 000
Profit 24 000
Drawings (21 000)

Non-current liabilities
Loan 24 000

Current liabilities 27 000

Accounts payable 15 000
Bank overdraft 12 000

TOTAL EQUITY AND LIABILITIES 105 00

Example 3

LIST OF BALANCES AS AT 28 FEBRUARY 2017

R
Bank (overdraft) 27 900
Buildings 150 000
Capital ?
Cash in hand (petty cash) 900
Creditors 15000
Debtors 18000
Equipment 24000
Investment 27000
Loan 60000
Motor vehicles 36000
Trading inventory 60000

ADDITIONAL INFORMATION
1. The profit for the year ended 28 February 2017 was R42 000.
2. The owner withdrew a monthly amount of R1 750.

Page | 5
REQUIRED
Prepare a Statement of Financial Position as at 28 February 2017
and determine the original amount for capital.

STATEMENT OF FINANCIAL POSITION AS AT

28 FEBRUARY 2017

Assets: R
Non-current assets 210
000
Buildings 150 000
Equipment 24 000
Vehicles 36 000

Financial assets
Investment 27 000

Current assets 78 900

Inventory 60 000
Accounts receivable 18 000
Cash 900

TOTAL ASSETS 315 900

Equity and liabilities:

Owner’s equity 213 000
Capital 192 000
Profit 42 000

Drawings (21 000)

Non-current liabilities
Loan 60 000
Current liabilities 42 900
Accounts payable 15 000
Bank overdraft 27 900

TOTAL EQUITY AND LIABILITIES 315 900

Example 4

Page | 6
 TRIAL BALANCE OF MATOME SUPPLIERS AS AT 28 FEBRUARY 2016
Debit Credit
Capital 295 189
Land and buildings 250 000
Accounts receivable 58 200
Accounts payable 49 200
Bank overdraft 17 500
Vehicles 145 000
Furniture at cost 100 000
Purchases 71 900
Railage on purchases 7 150
Railage on sales 2 750
Inventory (1/03/2015) 37 000
Sales returns 4 950 Commented [AA7]: Unhappy customers return the item
Purchase returns 6 000 Commented [AA8]: The business returned the purchas
Discount received 3 600 then received the money back so minus the amount

Rent received 12 000 Commented [AA9]: Other income

Telephone 6 820
Sales 365 000 Commented [AA10]: Can’t use this as it is because 495
Wages 40 000 was returned. That sales were returned meaning the
business sold the goods to the clients and recorded it as
Insurance 3 500 sales but the clients returned good worth to 4950 so minu
Advertising 4 050 from sales.
Notes if no sales return then take full amount
Drawings 13 000
Petty cash 4 169
R748 489 R748 489

Inventory as at 28 February 2016 was valued at 28500

REQUIRED

a. Prepare the Statement of Comprehensive Income for the year ended 28

February 2016.
b. Prepare the Statement of Changes in Equity.

ANSWER (a).

MATOME SUPPLIERS

Page | 7
 STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28
FEBRUARY 2016

Sales (365 000 – 4 950) 360 050

Less: Cost of sales 81 550 Commented [AA11]: To calculate the cost of sales, add
your beginning inventory to the purchases made during
Opening inventory 37 000 period and subtract that from your ending inventory. To
calculate the total values of sales, multiply the average pr
per product or services sold by the number of products or
Purchases (71 900 – 6 000) 65 900 services sold

Railage-in 7 150 Commented [AA12]: Transportation

Less: Closing inventory (28 500)

Gross profit 278 500

Add: Other income 15 600

Discount received 3 600

Rent received 12 000

Less: Operating expenses 57 120

Railage on sales 2 750

Telephone 6 820

Wages 40 000

Insurance 3 500

Advertising 4 050

Net profit 236 980

ANSWER (b).

STATEMENT OF CHANGES IN EQUITY

Capital 295 189

Profit 236 980

Page | 8
Drawings (13 000)

519 169

REFLECTION EXERCISES

1. Explain two of the qualitative factors; understandability and relevance?

2. Define the following concepts in accounting:

a. Going concern

b. Matching concept

c. Consistency concept

d. Prudence concept

3. Choose the correct answer.

1. Understandability is defined as …

a) the ability of financial information to make a difference in a decision by helping users

to form predictions about the outcomes of past, present and future events

b) information contained in the financial statements representing faithfully the

transactions and other events and be impartial

c) the ability of users to understand the information contained in the financial statements

d) a concept that implies that the business will continue to operate for a long time and
there is no intention to cease operations

2. The prudence concept …

a) considers the most conservative option that should be followed

b) considers the different ways in which the items are recorded

c) considers the revenue and costs as they are earned irrespective of the timing of the
receipts of cash or its payments

Page | 9
d) a concept that implies that the business will continue to operate for a long time and
there is no intention to cease operations

3. Receipts are for …

a) cash paid

b) cash received

c) goods returned

d) invoices issued

4. A financial statement of a business entity comprises of …

a) statement of profit or loss, financial position, changes in equity, cash flow, notes

b) statement of other comprehensive income, cost of goods manufactured statement

c) statement of ledger accounts, cost of goods manufactured statement

d) statement of profit or loss

5. Perpetual method for accounting for stock …

a) according to this method a retailer buys items for resale at a profit, the cost price of
the item affects the purchases account

b) according to this method the selling price and the cost price are known for each item
sold

c) according to this method the selling price and cost price are equal

d) according to this method the cost price exceeds the selling price

4 financial information

Capital 395 189

Land and buildings 240 000 Commented [AA13]: nca

Accounts receivable 56 200 Commented [AA14]: ca

Accounts payable 43 200

Page | 10
Bank overdraft 18 500
Vehicles 150 000 Commented [AA15]: nca

Furniture at cost 100 000 Commented [AA16]: nca

Purchases 51 900
Railage on purchases 6 150
Railage on sales 2 750
Inventory (1/03/2015) 35 000 Commented [AA17]: ca

Sales returns 5 950

Purchase returns 5 000
Discount received 2 600
Rent received 14 000
Telephone 4 720
Sales 355 000
Wages 50 000
Insurance 2 500
Advertising 5000
Drawings 4 000
Petty cash 4 169 Commented [AA18]: ca

REQUIRED
a. Prepare the Statement of Comprehensive Income.

b. Prepare the Statement of Financial Position.

c. Prepare the Statement of Changes in Equity 42:54

Page | 11
 CHAPTER 5 Commented [AA19]: PART OF EXAM

COMPANY FINANCIAL STATEMENTS

AND THEIR ANALYSIS AND
INTERPRETATION

Basic analysis and interpretation of financial statements by use of ratios (RATIO

ANALYSIS)

Ratio analysis: a systematic process where the financial statements of a business are analysed
by using various calculations. So, we can analysis financial statements using:
• Profitability ratios
• Solvency ratios
• Liquidity ratios
• Efficiency ratios Commented [AA20]: Different calculations under each

Study the following examples

Financial statement
Sales 700 000
Cost of sales (345000)
Gross profit 355000
Net Profit before Tax 133500
Total equity 371120
Total liabilities 554000
Total assets 925120
Debtors 40000
Creditors 54000
Credit sales 560000
Credit purchase 333300
Inventory 35000
Total current assets 312120
Total current liability 54000

Page | 12
1. PROFITABILITY RATIOS
Profitability ratios are used to thoroughly evaluate how profitable an organisation is. This
is used to analysis a financial statement and determine how profitable an organisation is.
Formula used to calculate profitability ratios Commented [AA21]: These are the three will be focusi
on
• Gross profit ratio = gross profit/sales X 100
Commented [AA22]: The gross profit margin ratio
expresses the gross profit as a percentage revenue

• Net profit ratio: Commented [AA23]: The net profit margin expresses th
net profit as a percentage of revenue. It looks at the
Net profit before tax/sales X100 relationship between profits earned and sales generated.

Note: the net will always be smaller than the sales especia
if it’s for the financial statement. Because gross profit is
• Return on capital invested: before the deductions and net profit is after the deductions
The deductions are: operating expense.
Net profit before tax/total equityX100 Remember from the income statement finial answer you g
net profit.
Steps:
1. sales – cost of sales = gross profit
2. check for any other income
Gross profit is before the deductions and net profit is after the deductions!! Gross > net 3. gross profit less (-) operating expenses = net profit
Gross – minus expense -net
Then can state whether the business is profitable or not for
GROSS PROFIT RATIO this or previous years or with a statement with another
company operating in the same occupation.
Gross profit/sales X 100 (percentage!!!)
Gross = Before deductions Commented [AA24]: Indicates the return on investme
for the business to the owner/ shareholder.
R 355 000 / 700 000 x 100
= 50,71%

NET PROFIT RATIO

Net profit = after deductions, but before taxation
133 500/700 000 x 100 = 19.07%

RETURN ON CAPITAL INVESTED

This shows how well investors were rewarded after investing capital.
Net profit before tax/total equity X 100
133 500/ 371 120 x 100
= 35,97%
2. SOLVENCY RATIOS

Solvency ratios are used to thoroughly evaluate how solvent an organisation is. To be solvent
means to have enough money to cover debt. Meaning the ratios measures the organisations’ ability
to repay its long-term depts, which include the payment of capital and interest. Insolvent -no

Page | 13
money to cover dept or too much dept no money to cover it. use it to check financial statements
of the business to see whether the business is solvent enough to cover its dept.

Which financial statement would be helpful for solvent? Balance sheet (assets/ liabilities/ equity)

Formula to calculate Solvency ratio

• Equity ratio:
Total equity
Total assets

• Debt ratio:
Total liabilities
Total assets

• Solvency ratio
Total assets
Total liabilities

EQUITY RATIO
Total equity/total assets
Written as a ratio
371 120 / 925 120
0,4:1 = 0.4 is the answer to the calculation. The 1 stand for R1 in assets.
Conclusion: For every R1 in assets, the organisation has R0,4 in total equity used to
purchase it. Commented [AA25]: For every R1 in assets then 0,4 is
equity share of the owner.
DEBT RATIO
Total liabilities / total assets
This reveals how big the liabilities are
554 000 / 925 120
=0,6:1
Conclusion: for every R1 in assets, the company has R0,60 in liabilities Commented [AA26]: So, the company has only 40c bu
the 60c is their liability
SOVENCY RATIO
Total assets/total liabilities
= 925 120 / 554 000

Page | 14
 =1,67:1
Conclusion: for every R1 in liability, the business has R1,67 to pay it back Commented [AA27]: Meaning that the business will pa
back the liability and still have the residual of 60c in their
disposal. So, the business is able to pay back its dept.
So, 67c x 554 000 = 371180 left after paying liability

3. LIQUIDITY RATIOS

Liquidity ratios are Used to evaluate how the cash on hand situation of a business appears.
Meaning = do the business has enough cash on hands to run their operations?
An organisation's liquidity is very important to its operations. Lenders and suppliers who
provide products and services on credit are concerned about these ratios. Liquidity ratios
indicate the ability of the organisation to generate and conserve cash from its working capital in
order to meet its short-term debts. Working capital refers to the current assets and current
liabilities, which are directly related to the operating activities of an organisation.
Formula to calculate liquidity ratio
• Current ratio: Commented [AA28]: It indicates the business' ability to
settle short-term obligations (current liabilities) using shor
Total current assets term assets (current assets).

Total current liabilities

• Quick ratio Commented [AA29]: The quick ratio is basically the

current ratio excluding stock, as stock is the hardest to
Total current assets - inventory convert into cash in the short term. It measures the immed
debt-paying ability of the company.
Total current liabilities

CURRENT RATIO – need to check if the business has enough cash to deals with
liabilities.
Total current assets/ total current liabilities Commented [AA30]: – the reason we divide these two
because we talking about the cash in hand situation.
= 312 120 / 54 000 The items under currents assets that can easily be conver
to cash. But also, you want to see how much current
=5,78:1 liabilities do we have. Overdraft? Creditors?

Conclusion: for every R1 in total current liabilities, the business has R5,78 in total
current assets to cover it Commented [AA31]: The liquidity cash is wide becaus
for every R1 the business still have about R 4,78 in cash.
QUICK RATIO
• Total current assets less (-) inventory / total current liabilities Commented [AA32]: The reason is because we less (-)
inventory is because if inventory won’t be sold easily then
• Why less (-) inventory? Not as easy. Previous one (current ratio) assumes that liquidity cash does not represent the reality meaning no ca
has been brought in because the inventory has not been so
inventory will be sold quickly. Because you still want to see if the liquidity is okay even i
the inventory is not sold. Therefore, it’s a prudence appro
• (312 120 – 40 000)/ 54 000 = 5,04:1

Page | 15
 Conclusion: For every R1 in current liabilities, the organisation has R5,04 in total debtors
to cover it Commented [AA33]: For every R1 the business has abo
R5, 4c to over dept. the liquidity is still good because cash
hand is there.
4. EFFICIENCY RATIO

These ratios measure how efficiently assets and liabilities have been utilised within the business.
These ratios can calculate the turnover of receivables, the repayment of liabilities and the
general use of inventory and machinery.

Formula to calculate efficiency ratios

• Debt collection period: Commented [AA34]: The debtor’s turnover ratio indica
the
Debtors/credit sales x 365 days number of times debtors are covered by
credit sales.
• Creditors payment period:
Commented [AA35]: The credit turnover ratio indicates
Creditors/credit purchase x 365 days how many
times creditors are paid during the year.
• Inventory on hand: Commented [AA36]: This ratio indicates how many tim
inventory on hand has been sold during the year. This rat
Inventory/cost of sale x 365 days may indicate whether there is an over- or under-investme
in inventory.
• Business cycle:
Commented [AA37]: This ratio indicates how many da
Debt collection period – Creditor’s payment period + Inventory on hand inventory
spends on the shelf before it is sold. A long
shelf life is not good for liquidity because it
ties up cash.
DEBT COLLECTION PERIOD
Shows how long it takes for debtors to pay money back Commented [AA38]: Calculate the period for debtors t
back the money. Meaning – customers buy the money on
Debtors / Credit sales x 365 = days credit and pay that money later/ why calculate the period
It’s for the efficiency of running the business. So, we can p
DCP = (40 000 / 560 000) x 365 days = 26,07 (that’s a portion of a day – the 0,07) therefore the business next steps accordingly.
equal to an additional day, 26 + 1 (additional day). Always round off. Portion of a day leads
to a full day.
DCP = 27 days. it takes the debtors 27 days to pay back the money to the business account
that that they bought goods on credit.

CREDITORS PAYMENT PERIOD

This shows how long it takes for business to pay its creditors.

Creditors / credit purchases x 365 days

CPP = (54 000 / 333 300) x 365 =59,13

CPP = 60 days. It takes the company 60 days to pay the money to their creditors for
the supplies purchased.

Page | 16
 Practical question: It takes the company 1 month to collect dept from its debtors and 2
months to pay back their credit owed to creditors? What does this mean? Is the business run
efficiently?

Students’ opinion: The business is conducted inefficiently, and this is evident by the fact that they
might be struggling to settle their debts on time. Because they should not take 2 months to pay their
debt as they have already received their debt from the debtors last month yet it took 2 months to pay
back their credit.

Sir opinion: it makes always take a shorter period to collect your debt than paying back your credit.
Because if it takes longer to get back the money from the debtors then you won’t be able to pay back
the creditors on time. Meaning it will take longer to settle the creditors debt. And that could affect
the creditors account when it comes to paying creditors, picturing you as a person that don’t pay on
time and takes long to pay back money.

INVENTORY ON HAND:
It shows how long it takes a company with stock on hand to conduct business, before they need
to buy more inventory Commented [AA39]: How does the trading stock last a
the business before needing to purchase new inventory? T
(35 000 / 345 000) x 365 days = plan ahead for when having to buy new stock.

38 days
If perishable goods, this needs to be less than 7 days.

BUSINESS CYCLE:
This is a collaboration of DCP, CPP and inventory on hand.
It Shows number of days takes a business, on average, to complete a full business cycle
Debt collection period – creditors payment period + inventory on hand
27 – 60 + 38 = 5 days before it has to buy inventory again

REFLECTION EXERCISES

1. Below is the recent Annual Financial Statements of Serawe Manufacturing Company.

1.1. Statement of financial position as at 31 December 2001.

2000 2001

Page | 17
 ASSETS R R

Non-current assets
Plant and equipment at 5 540 carrying 5 800
value

Current assets
Inventory 826 884
Accounts receivable 370 416
Cash 208 236
TOTAL ASSETS 6 944 7 336

EQUITY AND LIABILITIES

Equity
Share Capital – 1 176 1 140
Ordinary shareholders
Retained profit 3 500 4 138
Total equity 4 676 5 278

Non-current liabilities
Long-term loan 1 102 954

Current liabilities
Accounts payable 664 672
Short-term loan 502 432
TOTAL EQUITY AND
LIABILITIES 6 944 7 336

1.2. Statement of comprehensive Income for the year ended 31 December 2001.
R
Sales (all credit) 5 546
Less: Cost of sales -3 226
Gross profit 2 320

Page | 18
Less: Expenditure -331
Telephone 11
Stationery 100
Salaries 120
Depreciation 100
Net profit before tax and taxation 1 989
Interest paid -157
Net profit before taxation 1 832
Taxation -222
Net profit after taxation
1 610

Calculate the following ratios for 2001:

1. Profitability Ratios
1.1. Gross profit Ratio

1.2. Net profit Ratio

1.3. Return on investment

2. Solvency Ratios
2.1. Equity Ratio

2.2. Debt Ratio

2.3. Solvency Ratio

3. Comment on Profitability ratios and solvency ratios

2. The following information is provided for Kubu Ltd.

Statement of comprehensive income for the year ended 28 February 2002.

Page | 19
Revenue (all credit) 835 000
Less: Cost of sales (350 000)
Gross profit 485 000
Other costs (228 900)
Profit before interest and tax 256 100
Less: Interest expense (7 200)
Profit before taxation 248 900
Less: Taxation (4 350)
Profit for the year 154 550

Page | 20
 Statement of financial position as at 28 February 2002. ASSETS

Non-current assets
Property, plant, equipment 300 000
90 000
Financial asset

Current assets

Inventory 50 000

Accounts receivable 90 000

Bank 40 000
570 000
TOTAL ASSETS

EQUITY AND LIABILITIES

Share capital 350 000

Non-current liabilities 80 000

80 000
Long-term loan

Current liabilities

Bank overdraft 79 200

Accounts payable 60 800

TOTAL EQUITY AND LIABILITIES 570 000

ADDITIONAL INFORMATION

The following opening values were given:

Inventory amounts to R30 000

Accounts receivable amounts to R50 000

Accounts payable amounts to R40 000

Calculate the following Ratios for 2002

Page | 21
1. Liquidity Ratios

1.1. Current Ratio

1.2. Quick Ratio

2. Efficiency Ratios

2.1. Debtors collection Period

2.2. Creditors Payment Period

2.3. Inventory on Hand

3. Comment on the liquidity ratios and efficiency ratios

Page | 22