0% found this document useful (0 votes)

230 views447 pages

The Financial Accountant 2019

Uploaded by

michaelsichula8

We take content rights seriously. If you suspect this is your content, claim it here.

Available Formats

Download as PDF, TXT or read online on Scribd

0% found this document useful (0 votes)

230 views447 pages

The Financial Accountant 2019

Uploaded by

michaelsichula8

We take content rights seriously. If you suspect this is your content, claim it here.

Available Formats

Email [email protected]

The Financial Accountant 2019

ii
Study, understand and apply

The Financial Accountant

To our heavenly father the giver of knowledge and wisdom

To my lovely wife, Kunda S Muchinda Ngandalo

Our wonderful child Thabo.

To our mother Mrs. Judith M Ngandalo senior and the entire family.

Former and present teachers,

former and present workmates,

to all my financial accounting students.

The list is endless.

Thank you all for simply being there!

B Business Transactions and

Double Entry Bookkeeping
Sessions (5) to (8)

D Reconciliations
(14) to (15)
C Financial statements
adjustments
Sessions (9) to (13)

G Non-trading organizations and

other special accounting needs
E Preparation of Financial Session (22-23)
statements for trading
organizations.
(16) to (19)
H Public sector Accounting
Session (24)

F Statement of cash flows

and Interpretation of
Financial statements I Information Technology and The
extended Trial Balance
(20) to (21)
Sessions (25) to (26)

The Financial Accountant 2019

vi
Study, understand and apply

The Financial Accountant

Part A
Introduction to
Financial Accounting and
the Regulatory Frame-
work

Session Detail Time allocation

1 Nature and objective of financial accounting 30 min
2 The regulatory framework 30 min
Question Practice and assignments 1 Hour
3 Introduction to financial statements 30 min
4 Accounting conventions and the IASB 30 min
conceptual framework
Question Practice and assignments 1 Hour

The Financial Accountant 2019

1
Study, understand and apply

The Financial Accountant

Session 1
Nature and Objective
Financial Accounting

Focus
The main objective of financial accounting is to provide relevant and reliable financial
information to users in order to inform and consequently improve economic
decisions. Many financial experts agree that apart from helping a business to fulfill
it‘s legal requirements, financial accounting information can greatly enhance the
quality of business decisions made by investors, managers, regulatory authorities,
trade contacts and the public at large.

Session Learning objectives

Upon completion of this session you should be able to:

 Define financial accounting

 Explain the nature and purpose of financial accounting in a business
context
 Describe the importance of accounting
 Explain the merits and limitations of common types of business
entities; including sole traders, partnerships, limited companies.

 Explain the purpose of a non-trading organization

 Explain the business entity concept and the dual concept

 Explain the various users of financial accounting information and their

information needs

 Explain the difference between financial and management accounting

 Explain the basic purpose of corporate governance practices.

The Financial Accountant 2019

2
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

1 Introduction to Financial Commentary

Accounting Perhaps a major limitation of
Financial Accounting can be defined as a process financial accounting is it‘s
of recording and presenting historical business tendency to focus on past
transactions. Until recently some scholars viewed business transactions.
financial accounting as a commercial language
used by stewards in the day to day management
of an organization. Record keeping of financial
transactions is commonly
The main objective of financial accounting is to referred to as bookkeeping.
provide financial information to users which is Presentation of financial
capable of influencing their economic decisions. information is commonly
On a daily basis, the Financial Accountant‘s work known as financial reporting.
mainly involves identifying, analyzing, recording A full fledged Accountant
and summarizing business transactions. should be able to handle both
Obviously, the skills above are refined overtime the record keeping and
as an Accountant gets exposed to the wider reporting aspects of
business environment. accounting. Record keeping
largely fulfills legal
requirements but
reporting focuses on
2 Financial accounting and satisfying informational
business needs.

The Financial Accountant's arena is usually

placed or found within a business environment. A
Profit is an important
business can be defined simply as a commercial
performance indicator in
organization (large or small) which exists to
business and can assist
generate profit for its owners.
entrepreneurs to make
The above definition implies that the business important decisions including
owner is a major stakeholder in a business but those relating to the
this may not be consistent with modern continuation or closure of a
businesses practice where customers and other business.
stakeholder concerns are increasingly becoming
a major issue.
If total income is equal to
Profit is the excess of income over expenditure.
total expenditure, the
In economic terms profit is the reward for
business neither makes a
entrepreneurship. Where expenditure exceeds
loss nor a profit. This rarely
income, the business has incurred a loss.
occurs in practice.

The Financial Accountant 2019

3
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

3 The importance of Accounting Commentary

Many reasons can be raised to justify the need In most organizations the
for accounting output in the modern business accounting function is viewed
world. The explanatory points given below are not as a support function, unless
exhaustive. Accounting information is important of course you are looking at a
because: firm providing auditing
services or professional
A. Record keeping is a legal requirement and
tuition solutions such as the
accounting helps in fulfilling this requirement.
Zambian Accountancy and
B. Business owners need to know the value of Business Tuition Centre
their investment (capital) in the business ZABTUC. This perception
from time to time and accounting records can must change if the
provide such information. accountant‘s office is to
remain relevant in the near
C. Accounting profit is a key financial
future. The good news is that
performance measure for many businesses.
most practical Accountants
Accountants can provide this information by
are increasingly becoming a
preparing the statement of profit or loss.
major voice in the business
D. Knowledge of the total value of business world.
resources and obligations is essential for day
to day business planning, decision making
and control. This role is undertaken by Accounting output can help
business managers. organizations to meet legal
requirements, provide useful
E. Accounting information can be used to help
information to users and
access credit (or funding) where financial
improve the firms ability to
lenders, (e.g. banks) request to assess the
access borrowed funds.
performance and position of a business for a
given period. The modern user of
accounting information
F. Accounting information can be used to help
expects an Accountant to
establish the value of a business at particular
provide added value to their
point in time. This information can enhance
work by giving sound
the quality of investment decisions.
financial advise including
G. In modern business markets, most listed explanations on how
firms are required to produce financial expenses can be reduced
statements which conform to local legislation and how revenue can be
and international accounting standards. maximized without
Without the preparation of financial reports, a compromising the future well
firm may not qualify to be listed on a being of a business concern.
competent stock exchange market.

The Financial Accountant 2019

4
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

4 Types of Business Entities Commentary

Sole trader A sole trading business is the
most common type of
A sole trading business is a business owned and
business, partly because it is
controlled by one person.
not expensive to set up, it is
Advantages easy to manage and is not
subject to significant
 Easy to set up and manage (inexpensive to regulatory requirements.
set up).

 The owner can greatly benefit from the

The word sole simply means
autonomy of making business decisions
one.
without undue delay or approval from others.

 The business has minimal compliance costs.

Sole traders are personally
 A sole trader is not legally obliged to have liable (chargeable) for
their books checked by a certified auditor. business debts because
there is no legal distinction
between the business and
Disadvantages the owner. In the eyes of the
law, the sole trader and his
 Exposure to unlimited liability risk may lead business are viewed as a
to loss of the trader‘s personal property single entity. For accounting
because the debts of the business are fully purposes however, we must
borne by them. differentiate the business
 Prolonged absence of the trader from the from its owner regardless of
its legal status.
business may ultimately lead it‘s premature
closure. Most sole traders depend on
the business to finance their
 The business depends on the owner for
personal needs. This is
refinancing and day to day management. probably the motive of setting
Most sole trading businesses are heavily out in business alone but
reliant on the owner. sadly this has led to the
 Sole traders have restricted access to capital untimely demise of many
or credit mainly because lenders consider promising small businesses.
them to be highly risky clients. This concern
remains a major setback for most small to
medium entrepreneurs out there.

The Financial Accountant 2019

5
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

Partnerships Commentary
A partnership business is a business owned by A partnership business is
two or more individuals. effectively formed where two
or more sole traders join
Advantages
together to carry out trading
 Partners can benefit from shared business activities.
risks; like they say, a problem shared is half
solved.
The partners benefit from
 The business also benefits from shared pooled resources, skills,
business resources, knowledge and competencies of each other.
competencies.

 There are better continuity prospects under a

Partners are jointly and
partnership business compared to a sole
severally liable for the debts
trading entity.
of the business unless of
course, the business is a
limited liability partnership
Disadvantages
(LLP). The above thought
 Partners suffer from unlimited liability may be a major deterrent in
because they are personally liable for joining with others in
business debts, unless the business is a business.
limited liability partnership.

 Potential disputes (disagreements) may The partnership business

arise between partners which if not well can only work where each
handled, may adversely affect the continuity partner fulfills their
of the business. apportioned responsibilities.
The key therefore, in any
 Disagreements may result in delayed worthwhile business alliance
decisions even where the subject of the is to choose the right partner.
debate requires an urgent solution.

 The withdrawal of a key partner can greatly

negate business continuity. This ill
development should be anticipated and
measures must be put in place to avoid a
situation where the business becomes over
reliant on a single partner.

The Financial Accountant 2019

6
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

Limited Liability Company Commentary

A limited liability company is a business where Owners of a limited liability
the owners‘ liability for business obligations is firm are usually not
limited to the value of their existing share capital personally liable for the debts
and any earned profits. Basically, this is a of the business. The
business owned by individuals who are known as maximum loss they can
shareholders. suffer in relation to the
business is restricted to the
Advantages
amount they have invested in
 As mentioned above, shareholders enjoy shares plus any profits
limited liability cover and may not incur earned.
losses in excess of the value of the capital
invested in the business if operations fold.
 The business retains a separate legal identity
and can therefore enter into or withdrawal
from contractual arrangements with third The idea of limited liability is
parties in its own right. largely an advantage to the
shareholders and can
 The business has a wider access to capital
possibly disadvantage other
partly because of its ability to issue or sale
shares to the public. business stakeholders such
as financial lenders, credit
 The business has better continuity prospects suppliers, employees etc.
through share transferability.

Demerits
The conversion of a sole
 Increased legal requirements and trading or partnership
compliance costs. (taxes, employment law
business into a limited liability
etc.)
company (incorporation) will
 Increased administration costs due to the inevitably lead to increased
need for fulfill the legal requirement above. compliance and
Besides, the company will need a costly administration costs.
professional team of managers to look after
its affairs.
 All companies are required by law to prepare
financial statements for filing with the
registrar of companies.
 There is need for an audit for all public
limited liability companies. This helps to
improve transparence and accountability in
the way companies are managed.

The Financial Accountant 2019

7
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

5 Non-Trading Organizations Comment

Some organizations do not exist to make profit, Non-trading organizations, if
but to provide a service to their members and any well managed, can greatly
other external target groups. Such organizations improve community warfare.
are known as non-trading organizations.
Examples of non trading bodies include charities,
government, religious denominations, societies,
clubs, foundations etc.
Even though a non-trading organization does not
exist to make profit, there is still need for An Accountant can help to
accountability. This is partly because such strengthen the stewardship
organizations will need to manage their resources role of a non-trading
and obligations in line with stakeholder organizations through record
expectations. The stakeholders of a non-trading keeping and timely financial
body deserves to know on a regular basis how reporting.
resources have been utilized.
Non-trading organizations may carry out trading
activities in order to meet their objectives, but that
does not mean that they are partial commercial
organizations. Trading activities simply help such In a non-trading organization,
organizations to raise finance for recurring trading activity should be
expenditure such as salaries, rent, income taxes viewed as a means to meet
to mention just a few. the intended end. Trade and
One of the major challenges of a non-trading profit is not the main
entity is poor levels of accountability. The reason objective of a
for the above is that there is no defined ownership non-trading organization.
in a non-trading organization. This may lead to
gross inefficiencies in the operations of these
organizations. The other reason could be that the
members of a non-trading organization are there
on their own volition and any attempt to hold them
accountable could simply mean having less Any attempt to mobilize and
people. Nevertheless, accountability is vital for deploy resources for service
stewardship purposes as well as value or profit ventures calls for
preservation. accountability and
transparence.
We will discuss in details how to account for
financial transactions in a non-trading
organization at a later stage in our study.

The Financial Accountant 2019

8
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

6 The Business Entity Concept Commentary

As mentioned earlier on, for accounting There is no legal separation
purposes, the business and the owner (s) must between entrepreneurs and
be treated as separate entities. The above idea their businesses if the
can greatly enhance accountability of business is unincorporated.
transactions that takes place between the owner Therefore, owners of sole
and the business which largely takes the form of trading or partnership
capital injections and/or withdrawals. businesses are not legally
distinct from their businesses.
The owner invests funds or other resources in the
business and the business in turn generates a
return (profit) for the owner. In this single most
important thought we see the economic sense of All resources employed in a
business activity. business carry a claim.
Accountants call business
In addition, a good example of the implication of resources ―assets‖ and
the above concept is inventory taken out of the business claims ―liabilities‖.
business to meet the personal needs of the
owner. Such a transaction is not to be treated as
an ordinary expense but as drawings. Drawings
reduce the owners capital in a business.

7 The Dual Concept A change in asset values

The double entry system of accounting is used by generally results in an equal
accountants to ensure the full recognition of the change in liability values. For
effects of individual business transactions, one active businesses, this
transaction at a time. Under this very important change takes place on a daily
principle in your accountancy studies, equality basis, hence the inevitable
between assets and liabilities should be need for business
preserved. The value of resources of a business Accounting.
should be equal to the value of the claims on the
business. Most students find this part of their
accountancy studies somewhat daunting or Double entry is the golden
difficult. The author shares the students principle to be known and
concerns, but every problem has a solution. practiced through out your
One of the most effective remedies for all double accounting career.
entry problems is practice or learning through the
application of taught principles.

The Financial Accountant 2019

9
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

8 Users of Accounting Information

It is not possible for us to identify all the users of accounting information, but we can
highlight key users and possibly look at their informational needs.

User Objective/Need/interest Information required

Increase in investment  Profits or losses incurred

returns, shareholder‘s value
Shareholders  Value of assets and liabilities
and long term survival of the
business.  Business liquidity position

 Sales and expense values

Sales, expenses and profit
Management trends in order to assess their  Value of assets and liabilities
stewardship role.
 Business liquidity position

 Reported profit/Loss
Career progress, job security
Employees  Liquidity position
and salary increments.

 Sales values (Client base)

Reliable supplier who is able  Business ability to fulfill

Customers
to fulfill orders on time. orders

 Ability to pay
Reliable customer who is able
Suppliers  Cash or receivable balance
to pay in time.

 Tax paid
Tax compliance, employment
Government for the local community.  Payroll cost and number of
Compliance with labour laws. employees

 Reported profit, asset base

Seek for Employment in the
Public  Liquidity position of the firm
reporting entity.

The Financial Accountant 2019

10
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

9 Financial Accounting and Management Accounting

We now turn to the two major types of accounting information which are
primarily prepared for internal and external use.

Point of view Financial accounting Management

Accounting

Concerns past, present

Concerns historical (past)
Scope and future business
business transactions
transactions

Not a legal requirement

A legal requirement for
Legal requirement but simply a management
limited liability companies
initiative

There is a set format

There is no set format
(outline of presenting
Format (format differs from one
information in line with
company to another)
IAS 1)

Mostly prepared for Usually prepared for

User external users such as Internal use (Management
shareholders, bank etc. use)

Frequency of reporting At least once in a year At least once per month

Report Detail Summarized reporting Detailed reporting

Largely relates to Includes both quantitative

Further View
quantitative information and qualitative information

The Financial Accountant 2019

11
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

10 Introduction to Corporate Commentary

governance principles
Corporate governance
Corporate governance can be defined as a focuses on company control
system by which companies are directed and initiatives aimed at
controlled. Corporate governance was preserving shareholders
necessitated by corporate scandals that occurred value. There is no legal
in the recent past, leading to the so called requirement which compels
financial crisis that engulfed the business world firms to adopt corporate
and saw the failure of big companies. governance rules.

Advocates of corporate governance hold the view The divorce of ownership and
that where there is separation between business control in companies is the
ownership and control, privileges can easily be fruitful source of many
abused by business controllers i.e. the directors. corporate dilemmas.
In large limited liability firms, shareholders are
Agency costs such as
usually not involved in the day to day running of
auditing fees and board
the business. Company management is left in the
expenses cannot be avoided
hands of stewards known as Directors. The
if a firm adopts corporate
directors are therefore in position to abuse
governance rules.
delegated authority and this may lead to the
ultimate failure of a company. It is believed that The directors are the primary
corporate governance principles can help to agents of the shareholders
reduce the risk of company failure resulting from and are expected to pursue
the negligence of directors. actions which are in line with
key stakeholder expectations
Because directors are expected to act in the best
for the enduring benefit of the
interest of shareholders, they should diligently
business.
exercise their fiduciary duties in all pertinent
affairs of the business. If the company suffers The board of directors are
financial or reputational damage as a result of the collectively responsible for
ill conduct of a director, compensation can be the prevention and detection
demanded from the office bearer. of systemic fraud and error.
Directors are accountable to
It is important to appreciate that the duty of
shareholders and other key
preparing and presenting financial statements lies
stakeholders.
in the hands of the board of directors and not
company auditors or regulatory agencies. In
order to promote accountability at board level, the
positions of chair and chief executive officer
should be held by different individuals.

The Financial Accountant 2019

12
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

Session Summary
 Information value defines the purpose of accounting.

 The original intent or purpose of accounting is to provide information to

users capable of influencing economic decisions.

 Accounting information is needed for planning, control and decision

making.

 Profit is the motive for carrying out business activities. It is the

promised reward for accepting the risk of entrepreneurship.

 For accounting purposes, the business must be treated as a separate

entity from those who own it.

 Double entry means every business transaction gives rise to two (duo)
entries, a debit and a credit.

 There are three major types of business organizations; sole trader,

partnership and limited liability company.

Preparation Question 2
You have just completed your CA Zambia knowledge level and you happen to meet
Machai Mubanga your former high school mate who is currently pursuing a degree
program in Law at the University of Zambia. Machai wants to know the importance
of accounting in business and he has asked you to explain in detail the role of the
financial accountant in business using an informal letter.

Required:
i) Write an informal letter to Machai explaining why accounting is important in
the business world. (10 marks)
ii) List five users of accounting information and explain their informational needs
(10 marks)

[Total: 20 marks]

The Financial Accountant 2019

16
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

The Financial Accountant 2019

17
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

Suggested Answers
Question 1
1 D
2 D
3 C
4 A
5 C
6 C
7 A

Question 2
a) Response to Machai
Dear Machai,
It was nice to meet you after a while. I trust that you are well.
Now concerning your request for information relating to the importance of accounting
information, I have managed to gather up several points as detailed below.
Firstly, record keeping is a legal requirement and accounting helps in fulfilling this
requirement. Many supervisory bodies, not to mention tax authorities require their
clients to keep adequate accounting records for future reference purposes.
Business owners need to know the value of their investment (capital) from time to
time and accounting records can provide such information. In addition, without
accounting information entrepreneurs may find it difficult to arrive at informed
decisions when it comes to making investment or divestment decisions.
Accounting profit is a key performance indicator for many businesses. Accountants
can provide this information through the profit or loss statement. Management and
other key users of accounting information can use the reported profit or loss figure
to assess how well the company has performed over a period of time. If a company
makes profit investor confidence is enhanced.

The Financial Accountant 2019

18
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

The management team of a business needs to know the total value of business
resources and obligations in order to effectively plan and control business activities.
This knowledge will help managers to among other things, priorities overdue
payments and make follow ups on outstanding receivables.
Accounting information can be used to help businesses to access finance where
fund providers require the performance and position of the business to be reviewed
(e.g. Banks). Without readily available financial reports, financial lenders may not
advance credit facilities to a business in need of cash. Inability to access funding
could lead to business closure because without cash no business can survive.
Accounting information can be used to help establish the value of a company. There
are of course several ways of valuing a company including making reference to the
values of other similar businesses. If the owners of the business wants to get a fair
deal when selling a business, they will normally require a full list of assets and
liabilities as well as projected results for a few years to come as part of the critical
information required to arrive at the value of a business.
In modern business markets all listed firms are required to produce financial
statements in accordance with the companies act and accounting standards.
Accountants all over the world act as support experts by helping listed firms to fulfill
this need through the provision of credible financial information.
Finally, quality accounting practices normally has a positive impact on the economic
development of any country. Kindly note that the above is not a comprehensive
elaboration of what makes accounting information important. Hope you will find this
letter helpful.
Do not hesitate to call me if you have any questions on this letter.
Yours friend,
James Banda.

The Financial Accountant 2019

19
Study, understand and apply

The Financial Accountant

Nature and objective of Financial Accounting

b) Fives users of accounting information and there information needs

Shareholders
Shareholders want a satisfactory return as well as sustainable growth of their
investment. They will be interested in the reported profits of an entity as that will
affect their level of returns to be realized on their investment in the foreseeable
future.
Management
Management‘s primary duty is to increase the value of shareholders wealth.
Management will therefore be interested in the reported performance and position of
the business as this helps to assess their stewardship role.
Employees
Employee informational needs are connected to job security and improved
conditions of service. Basically, a higher reported profit and healthy cash flows is
likely to satisfy this need.
Customers
Customers provide the necessary repeat business support and their concern
borders on the reliability of supplies to be made in future. Institutional customers will
want to work with a business with a healthy cash flow in order to minimize the
adverse impact of unfulfilled orders.
Suppliers
Suppliers would like to work with reliable customers. They are likely look out for a
business ability to meet payment terms. Ability to pay can be assessed through
forecasted cash flows or the value of the receivable balance.
Lenders of funds
A business may find it necessary to borrow additional funds in order to finance
capital investments. Examples of lenders include banks, Wealthy individuals, foreign
companies etc. This stakeholder group will need to assess the business ability to
pay and not just the willingness repay advanced funds and any interest charges
arising thereon. This ability can be assessed through the review of a business‘ cash
flow forecasts, budgets , financial statements etc.

The Financial Accountant 2019

20
Study, understand and apply

The Financial Accountant

Session 2
The Regulatory Framework
Session Focus
The office of an accountant is a public office which should be subject to regulatory
control in order to among other things safeguard public interest. Accordingly,
accounting output should conform to set rules and regulations. In this session we
will look at how accountants are regulated in their daily work.

Learning objectives
Upon completion of this session you should be able to:

 Explain the need for regulation in the accounting profession

 Discuss the key influences on the content and scope of accounting

information

The Regulatory Framework

Advantages of global accounting standards include;

 International accounting standards can improve the credibility of accounting

information by minimizing potential for misleading and subjective treatment of
economic business transactions.
 It is conceivable to think that international accounting standards can compel
preparers of accounting information to disclose more information about the
reporting entity.
 The consistent application of global accounting standards makes comparisons
of financial information overtime possible.
 Global accounting standards can to a greater extent promote foreign direct
investment in local markets. Foreign investors are more likely to invest in a firm
which complies with global accounting standards.
 Global accounting standards has made it possible for professional
accountants to work in different countries where IFRSs have been adopted.
 Accounting standards can be a basis for discussing emerging issues which
may form part of the discussions in the accounting profession.

Shortcomings of global accounting standards

 Global accounting standards may not suit the specific needs of a reporting
entity particularly the needs of small to medium enterprises (SME‘s).
 Compliance costs of global accounting standards may outweigh associated
benefits. This is particularly true for a business that cannot afford the services of
a professional accountant.
 Global accounting standards are prone to misinterpretation by preparers of
accounting information.
 Culture differences may lead to different objectives for preparing accounting
information and this makes global accounting standards less relevant.
 Global accounting standards may not be legally enforceable in individual
countries. Local accounting standards are therefore given first preference by
individual countries.

The Financial Accountant 2019

26
Study, understand and apply

The Financial Accountant

The Regulatory Framework

Session Summary
 Regulation in the accountancy profession is needed in order to protect
the interest of users of accounting information.

 Regulation is key in preserving the credibility of accounting output.

 Accounting information is largely affected by generally accepted

accounting practices which is broadly made up of the law, IFRSs, local
accounting standards, stock exchange rules among other things.

 The IASB is a private body charged with the mandate of formulating

high quality IFRSs.

 Global accounting standards can improve financial reporting in

different world markets but may not suit all the informational needs of
different user groups.

The Financial Accountant 2019

27
Study, understand and apply

The Financial Accountant

The Regulatory Framework

Preparation Question 1
Objective Test Questions
1 What does the term GAAP stand for?
A Generally Accepted Accounting Procedures
B General Accounting and Audit Practice
C Generally Agreed Accounting Practice
D Generally Accepted Accounting Practice ZiCA Dec 2010

2 Which of the following bodies is responsible for accounting and financial

reporting needs and issuance of standards for accountants working in the
Public Sector?
A IFRSB
B IPSASB
C IFRSIC
D IFRSAC ZiCA Dec 2015

3 Which of the following statements is true?

A The IFRS Advisory Council (formerly Standards Advisory Council or SAC)

is not a forum used by IASB to consult with the outside world.
B The IFRS interpretation committee oversees the IASB.
C The IFRS foundation provides guidance on specific issues in the
interpretation of IFRSs.
D The IASB formulates the international financial reporting standards.
ZiCA Dec 2014
4 Which of the following is an advantage of international Financial reporting
standards (IFRSs)
A IFRSs minimize administration costs of an entity
B IFRSs are easy to understand and apply

The Financial Accountant 2019

28
Study, understand and apply

The Financial Accountant

The Regulatory Framework

C IFRSs reduce the complexity of accounting

D IFRS increase potential for international investments

5 The following items affect the form and content of accounting

information. Which option is NOT correct?
A International Financial reporting standards (IFRSs)
B Local accounting standards
C Local legislation
D Going Concern

6 Charles Tembo is an ACCA qualified Accountant currently working in

Zambia as an external auditor at JLN and associates Chartered
Accountants. Which institution regulates Charles Tembo’s professional
conduct in Zambia.
A Association of Certified Accountants (ACCA)
B Zambia Institute of Chartered Accountants (ZICA)
C JLN and Associates
D Law association of Zambia (LAZ)

7 The __________ acts as a forum through which the IASB interacts with
the outside world. Choose the correct option.
A The International financial reporting interpretation committee
B The international quality assurance body
C The international financial reporting advisory council
D The international financial reporting committee foundation

[Total: 14 marks]

The Financial Accountant 2019

29
Study, understand and apply

The Financial Accountant

The Regulatory Framework

Preparation Question 2
Andy Mark is a limited liability company which has just been incorporated. The
director of the company has heard of the requirement to comply with International
Accounting Standards (IASs) and International Financial Reporting Standards
(IFRSs). He is not, however, sure how useful compliance to the standards in issue
would be, and whether international harmonization of accounting standards is
practical.

Required:
Write a memorandum to the Director of the company, explaining:
i) The extent of application of IASs/IFRSs to companies in a country such as
Zambia (4 marks)
ii) Give four (4) benefits of global application of International Accounting
Standards. (8 marks)
iii) Give four (4) limitations of global application of International Accounting
Standards. (8 marks)
[Total: 20 marks]
ZiCA Jun 2012

The Financial Accountant 2019

30
Study, understand and apply

The Financial Accountant

The Regulatory Framework

Suggested Solutions
Question 1
1 D
2 B
3 D
4 D
5 D
6 B
7 C

Question 2
i) Extent of application of IFRSs:
Every country has a national regulatory body that ensures that local laws and
accounting standards are applied by companies. International Accounting Standards
do not mandatorily override or replace local regulation. Accounting standards to
apply are therefore those issued by the local regulatory body of each country
Where it becomes necessary to apply international accounting standards the
members of the local regulatory body should persuade local authorities to adopt the
application of IASs, considering the benefits that would accrue for doing so.
IASs are intended to be simple to adopt, to be applied prospectively and to essential
material matters only. Companies that adopt the application of IASs should disclose
this fact in their financial statements.
ii) Benefits of adopting IASs

 Investors would compare financial results in terms of profitability of different

companies nationally and internationally before making decisions

 Foreign entities coming to Zambia as investors would easily be appraised

 Accounting staff between countries would easily and acceptably be transferred.

The Financial Accountant 2019

31
Study, understand and apply

The Financial Accountant

The Regulatory Framework

 Adopting IASs by governments of developing countries would save money

since they would avoid the lengthy and expensive process of issuing a new
standard.

 Determining the tax liability payable by multinationals and other foreign

investors would easily be done.

 Application of common accounting standards would promote regional trade

such as that between SADC members.

 International accounting firms would find it easier to audit companies in different

countries as a result of application of IASs.
iii) Barriers to adoption of International Accounting Standards:

 Some countries have different purposes for preparing financial statements e.g.
for tax purposes, and others for tax and investment decision purposes

 Differing legal systems prevent development of certain accounting practices,

and sometimes list the options available.

 Identification of the primary user group differs from country to country. For
example, in the UK the employee is more important whereas in the US the
creditor and investor are more important.

The Financial Accountant 2019

32
Study, understand and apply

The Financial Accountant

Session 3
Introduction to Financial
Statements

Focus
As discussed in session one, Accountants should provide useful information to
management and other stakeholders in order to affect and possibly improve the
quality of economic decisions. They use financial statements to communicate the
business performance and position to users of accounting information. This session
gives us an overview of the general purpose financial statements generated by
Accountants. Everything discussed in this book is supposed to help the reader to
prepare basic financial statements.

Learning objectives
Upon completion of this session you should be able to:

 Discuss the objective of general purpose financials statements

 List and describe a full set of financial statements

 Discuss the underlying assumption of the Financial Statements

The Financial Accountant 2019

38
Study, understand and apply

The Financial Accountant

Introduction to Financial Statements

5 Elements of the Financial Commentary

Statements With regards to the definition
The five elements (building blocks) of financial of an asset, the word control
statements are assets, liabilities, income, replaces the word owned. A
expenses and equity detailed as follows. firm derives benefits from an
assets through usage or sale.
Assets
According to the IASB conceptual framework,
assets are resources controlled (not necessarily Control means the business
owned) by an entity as a result of past events and has exclusive rights to the
from which an entity obtains economic benefits economic benefits of an
through usage or sale. asset.

Assets are further divided into current (short term

assets) and non current assets (Long term
assets) as discussed above. For an item to
qualify as an asset it should have monetary or
economic value.
Liabilities or obligations
Liabilities generally represent funds
owed to third parties who
According to the IASB conceptual framework, supply goods or services to a
liabilities are present obligations (legal or business on credit terms.
constructive) whose settlement will result in the
outflow of economic benefits.
in basic terms, liabilities can be defined as
amounts awed to outsiders by the business.
liabilities are also classified into either current or
non current. Current liabilities are those liabilities
due for repayment in less than twelve (12)
months. Non-current liabilities are due for
repayment in more than one year. A constructive obligation can
result from the past actions of
Further, liabilities can either be legal ( those that
an entity.
are enforceable by law) or constructive those that
are based on written policies of the business
(such as warranty guarantees)

The Financial Accountant 2019

39
Study, understand and apply

The Financial Accountant

Introduction to Financial Statements

Income Commentary
Income is the general increase in economic Income generally refers to
benefits in a period resulting from the sale of an moneys earned by a
entity‘s goods or services. In general terms, business through the supply
increase in income will result in increase in assets of goods and services.
or reduction in liabilities.

Expenses
Expenses are costs incurred in making a sales or
furthering business activities. Incurrence of
expenses leads to increase in liabilities or All costs incurred to meet the
reduction in assets. needs of the business owner
do not qualify to be treated as
expenses. Value taken from
Capital the business for personal use
Capital is the owner‘s investment (interest) in the is termed as drawings.
business. Capital is the difference between the
total assets and total liabilities of a business. The
proper accounting treatment of capital and
drawings revolves around the business entity
concept.

Remember (!)

 All value (cash, goods) introduced in the

Capital is a special type of
business by the owner is not income but a
liability representing what the
liability called Capital.
business owes its owner (s)
 All value derived from the business by the
owner is not an expense but is to be treated
as drawings or a reduction in capital.

The Financial Accountant 2019

40
Study, understand and apply

The Financial Accountant

Introduction to Financial Statements

Session Summary
 Accountants use financial reports to communicate the performance
and position of a business in a specific period.

 There are two primary financial statements namely, the income

statement and the statement of financial position.

 The income statement measures the financial performance of a

business or shows how well the business has performed over a given
period of time.

 The statement of financial position lists the assets and liabilities of the
business.

 There are five elements of the financial statement namely, assets,

liabilities, capital, income and expenses.

The Financial Accountant 2019

41
Study, understand and apply

The Financial Accountant

Introduction to Financial Statements

Preparation Question 1
Objective Test Questions
1 An asset held for sale in the normal course of an entity’s operating cycle
is classified as ____________
A Non-current asset
B Current asset
C Equity
D Raw materials ZiCA Jun 2010

The Financial Accountant 2019

46
Study, understand and apply

The Financial Accountant

Introduction to Financial Statements

Suggested Solutions
Question 1
1 B
2 B
3 D
4 C
5 A
6 B
7 D
Question 2
i)

Element Detail

Asset A resource controlled by an entity as a result of past events

from which an entity expects to derive economic benefits.

Liabilities Present obligation of an entity resulting from past events

whose settlement will result in the outflow of economic bene-
fits.
Income Cash earned from the sale of goods and services.

Expenses Cost incurred in the provision of goods and services.

Equity The residual interest in the business attributed to the owners

of the business after deducting all liabilities from all the as-
sets of a business.

The Financial Accountant 2019

47
Study, understand and apply

The Financial Accountant

The Financial Accountant

Accounting Conventions and the Conceptual Framework

Concept Detail

States that an entity will continue in operation for the

Going concern
foreseeable future or one year from the reporting date.

Accruals or
States that business transactions should be recognized when
matching
they occur regardless of whether cash is paid or received.
concept
States that like business transactions should be treated in a
Consistency
similar way from one period to another. This includes the
concept
consistent application of accounting policies.

An accountant should not allow third party influence or bias to

Objectivity
influence his/her work. His report should be factual.

Requires full recognition of anticipated losses and prohibits the

Prudence recognition of anticipated income or gains. If it helps, the
Concept concept advocates that it is desirable for assets to be
understated and liabilities to be overstated.
States that only income that has been earned or realized
Realization
should be recognized. Generally speaking, income is realized
Concept
when a supply has been made.
Limits the recognition of business transactions to items which
Money
can be measured in monetary terms. Only transactions with
Measurement
monetary or economic value should be accounted for.

Historical cost States that financial transactions should be measured at

concept invoice value (i.e. transaction price)

Requires that only material financial transactions be

Materiality recognized in the financial Statements. A material transaction
is one which is important to the user of accounting information.
States that each financial transaction gives rise to two
Dual concept accounting entries; a debit and a credit. Equality of resources
and obligations should be preserved.
States that the entrepreneur and their business are two
Business
separate entities for accounting purposes. This is a basic
entity
principle of business accounting.
Business events and transactions must be accounted for and
Substance
presented in accordance with their substance or economic
over form
reality and not merely their legal form.
The Financial Accountant 2019
51
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

The Financial Accountant

Accounting Conventions and the Conceptual Framework

Relevance Commentary
Information is relevant if it can be expected to If users of accounting
influence or affect the economic decisions of information can on the basis
users. The timely provision of information can of availed financial reports
greatly enhance the relevance of accounting confirm or predict future
information. values within an acceptable
In addition, relevant accounting information margin of error, it can be
should possess predictive and confirmatory argued that the information
presented to them has
value. In other words, users should be able to
predict or confirm future and past accounting predictive value.
values respectively if they use relevant
accounting information.
Materiality which is dependent on the nature and
size of a financial transaction will also determine
whether information is relevant or not.

Faithful representation Faithful representation simply

Faithful representation means information is mean information should be
capable of representing what it purports or reliable.
intends to represent. Faithful representation is
achieved when information is error free, neutral
and complete.

 Free from material errors: Particularly so

when we consider the descriptions and Relevance and faithful
processes involved in producing financial representation are the two
information. fundamental qualitative
characteristics of financial
 Neutral: Which entails that information is information. The other four,
free from bias and the undue influence of understandability,
third parties. comparability, timeliness and
verifiability are enhancing
 Complete: Information is considered to be
qualitative characteristics of
complete if it includes all necessary details,
accounting information.
descriptions and explanations.

The Financial Accountant 2019

56
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

Understandability Commentary
Information is understandable (or In basic terms,
comprehensible) if users can perceive its understandability depends on
significance or importance. Under this information two things; the economic
quality, it is assumed that the user has knowledge of users and the
reasonable economic knowledge and they are way information is presented.
diligent enough to study the information
presented to them.
Detailed and complex information should not be
withheld from users because preparers are
concerned that users may not be capable of
interpreting the information correctly.

Comparability
Two or more sets of Information are comparable Comparisons requires sound
if users can derive meaningful conclusions by analytical judgment. Caution
assessing their plausible relationships. An entity‘s must be exercised when
accounting information for a specific period making comparisons in order
should be compared to: to avoid obvious pitfalls. Pay
attention to the size of
 Past accounting information companies being compared.
You will inevitably arrive at
 Forecasted financial statements
wrong conclusions if you
 Accounting information of other entities compare the results of a
small business to a large
 Industry benchmarks multinational business.
The usefulness of comparisons depends on the
consistency and disclosures of accounting
policies applied during the reporting period.
Any departure from an accounting policies must
be fully disclosed. IFRS‘s permits departure from
accounting policies on two grounds only:
i) Where departure is permitted by an IFRS.
ii) Where departure improves the reliability of
financial information.

The Financial Accountant 2019

57
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

Timeliness Commentary
Information should be provided in time in order Verification has taken place if
for it to be of value to users. This should be a different users who are
basic fact when we consider for instance, the reasonably informed can
value of the yesterday's newspaper headline. arrive at a common
conclusion after assessing
the same information availed
Verifiability to them.
Information is verifiable if it is capable of being
subjected to audit procedures. This requires audit
evidence to be readily available. Further,
Information is verifiable if different users broadly
agree that faithful representation has been
achieved.

Conclusion
The overlaps in the qualitative attributes
discussed are obvious. The scholar should be
able to note the potential conflicting views arising
out what has been discussed. Below are some
suggested views on the thought above: Where an Accountant omits
important steps in information
 Relevant information may not be reliable if it gathering his report may
is incomplete. come in time with a lot of
obvious but avoidable errors.
 Timely information may not be complete
since it may contain a lot of material errors.

 Reliable information may not be

understandable. Complete information may
be too complex for the user‘s understanding

 Reliable information may not be comparable

where an entity decides to include more
complex information in its financial reports.

The Financial Accountant 2019

58
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

4 The underlying assumption of the Commentary

Financial statements
You may recall that under the
At the time of writing, the only underlying going concern assumption,
assumption of financial statements is the going that the reporting entity is
concern assumption. Until recently, we have had
two underlying assumptions of the financial deemed to be operational for
statements, that is, going concern and the the foreseeable future. This
accruals concept but at present only going means there is no necessity
concern has been retained after the IASB or intention by management
consulted with different stakeholders. to wind up business
Further, the going concern assumption has far operations. A person who
reaching consequences on decisions made by reads the financials of a
users of accounting information hence the need reporting entity usually
for the reporting entity to explicitly confirm or
assumes (takes it for granted)
deny their going concern status. Whenever
management is aware of any conditions or that the entity will be in
circumstances which would invalidate the going existence for the predictable
concern status of the business, financial future (say twelve months
statement should be prepared on a break up from the reporting date). It is
basis. The above means all non-current assets
therefore the duty of
and non-current liabilities become current assets
and current liabilities respectively. management to correct this
assumption if it is wrong.

5 The concept of capital and capital

maintenance
The above concept basically looks at the ideas
underpinning capital preservation.
Physical capital maintenance

This concept employs the use of current cost

basis of measurement of capital and states that
capital has been maintained if the productive Capital is maintained if the
capacity of an entity improves.
closing net assets value of an
Financial capital maintenance entity is greater than the
opening net assets
This concept states that capital can be measured
in either nominal monetary units or in units of
constant purchasing power. value.

The Financial Accountant 2019

59
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

Session Summary
 For information to be of value it should conform to regulatory
requirements and contain specific qualities.

 The form and content of accounting information to a large extent is

affected by generally accepted accounting practice (GAAP).

 Accounting conventions are general rules that accountants use when

preparing accruals based financial reports.

 The qualitative characteristics of accounting information enhances the

value of accounting information.

 There are six qualitative characteristics of accounting information

namely:
i) Relevance
ii) Faithfull representation
iii) Understandability
iv) Comparability
v) Timeliness
vi) Verifiability

The Financial Accountant 2019

60
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

Preparation Question 1
Objective Test Questions
1 Financial statements prepared using International Accounting Standards
issued by the International Accounting Standards Board’s (IASB)
framework for the preparation and presentation of financial statements
(framework) are presumed to apply to ONE of the following underlying
assumption:
i) Relevance
ii) Going concern
iii) Prudence
iv) Accruals
Which ONE of the above is an underlying assumptions according to the
IASB’s Framework?
A. (ii) only.
B. (iii) only.
C. (iv) only.
D. (i) only ZiCA Dec 2010

2 According to the IASB Framework, the qualitative characteristics of

financial statements are:
A. understandability, consistency, reliability and going concern
B. understandability, prudence, reliability and relevance
C. understandability, relevance, faithful representation and comparability
D. prudence, consistency, relevance and accruals ZiCA Dec 2012

The Financial Accountant 2019

61
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

3 Which of the following is NOT a qualitative characteristic of financial

statements?
A Understandability
B Timeliness
C Relevance
D Reliability ZiCA Dec 2016

4 Qualitative Characteristics are standards for judging the information

accountants give to decision makers. Completeness, neutrality and free
from error are ingredients for which fundamental quality?
A Relevance
B Comparability
C Faithful representation
D Timelines ZiCA Dec 2014

5 Which of the following options are prerequisite factors for the qualitative
characteristic comparability?
A Consistency and timeliness
B Disclosure and completeness
C Consistence and disclosure
D Relevance and reliability

The Financial Accountant 2019

62
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

6 If a business is not a going concern management must make adequate

disclosures in order to protect the interest of the public. How is
presentation of the financial statements elements affected if a company is
not a going concern?
A All assets and liabilities are classified as current assets or obligations in
the statement of financial position and are valued at their enforceable
sellable value .
B There is no effect on the presentation of long term and short term
resources and obligation of the business
C Assets and liabilities are valued at market values
D Some assets and liabilities are valued at their net book values

7 Which group of stakeholders is responsible for the preparation and

presentation of financial statements in a business?
A The board of directors
B The finance director
C Management
D External auditors
[Total: 14 marks]

The Financial Accountant 2019

63
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

Preparation question 2
The main objective of IAS 1 is to prescribe the basis for the presentation of general
purpose financial statements and to ensure comparability both with the entity‘s
financial statements of previous periods and those of similar entities. Under the
provisions of IAS 1, the objective of financial statements is to provide information
about the financial position, performance and cash flows of an entity that is useful to
a wide range of users in making decisions.
Required:
a) List six (6) aspects of an entity‘s results that financial statements will provide
information on. (3 marks)
b) Briefly explain the following qualitative characteristics of financial statements.
i) Relevance
ii) Comparability (2 marks)
c) Explain three (3) arguments in favour of accounting standards in matters of
financial reporting. (3 marks)
d) IAS 1 identifies four (4) fundamental assumptions that must be taken into
account when preparing financial statements. It also considers THREE other
concepts as very important.
Consider how the following situations will be dealt with or explained to a
non-accountant, citing the appropriate concept (assumption):
i) Chimanga manufactures hand ploughs. In the financial year ended 31
December 2013, they produced 100 ploughs at a cost of K420 each and sold
80 ploughs at K600 each. In the year to 31 December 2014, they produced 130
ploughs at a cost of K450 and sold 140 ploughs at K620 each.(3 marks)

ii) Exodus Engineering bought machinery at a cost of K4,500,000 in 2010 and

paid for them in cash. The income statement for the year ended 30 April 2015
has been charged with depreciation on equipment. The new General Manager
is asking why the company‘s profits has been reduced by the amount of the
depreciation charge.

(3 marks)

The Financial Accountant 2019

64
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

iv) Due to severe economic recession, Exodus Engineering is forced to drastically

scale down its operations and lay off most of its workers. The machinery cited in
(ii) above whose net book value is K2,700,000 at the start of the financial year
ending 30 April can only sell for K1,000,000. (3 marks)

v) Chibwenzi Enterprises offers a credit facility to its major customers. During the
year ended 30 June 2014, its total sales were K990,000. As at year end, there
were accounts receivable of K82,000. However, there is one customer who has
found it difficult pay his debt amounting to K8,000, and they are not sure if they
will collect this money. (3 marks)
[Total: 20 marks]
ZiCA Jun 2015

The Financial Accountant 2019

65
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

Suggested Solutions
Question 1
1A 2C 3D 4C 5C 6A 7A

Question 2
a)

 Assets

 Liabilities

 Equity

 Income and expenses

 Other changes in equity

 Cash flows
b)

 Relevance: only relevant information can be useful. Information is relevant

when it helps users evaluate past, present or future events, or if it confirms or
corrects previous evaluations.

 Comparability: users must be able to compare an entity‘s financial statements

through time to identify trends and with other entity‘s statements to evaluate
their relative financial position, performance and changes in financial position.
c)

 Accounting standards reduce or eliminate confusing variations in the methods

used to prepare accounts

 Accounting standards oblige companies to disclose more accounting

information than they otherwise would.

 Accounting standards are a less rigid alternatives to enforcing conformity by

means of legislation

 Accounting standards oblige companies to disclose the accounting policies

uses in preparation of accounts.

The Financial Accountant 2019

66
Study, understand and apply

The Financial Accountant

Accounting Conventions and the Conceptual Framework

d)
i. Accruals – closing/opening inventory

 Match revenue earned with the cost of goods sold.

 For year ending 31 December 2013, match 80 ploughs sold to cost of 80 by
carrying forward unsold inventory 920) to next year.
 For year ended 31 December 2014, match the 140 sold with the 20 brought
forward plus the 130 bought in the year less unsold of 10 carried forward to
2015.
ii. Accruals – depreciation charge
 Match revenue earned with part of cost of asset spread over its useful life.
 It is necessary to apportion the value of the machinery used in a period
(depreciation charge) against the revenue it has helped to create.
iii. Going concern
 The business entity is normally viewed as continuing in operation for the
foreseeable future. It is assumed that the business has no intention of
liquidating or curtailing materially the scale of operations.
 Exodus Engineering has drastically scaled down its operations and laid off most
of its workers. The risk of closure is not remote.
 Therefore, the value of the machinery should be written down to its
break-up value rather than continuing to state it at the net book value, which is
an over-statement.
iv. Prudence
 Assets or income are not to be overstated and liabilities and expenses are not
understated.
 Where there is uncertainty regarding the collectability of a debt from a customer,
the loss should be foreseen and taken into account immediately.
 The K8,000 should either be written off as an irrecoverable debt or be treated as
a provision for doubtful debts should be made. The irrecoverable debt should be
charged as an expense in the income statement and the net amount of
receivables reduced in the statement of financial position.

The Financial Accountant 2019

67
Study, understand and apply

The Financial Accountant

Part B
Business
Transactions and
Double Entry
Bookkeeping

Session Detail Time allocation

5 Business transactions and the books of prime 30 min
entry
Question Practice and assignments 1 Hour
6 Double entry 30 min
Question Practice and assignments 1 Hour
7 Trial balance and correction of accounting errors 30 min
Question Practice and assignments 1 Hour
Assessment 1 (use a different day!) 2 hours

The Financial Accountant 2019

68
Study, understand and apply

The Financial Accountant

Session 5
Business Transactions and the
Books of Prime Entry
Focus
In this session we will look at a basic accounting cycle in order to appreciate what is
involved in accounting. We will also observe the need to capture accounting data in
the books of original entry. It helps to note that before posting the general ledger, the
data on source documents is first recorded in the books of prime entry . As we make
our way through this session, we will do well to remember that record keeping is a
minimum legal requirement.

71
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

A basic specimen of an invoice is given below. Take a closer look at some of the
basic items found on a simple invoice below for King Traders Inco.

———————————
Jones King Traders Inco. Tax Invoice
———————————
P.O. BOX 12088,
Chachacha Road, Invoice #

Lusaka, 1005

Zambia.
For your Quality
Supply
Joy Bell Distributors,
P.O. BOX 55482,
Chacha Road,
Lusaka,
Zambia.

Qty Description Unit Price Amount (K)

200 Cement 70 14,000

Sub Total 14,000

VAT @ 16% 2,240
Total 16,240
Date Prepared by Reviewed by

—————- —————- —————-

Activity 5.1
List six items of data that you can see on the document above.

The Financial Accountant 2019

72
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

2 The Books of Prime Entry Commentary

books of prime entry are books in which financial Remember, the first place
transactions which takes place on a daily basis in where financial transactions
a business are listed by order of date. It is helpful are recorded is in the day
to know that a financial transaction should first be books.
recorded in the day books before being recorded
elsewhere. Books of prime entry are therefore
kept in order to:
Direct posting to the general
 Minimize posting errors in the general ledger accounts should be
ledger. The bookkeeper should NOT make
direct postings to the general ledger unless avoided in order to reduce or
there is a necessity as this can result in prevent errors made within
avoidable errors being committed in the the general ledger.
general ledger.
 Avoid unnecessary detail in the general
ledger. totals from the day books are fed into Day books may also
general ledger accounts thereby minimizing strengthen a firms financial
unnecessary detail in the general ledger. controls where there is a
separation of roles between
 Fulfill minimum record keeping
requirements. The day books record the person responsible for
business transactions of an entity in updating the day books and
sufficient details so as to fulfill legal the person responsible
requirements. making postings to the
general ledger.
 Provide an alternative source of information.
Where general ledger records are not
available, Accountants can use the books of
original entry as an alternative information
source in his/her preparation of accounting
information.
 Strengthen financial controls. Day books can They say ―the devil is in the
promote segregation of duties in a business detail‖. Proper record
thereby reducing the potential for avoidable keeping helps to highlight
errors in the accounting system. accounting problems before it
 It can be argued that well kept day books is too late.
can in part help to minimize potential for
fraud in a business. If a business is failing to
keep record of daily transactions, huge
amounts of resources, including cash may
go missing without being noticed for a long
period of time.

The Financial Accountant 2019

73
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

2.1 Types of Day Books

A company can keep several types of day books including the ones listed below.

Summarized and Posted

Day book Description
to:

Purchases Day Lists invoices received Payable ledger

1
Book from suppliers Payable ledger control

Purchases Returns Lists credit notes Payables ledger

2
Day Book received from suppliers Payable ledger control

Lists sales invoices sent Receivable ledger

3 Sales Day Book
to credit customers Receivable ledger control

Sales Returns Day Lists credit notes sent to Receivable ledger

4
Book credit customers Receivable ledger control

Lists receipts and

5 Cash Book payments made through Cash or bank account
the bank

6 Petty Cash Lists small expenses Cash or bank account

Lists double entry

adjustments made to
7 Journal General ledger
the general ledger
accounts
Lists invoices received
from credit suppliers
8 Expense Day Book General ledger
other than those who
supply inventory.

The Financial Accountant 2019

74
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

Purchases day book

The purchases day book lists credit invoices received from suppliers. This day book
records credit purchases. As seen from the extract below, there is no consecutive
order in the number of invoices since the business receives invoices from different
suppliers.

Date Supplier Invoice VAT VAT Total

details # exclusive
K K K
01.01.18 AB Co. 524278 200 32 232
15.01.18 RT Co. 8762 50 8 58
——— ——— ———

Total 250 40 290

——— ——— ———

The amounts owed to suppliers is the tax inclusive total as shown above. Input tax
is usually recovered from the government by registered traders. Accounting for
value added tax will be discussed in detail shortly.
Sales day book
The sales day book lists invoices sent to credit customers. This day book records
credit sales. Note that invoice numbers in the basic format of the sales day book
below are in a consecutive order because it is the same business which is issuing
the invoices to its credit customers. The credit customers owe the business the VAT
inclusive amount.

Date Customer Invoice # VAT VAT Total

details
exclusive
K K K
01.01.18 XY Co. 10023 300 48 348
15.01.18 VW Co. 10024 500 80 580
——— ——— ———
Total 800 128 928
——— ——— ———

The Financial Accountant 2019

75
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

Cash Book
The cash book is a day book which shows a record of receipts and payments
made through the bank. The discount allowed column in the cash book is a
memorandum column and does not represent reduction in cash. Discount allowed is
a business expense. The payments side of the cash book is similar to the basic
format below.
Cash
Date Details Receivable Discount Total
sales
K K K K
20.01.18 J. Banda 2,000 200 2,000
25.01.18 B. Nawa 500 500

——— ———— ———— ————

Total 2,000 500 200 2,500
——— ———— ———— ————

Petty cash Book

The Petty cash record is a book of prime entry which records small or petty
expenses. Generally, petty cash should be subject to cash control limits commonly
known as float or imprest. Float is the maximum amount allocated for petty
expenses.
The daily handling and security of petty cash, falls in the hands of the petty cashier.
Access to petty cash must be restricted to authorized staff only. All petty expenses
must be supported by petty cash vouchers as well as receipts.
Where the petty cashier is not availed with receipts from employees who used petty
cash, he or she may report the matter to his/her superior who may recommend, in
the absence of meaningful explanations that petty cash be recovered from the
employee in question.
On a regular basis, the petty cashier will have to generate a list of expenses made
during a period which should be added to the notes and coins in the petty cash tin
for reconciliation purposes. The petty cashier will have to notify management in time
if she/he reaches the minimum cash balance according to company policy. The
basic format below is an example of a petty cash record.

The Financial Accountant 2019

76
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

Bank Amount Date Details Taxi Milk Total

K K K K
Bank 500 02.11.16 Coffee 50 50
25.11.16 stationary 250 250
——— —— —— ——

Total (300) Total 250 50 300

——— —— —— ——

Closing Bal 200 Date

Petty Reconciliation basic format

Float = vouchers + notes and coins + IOU - receipts

If all is well, the float must be equal to the vouchers total plus the cash in the till plus
refundable amounts advanced to staff members (IOU) if any, less receipts
IOU represents petty cash advanced to members of staff which needs to be
refunded to the cashier. Receipts are amounts received by the petty cashier not
originally meant for funding petty expenses.

The Journal
The journal is defined as a day book essentially used for:
 Correction of accounting errors.

 Making year-end adjustments before preparation of final accounts.

 Posting unusual entries which occurred during the accounting period.

DR CR An example of a Journal entry is

given below :
Account 1 X
Account 2 X
Narrative note

The Financial Accountant 2019

77
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

Session Summary
 Record keeping is a minimum legal requirement and Accountants can
greatly assist a business to fulfill this duty.

 Books of original entry essentially record the cash and credit

transactions of a business.

 Data on source documents is first recorded in the books of prime entry

which are also known as day books.

 An invoice is a business document issued by a credit supplier to

demand for payment from a credit customer.

 A credit note is a business document issued by the supplier to reduce

or cancel in full the invoiced amount.

 There are about eight books of prime entry although this number may
vary depending on the special needs of the reporting organization.

 The purchases day book lists invoices received from credit suppliers.

 The sales day book lists invoices sent to credit customers.

 The cash book lists receipts and payments made through the bank.

 Petty cash is a record of small or petty expenses.

 The journal is a book of prime entry used for correction of errors,

adjustments and posting of unusual entries.

The Financial Accountant 2019

78
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

Preparation Question 1
Objective Test Questions
1 Whenever a business buys goods or services on credit from a supplier, it
receives an invoice. To the supplier, the invoice is referred to as a
_______
A Sales invoice
B Purchases invoice
C Proforma invoice
D Quotation invoice ZiCA Jun 2010

2 The books of prime entry are ____________

A a listing of all account balances from the ledgers
B a diary to record the purchases and sales of non-current assets
C books in which transactions are first recorded from source documents
D an accounting record which summarizes the financial affairs of a
business
ZiCA Dec 2012
3 Mike Enterprises Ltd operates an imprest system with a cash float of
K550.00. During the month of February 2015, the following payments
were made:

K
Stationary 145.00
Postage 10.50
Refreshment 89.20
Travel expense 65.00
Office Supplies 90.30

How much cash reimbursement was made from the bank to restore the imprest
at the end of the month.

The Financial Accountant 2019

79
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

A K400
B K550
C K50
D K600

4 Which of the following books of prime entry is used to record the sale of
non-current assets on credit?
A The general ledger
B The journal
C The sales day book
D The cash book ZiCA Dec 2015

5. A company uses the imprest system to control its petty cash, keeping a
float of K500. Since the cash was last replenished, it had the following
transactions:

K
Reams of paper 105
Cleaning materials 80
Taxi fare 50
Beverages 120
Refund to customer 85

Calculate the amount to be withdrawn from the bank in order to replenish

petty cash?
A K560
B K 60
C K500
D K440 ZiCA Jun 2016

The Financial Accountant 2019

80
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

6 Which book of prime entry is used to record goods returned by

customers of a business organization.
A Purchases returns day book
B Purchases day book
C Sales returns day book
D Sales day book

7 Kunda Enterprises billed its customer, Bwacha, an invoice of

K23, 500, VAT inclusive, for the supply of office stationery. The terms
were 3/14, net 30.
Calculate the amount of settlement discount given to Bwacha on this
invoice if he decided to settle his bill within the discount
period?
A K817.80
B K705.00
C K592.20
D K607.76 ZiCA Mar 2014

[Total: 14 marks]

The Financial Accountant 2019

81
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

Preparation Question 2
Chibwenzi Ltd is a manufacturer and distributor of safety clothing for industrial
customers. On 15 May 2015, Chibwenzi Ltd sold the following items to Remote
Mining Company:

 30 pairs of work suits at K150.00 per pair.

 30 pairs of safety shoes at K195.00 per pair.
 30 hard hats at K120.00 each.
 60 torches at K80.00 each.

All goods are subject to VAT at 16%. Invoice no. 2347 was issued. A 20% trade
discount was negotiated together with a 2½ % cash discount if payment was made
within 14 days.
Required:
a) Calculate the following:
i) Total trade discount (3 marks)
ii) Total VAT (3 marks)
iii) Invoice amount due from Remote Mining Ltd. (2 marks)

b) For the transaction in (a), prepare an extract of the Sales daybook.

(3 marks)
c) Show the double entry that will be recorded upon receipt of a cheque from
Remote Mining Company in full settlement of the debt, less the cash discount.
(3 marks)
d) Explain the difference between:
i) Trade discount and cash discount (2 marks)
ii) Personal accounts and impersonal accounts (2 marks)
iii) Input VAT and output VAT. (2 marks)
[Total: 20 marks]
ZiCA Dec 2015

The Financial Accountant 2019

82
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

List price 15,000

Plus Vat 2,340
———
Invoice amount 17,340
———

The Financial Accountant 2019

83
Study, understand and apply

The Financial Accountant

Recording Business Transactions and the books of prime entry

b)
Date Customer Invoice # Total Net Vat
K K K
15.05.15 RM Ltd 2347 17,340 15,000 2,340

c)
Journal Entry for discount DR CR
K K
Bank 16,967
Discount 375
Trade Receivables 17,340

d)
i) Trade discount is a reduction in price given to attract large customers and no
entries are made in the double entry records or in the sales day book. Cash
discount is given to encourage prompt payment of outstanding accounts and is
shown in double entry accounts.

ii) Personal accounts are accounts that deal with people and firms i.e.
receivables (debtors) and payables (creditors).
Impersonal accounts are accounts in which possessions (assets) are recorded
(real accounts). Accounts in which expenses, income nominal accounts are
recorded are known as nominal accounts. Input VAT is VAT paid on goods
and services bought in by a business. Output VAT is VAT charged on goods
and services sold by a business.

The Financial Accountant 2019

84
Study, understand and apply

The Financial Accountant

Session 6
Double Entry
Focus

Double entry is perhaps the most important topic in your financial accounting
studies. Most of the succeeding sessions will in some way relate to this vital topic.
Apart from ensuring completeness of recorded transaction double entry seeks to
preserve the equality of resources and obligations in an entity. The correct
application of double entry principles can help an accountant to easily balance the
books of accounts.

Learning objectives
Upon completion of this session you should be able to:

 Describe the stages involved in a basic accounting cycle

 Explain the dual concept of accounting

 Define the nominal ledger

 Describe the receivables and payables ledgers

 Explain the accounting equation

 Demonstrate how to rule off ledger accounts

 Discuss types of business discounts

 Perform day book analysis

The Financial Accountant 2019

85
Study, understand and apply

The Financial Accountant

Double Entry

1 Basic Accounting Cycle Commentary

A basic accounting cycle is given below :

Business Transactions Business transactions give rise

(Financial transactions which involves an to source documents such as
exchange of goods and services for
invoices and credit notes as
payment or a promise to pay) discussed in session five (5).

Books of Prime Entry The BOPE records all Business

(also known as day books BOPE lists credit transactions.
and cash transactions)

The general ledger contains all

General Ledger
types of company ledger
(The GL is a summary record of an entity‘s
accounts (The general ledger is
financial affairs)
also known as nominal ledger)

Trial Balance The trial balance is used to

(The trial balance is a list of ledger account check the arithmetic accuracy of
balances) double entry.

Once the statements of profit or

Financial Statements loss and financial position are
(Shows the financial results and position of an produced the cycle begins all
organization) over again!

The Financial Accountant 2019

86
Study, understand and apply

The Financial Accountant

Double Entry

2 The Dual Concept Commentary

The duo concept of accounting states that each The word duo simply means
financial transaction gives rise to two equal but
two. Every debit entry should
opposite entries; a debit and a credit. Equality of
assets and liabilities should be preserved. be matched with an equal but
opposite credit entry. This
Experience shows that successful scholars of
means that if the bookkeeper
financial accounting should first master the
principle of preservation; that is every resource correctly applies the
carries a claim. Again, The above concept will be principles of double entry
relevant to most of the diet contained in this book. they should be able to
The table below can help in enforcing the balance the books of
thoughts above. Look at the table below and think
accounts.
about the law of preservation.

ACTION = REACTION
LOSS = GAIN
RESOURCE = CLAIM
DEBIT = CREDIT
You may recall the law of
ASSET = LIABILITY
science as coined by Isaac
Newton, which states that to
The thought above is a key concept in every action there is an equal
accounting. Value preservation is the basis of but opposite reaction. The
value addition because you cannot genuinely same principle is applied
increase or reduce a false position without here in the context of values
misleading yourself. Value preservation through
competent record keeping is perhaps a of business resources and
fundamental role of accounting in the wider obligations.
society.
It is important to remind ourselves of the business
entity concept. It was ascertained under this
concept, that the business and the owner were to
be treated as separate entities. Therefore, when Separation of the owner from
their business can in part
a business owner transfers value in the business,
assist to raise the standard of
we say that capital has been introduced. This
single act gives rise to an increase in assets as accountability on all dealings
that the owner does in
well as liabilities of a business.
relation to the business.

The Financial Accountant 2019

87
Study, understand and apply

The Financial Accountant

Double Entry

3 The Nominal Ledger Commentary

The nominal ledger (or general ledger) is a All the ledger accounts for a
summary record of an entities financial affairs. business including, assets,
This record contains double entry ledger liabilities, income, expense
accounts including income, expense, asset,
liability and capital accounts which are broadly and capital accounts are
classified as real, nominal and personal found in the nominal ledger.
accounts. Real accounts mainly relates to assets
or tangible valuables, personal accounts relates
to individual accounts and nominal accounts
relates to expenses and income.

4 Receivables and Payables

Ledgers A receivable is a current
The receivable and payable ledgers are asset because a it represents
examples of personal accounts and they contain a future cash inflow to the
customer and supplier accounts respectively. business or an entitlement to
receive cash in future.
A receivable is a person who owes the business
cash for goods supplied on credit. A credit sale
will give rise to a receivable. A receivable should
always be treated as a current asset by the A payable is current liability
supplier of goods or services supplied on credit. because it represents an
A payable is a person who is owed by the obligation to transfer cash to
business for goods supplied on credit. A credit another entity in future.
purchase is the primary cause of a payable. A
payables is therefore treated as a current liability
by the customer who obtains goods or services
on credit.

Obviously, thriving business houses must

deliberately aim at having more credit sales Note that the word person is
compared to credit purchases in order to avoid being used here to refer to
straining their liquidity position. The above is a individuals and businesses
relative perception, a business will adopt a alike.
suitable model depending on the circumstances
obtaining. We have a full topic to be discussed in
a short while on payables and receivables.

The Financial Accountant 2019

88
Study, understand and apply

The Financial Accountant

Double Entry

5 The Accounting Equation

The duo concept can be fully understood by using the accounting equation. The
progressions of the accounting equation is given below with associated
explanations.

Initially, business assets are fully

ASSETS = CAPITAL
financed by capital

Eventually, the owner may borrow

ASSETS = CAPITAL +
funds or buy goods on credit thereby
LIABILITIES
creating a liability

ASSETS = CAPITAL + PROFIT + Hopefully the business becomes

LIABILITIES profitable. Profit increases Capital

All business owners have personal

commitment and this can drive them to
ASSETS = CAPITAL + PROFIT -
withdraw value from business. Drawings
DRAWINGS + LIABILITIES
reduces capital and must not be treated
as an expense
It rarely occurs, but let us note that if the
ASSETS = CAPITAL - LOSS - loss and the drawings exceed the
DRAWINGS + LIABILITIES capital, the business will be fully
financed by outsiders.

6 The Business Equation

This is a modified version of the accounting equation which carries an idea of profit
as being the difference between closing net assets (closing Capital) and opening net
assets adjusted for drawings and capital introduced.

Profit = Closing net assets - Opening net assets + Drawings - Capital introduced

The reasoning behind the business equation is as follows:

 Without drawings and capital injections, the profit or loss made by the business
is the difference between closing and opening capital. Capital is increased or
reduced by profit or loss respectively as stated earlier on.

 Drawings are added back because, we must not understate closing capital.
Remember, drawings are not expenses.

 Capital injection is deducted because capital is not income but a liability.

The Financial Accountant 2019

89
Study, understand and apply

The Financial Accountant

Double Entry

Activity 6.1
The accounting equation is a good tool to use in demonstrating the duo
concept. Let us look at the following illustration.
Melvin started a vegetable business and had the following initial seven transactions
for the month of January 2018 :

# Detail

1. Introduced K3,000 Capital into his business.

2. Bought a vegetable stand from a local Carpenter for K500 Cash.
3. Bought vegetables worth K300 from Y Farms for cash.
4. Sold half of the vegetables for K200 to cash clients.
5. Bought a second batch of vegetables for K600 on credit.
6. Sold all the vegetables to credit customers for K1,000.
7. Withdrew K200 cash for personal use.
Required:
Show how each transaction above will affect the accounting equation.

(!) We recommend that this basic exercise be done in a group so that members can
discuss how the accounting equation is affected by each transaction thereby
encouraging the learning process.

The Financial Accountant 2019

90
Study, understand and apply

The Financial Accountant

Double Entry

Suggested Solution
Note that all transactions left the accounting equation in equal balance and equality
of assets (resources) and liabilities (obligations) was preserved.
ASSETS = CAPITAL + LIABILITIES

OBLIGATION
1 CASH K3,000 = + 0
3,000

STAND K500+CASH
2 = CAPITAL K3000 + 0
K2,500

INVENTORY
3 K300+STAND = CAPITAL K3,000 + 0
K500+CASH K2,200
INVENTORY CAPITAL
4 K150+STAND = K3,000+ PROFIT + 0
K500+CASH K2,400 K50
INVENTORY CAPITAL
5 K750+STAND = K3,000+ PROFIT + PAYABLE K600
K500+CASH K2,400 K50
RECEIVABLES K1,000 CAPITAL
6 +STAND K500+CASH = K3,000+ PROFIT + PAYABLE K600
K2,400 K300
CAPITAL
RECEIVABLES K1,000
K3,000+ PROFIT
INVENTORY+STAND
7 = K300- + PAYABLE K600
K500+CASH K2,400-
DRAWINGS
DRAWINGS K200
K200

8 ASSETS=K3700 CAPITAL=K3100 + LIABILITIES=K600

The Financial Accountant 2019

91
Study, understand and apply

The Financial Accountant

Double Entry

7 The Ledger Accounts

Most accounting tutors use a T account to teach their students double entry. The T
account as shown below has two sides, a debit and a credit.

Ledger Account
Debit (Left side) Credit (Right side)

Increase in Assets Increase in Liabilities

Increase in Expenses Increase in Income

decrease in Liabilities Decrease in Assets

Tutors Guidance
The concept of double entry is by no means rocket science! A little consistency in
memory usage will give way to the needed understanding.
The thought; always debit the left side, and always credit the right side of a ledger
account is very helpful for starters.
In addition, from time to time please recite the mnemonic “DEAD CLIC” which
simply means:

 Debit Expenses, Assets and Drawings and,

Capital Account (Liability)

K K
Balance c/d 3,000 Cash 3,000

3,000 Balance b/f (TB) 3,000

Cash Account (Asset)

K K
Capital 3,000 Vegetable stand 500
Sales 200 Purchases 300
Cash Drawings 200

Balance c/d 2,200

3,200 3,200

Balance b/f (TB) 2,200

Vegetable stand assets Account (Non Current Asset)

K K
Cash 500 Balance c/d 500

Balance b/f (TB) 500 500

Purchases Account (Expense)

K K
Cash 300
Payables 600 Balance c/d 900

900 900

Balance b/f (TB) 900

Sales Account (Income)

K K
Cash 200
Balance c/d 1,200 Receivables 1,000

1,200 1,200

Balance b/f (TB) 1,200

The Financial Accountant 2019

95
Study, understand and apply

The Financial Accountant

Double Entry

Payables Account (Liability)

K K
Balance c/d 600 Purchases 600

600 Balance b/f (TB) 600

Receivables Account (Asset)

K K
Sales 1,000 Balance c/d 1,000

Balance b/f (TB) 1,000

Drawings Account (Reduction in Capital)

K K

Cash 200 Balance c/d 200

Balance b/f (TB) 200 200

Part (iii)

Melvin’s Trial Balance for the month of January, 2018

DR CR
K K
Capital 3,000
Cash 2,200
Vegetable Stand 500

Purchases 900
Sales 1,200
Payables 600
Receivables 1,000

Drawings 200
——— ———

4,800 4,800
——— ———

The Financial Accountant 2019

96
Study, understand and apply

The Financial Accountant

Double Entry

9 Discounts
A discount is a reduction in the price of goods or services. Discounts are used to
encourage or promote trade and it‘s a logical step in business to sale more units at
a lower price than to retain high valued units in the warehouse for a long time
thereby tying up working capital in inventory. Three types of discounts are
discussed in the table below:

Settlement
Cash discount Trade discount
discount
A permanent
A conditional discount discount given on A conditional
given to a customer for the nature of the discount given for
Define immediate or prompt transaction (bulk timely settlement
payment. or regular of supplier invoice.
purchases).
Normal
7-14 days N/a 30-45 days
period
 Included in the cash
book.
 Not included
 There is NO in the cash  Included in
guarantee that book. the cash
discount will be book.
treat- taken.  Trade
ment discount is a  There is NO
 The discount is permanent guarantee
optional. Further, the discount given that discount
customer must on the sales will be taken
consider the benefits invoice.
of the discount
altogether.

Tutorial brief

Discount allowed is Discount received is

 Cash or settlement discount  Cash or settlement discount
given to customers received from suppliers

 Treated as an expensed in the  Is treated as income in the

statement of profit or loss statement of profit or loss

 A credit entry in the receivables  A debit entry in the payables

Trade is involves buying and selling!

Buying or Selling or Sales can

purchases can be be done on cash or
done on cash or credit terms
credit terms.

Cash Purchase Credit Purchase Cash sale Credit Sale

We now need to identify the ledger accounts

DR Purchase DR Purchase DR Cash DR Receivables

CR Cash CR Payables CR Sales CR Sales

With practice, you will perfect your basic skills on double entry!

Remember DEADD CLICE

Debit increase in Expenses, Assets and Drawings or Dividends

Credit Increase in Liabilities, Income and Capital or Equity

The Financial Accountant 2019

100
Study, understand and apply

The Financial Accountant

Double Entry

Practice perfects any good art !

4 The books of prime entry are……………..

A A listing of all account balances from the ledgers
B A diary to record the purchases and sales of non-current assets
C books in which transactions are first recorded from source documents
D An accounting record which summarises the financial affairs of a
business ZiCA Dec 2012

5 The accounting equation can be rewritten as:

A assets plus profit less liabilities equals closing capital.
B assets less liabilities less drawings equals opening capital plus profit
C assets less liabilities less opening capital equals profit.
D assets less profit less liabilities less drawings equal capital
ZiCA Jun 2013

The Financial Accountant 2019

104
Study, understand and apply

The Financial Accountant

Double Entry

6 Melody sold goods with a list price of K10,000 to Emmanuel. She gave
Emmanuel a 10% trade discount and a further 5% cash discount if he paid
within a weeks time. Emmanuel paid his debt in seven days. Calculate the
amount Emmanuel paid to Melody.
A 8,550
B 9,000
C 9,500
D 8,000

7 Which of the following will give rise to a credit entry

A Increase in income
B Decrease in liability
C Decrease in Capital
D Increase in drawings
[Total: 14 marks]

The Financial Accountant 2019

105
Study, understand and apply

The Financial Accountant

Double Entry

Preparation Question 2
Ms. Judy Jones Started a grocery business on 1st June, 2018 and she had the fol-
lowing transactions in her first month of trading.:

1 June Introduced Capital into the business worth K15,000

1 June Paid rent for the shop costing K1,000

2 June Bought Groceries worth K7,000 for cash

3 June Made cash sales of K3,000 worth of groceries

4 June Made credit sales of K5,000 to MC and Sons

10 June Bought Groceries worth K10,000 on Credit

12 June Paid rates costing K200 to the local authority

15 June Withdrew cash worth K500 for personal use

19 June Took out a loan from Kaloba Bank worth K16,000

25 June Bought shop wooden shelves at a cost of K9,000

27 June Paid for prepaid electricity worth K200

30 June Paid K700 wages to shop attendant

Required:
i) Open the relevant ledger accounts (10 marks)
ii) Balance (Rule off) ledger account (5 marks)
iii) Extract a trial Balance for Judy‘s first month in business.
(5 marks)
[Total:20 marks]
(!) This is a group discussion question without a suggested solution. It is fairly simple
and is ideally meant to sharpen your double entry skills. Have a go at it!

The Financial Accountant 2019

106
Study, understand and apply

The Financial Accountant

Double Entry

Suggested solutions
Question 1
1 D
2 D
3 D
4 C
5 D
6 A
7 A

The Financial Accountant 2019

107
Study, understand and apply

The Financial Accountant

Session 7
Trial Balance and Correction of
Accounting Errors
Focus
In this session, we will focus on the trial balance, a very important check in the
process of preparing financial statements. Before the financial statements are
prepared it is strongly recommended that a trial balance be extracted in order to
proactively resolve double entry errors.

Learning objectives
Upon completion of this session you should be able to:

 Define and explain the importance of the trial balance

 Identify and discuss the different types accounting errors

 Explain how different accounting errors are corrected through the

usage of the suspense account and the journal.

The Financial Accountant 2019

108
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

1 Trial Balance Commentary

A trial balance is a list of ledger account The trial balance is normally
balances. It is used among other things as a: used to confirm the accuracy
and proper application of
 Test of the arithmetic accuracy of ledger double entry bookkeeping.
accounts double entry.

 Technique of detecting some (not all!)

accounting errors.

 Source of important information (e.g. value

of sales, capital etc.) If the trial balance agrees, it
means the book keeper has
 Basis (reference) for preparing financial properly applied the double
statements. entry principle in the ledger
Extracting a Trial balance will involve the accounts.
following three (3) steps:
A. Collecting together the ledger accounts
from the general ledger.
B. Balancing off the ledger accounts.
C. Collecting the balances on the ledger
accounts in Debit and Credit columns in the The trial balance cannot
trial balance detect all accounting errors
and should therefore be
viewed as a starter error
Again, All things being equal the trial balance screening tool by preparers
should agree indicating that double entry has of financial statements.
been correctly applied or at least a few
accounting errors not identifiable by the trial
balance have been committed which of course
need correction. If the trial balance fails to agree,
a suspense account should be opened.

The Financial Accountant 2019

109
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

A basic example of a trial balance is given below :

KSM
Trial balance for the year ended 31 December, 2016
DR CR
K K
Assets 10,000
Liabilities 5,000
Sales 3,000
Expenses 2,000
Capital 4,000
_____ ______
Total 12,000 12,000
_____ ______

If the basic principles of double entry were followed, the trial balance should agree
that is the debit side should be equal to the credit side in accordance with the duo
concept. The basic trial balance above agreed because the debit total is equal to
the credit total.

2 The Suspense Account

A suspense account is a temporal account opened pending investigations into
accounting errors which resulted in an imbalance in the trial balance. If an
accountant fails to balance the trial balance, it means an accounting error has
occurred. It is the duty of that accountant to identify the error, classify it and correct it
before the final accounts are drafted. An imbalance in the trial balance is always a
result of human error and not a systemic one as many put it.
The suspense account can also be opened when the book keeper knows the
account to debit but does not know which account to credit (or vis-versa). An
example would be a receipt of cash from a customer or someone whose identity is
not clear at the time, particularly when you are dealing with two persons with the
same names. experience shows that most accounting scholars do not find the
suspense account easy to handle. That said, suspense account questions can be
easily tackled if the students appreciates the ten types of accounting errors and
attempts to think about the potential impact of accounting errors on the two grand
totals on the debit and credit side of the trial balance.

The Financial Accountant 2019

110
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

This time KSM trial balance below has not balanced!

KSM
Trial balance for the year ended 31 December, 2016

DR CR
K K
Assets 10,000
Liabilities 5,000
Sales 3,000
Expenses 1,000
Capital 4,000
Suspense Account 1,000
_____ ______
Total 12,000 12,000
_____ ______

You can see above, that the trial balance has temporarily balanced by inserting an
amount of K1,000 on the side with a lower total. Further, since the suspense
account in the trial balance is on the debit side, we should debit the suspense
amount as shown below.

Suspense Account
K K
TB 1,000

The suspense account is cleared by passing a journal entry (!)

DR Relevant account
CR Suspense account
Narration

The Financial Accountant 2019

111
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

3 Types of Accounting Errors

There are so many types of accounting errors. In the table below we have only
listed the common types which are relevant for your syllabus.

ACCOUNTING DESCRIPTION EXAMPLE

The financial transaction

1 Error of Nil - since no account was
was completely left out of
Omission updated
the accounting books.
Cheque payment for rent
The transaction was posted
2 Error of to a wrong account of the DR Electricity
Commis- same class.
sion (Instead of rent)
CR Bank
The transaction was posted Credit purchase of Motor Van
to a wrong account of a
3 Error of different class. Capital DR Motor van repairs (instead
Principle expenditure was treated as of motor van a/c)
revenue expenditure or
vise-versa CR Payable

4 Error of A wrong amount was

posted to both accounts. You pay a supplier K3,200
Original
Entry or (Usually result from DR Payables K2,300
double mis-totalling day book
reversal CR Cash K2,300
entries.
Payment of wages
5 Entry
The double entry has been
Reversal DR Bank K50,000
made the other way round.
error
CR Wages K50,000
K1,000 Credit sales
DR Receivables K1,010
Two or more separate
errors have occurred on CR Sales K1,000
6 Compen-
both the debit and the
sating K100 Purchases Returns
credit side of the trial
error
balance and therefore DR Payables K100
cancel each other out.
CR Purchases K110

The Financial Accountant 2019

112
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

ACCOUNTING
DESCRIPTION EXAMPLE
ERRORS

One account was Credit sale of K3,000

7 Error of Single updated or posted
DR Receivables K3,000 (only)
entry (The double entry was
not completed!) (Sales was not updated)

There was a mismatch Cash purchase of an asset for

(or interchange) of K345 treated as
8 Transposition digits in a number
error posted to one of the DR Asset K345 (correct)
accounts in the general
ledger. CR Cash K534 (wrong)

Cash Sale of inventory at K600

9 Double debit Both (All) accounts
or double were debited or DR Cash K600 (Correct)
credit credited.
DR Sales K600 (Wrong!)

Electricity Bill of K1,200 posted

10 Different debit Different amounts were as
different used in posting the
Dr Electricity K1,200 (Correct)
credit ledger accounts.
CR Cash K120 (Wrong!)

Correcting Errors

 Errors 1 to 6 CANNOT BE DETECTED by the trial balance and should

therefore be corrected by using a journal entry. We only need to identify the
account to debit and the account to credit before proceeding to the pass the
journal entry. Despite the occurrence of the errors mentioned, the trial balances
will still balance. Errors 1 to 6 will therefore NOT give rise to a suspense
account!
 Errors 7 to 10 WILL BE DETECTED (revealed or highlighted) by the trial
balance and are corrected by first opening a suspense account and then
passing a relevant journal entry. Again, these types of errors (7 to 10) will be
detected by the trial balance, because the trial will not agree if the bookkeeper
commits such errors.

The Financial Accountant 2019

113
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

There are several ways of handling suspense Commentary

accounts questions and in this session we will
discuss only two methods. Although there are different
techniques used in
The first method involves three questions as answering suspense
highlighted below: accounts related questions,
i) What happened? (Ask yourself what were the key lies in knowing the
the wrong entries made) different types of accounting
errors. A closer look at the
ii) What should have happened? (Ask yourself table above and the notes
what should have been the correct entries) that follow will show you that
iii) What are the correcting entries? (which if a bookkeeper does not
account need to be updated to correct the know how to correct an error
identified error) of omission for instance, they
will attempt to open a
The second method does not bother to go suspense account even if
through all the trouble above but requires an there is absolutely no need to
ability to do two things only. This method do so! Again, errors 7 to 10
somewhat works in reverse order as follows: are the only errors that will
i) Firstly, you should identify the type of require us to open a
accounting error that has occurred. It is suspense account.
therefore important that the reader knows Further, many students who
(through practice) the types of accounting happen to have a weak
errors written above. This will help them to foundation in double entry
know if the suspense account is involved in may not find it easy to deal
correcting a particular error. with a suspense account
ii) Secondly, you should then proceed to related question. This is
update the affected accounts. Again this because suspense accounts
requires sound knowledge of double entry. If knowledge builds on double
you debit a relevant account then the entry knowledge.
suspense account is automatically credited. It is not wrong to revisit the
Doing more questions on this part of the syllabus basics of double before
will prove to be very beneficial for the student. attempting a suspense
Most questions on suspense accounts carry a account question.
similar language which can be learnt and
mastered.
Further correction of errors tend to carry more
marks and it is the student who practices
questions on this vital topic who will get some
easy marks in the forthcoming exam!

The Financial Accountant 2019

114
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

Activity 7.1
When Paul extracted his trial balance for the month of July, he noted that his credit
total exceeded the debit total by K1,500. He opened a suspense account and
discovered that the following errors had transpired :
i) A sales invoice of K500 was completely left out of his records.
ii) The sales account was overstated by K700.
iii) A discount of K800 was omitted from the discount allowed account.
Required.
i) Pass the relevant Journal entries for each error and,
ii) Clear the suspense Account
Solution :

DR CR
K K
1 Receivables 500
Sales 500
Being correction of an error of omission
2 Sales 700
Suspense 700
Being Correction of overstated sales
3 Discount 800
Suspense 800
Being correction of omitted discount allowed

Suspense Account
K K
TB 1500 Sales 700
Discount allowed 800
——— ———
1500 1500
——— ———

The Financial Accountant 2019

115
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

Session Summary
 The trial balance is an important stage in the preparation of the
financial statements because it affords the bookkeeper an opportunity
to check for detectable double entry errors in time.

 If the trial balance is not extracted, the bookkeeper will inevitably omit
to correct some errors for a period and this will lead to misleading
reporting.

 There are different types of accounting errors which require

identification and correction.

 Some errors are corrected by a journal entry, but other errors will
require opening the suspense account.

 Errors which do not cause the trial balance to disagree will not give
rise to a suspense account.

 Errors which lead to an imbalance in the trial balance will give rise to
the suspense account.

The Financial Accountant 2019

116
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

Preparation Question 1
Objective Test Questions
1 On checking his ledger entries, Michael found the following errors:
i) An invoice from a supplier has not been recorded; and
ii) The debit entry of K500 for repairs has been correctly recorded, but
the credit entry was recorded as K50.
Which of the above errors would cause a difference between the total of
the debit balances and the total of the credit balances when the trial bal-
ance is extracted?
A (i) only
B (ii) only
C Both (i) and (ii)
D Neither (i) nor (ii) ZiCA Dec 2010

2 Which of the following represents an error of original entry:

A Payment of motor vehicle repairs of K6,600 were taken to Motor
Vehicles account.
B Payment of K6,600 motor vehicle repair were taken to the repairs
account as K6,060.
C Payment of K6,600 motor vehicle repairs were taken to machine repairs
account as K6,600.
D Payment of motor vehicle repairs of K6 600 was recorded in the cash book
as K6,060.
ZiCA Jun 2012

The Financial Accountant 2019

117
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

3 The book-keeper at Teddy Enterprises was unable to balance the

accounts. The trial balance totals were, debits K24,800 and credits
K28,400. The difference was taken to a suspense account. It was later
discovered that the entry in the returns inward account was recorded as a
debit. This type of error is known as…..
A Error of principle
B Transposition error
C Error of original entry
D Error of commission ZiCA Mar 2014

4 The trial balance is………………

A An account showing ledger balances
B A statement listing all debit and credit balances
C A ledger indicating debit and credit balances brought forward
D All the above. ZiCA Mar 2014

5 The suspense account shows a credit balance of K36,000. This could be

due to;
A Overcasting the sales day book by K27,000
B Undercasting the purchases account by K27,000
C Recording sales returns as K95,000 instead of K59,000
D Entering K18,000 paid to Kapoto on the credit side of Kapoto‘s account.
ZiCA Jun 2016

The Financial Accountant 2019

118
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

6 Which of the following errors will NOT be revealed by the trial

balance?
i) Sales K1,500 to A. Kampeni entered in P. Kampeni‘s account

ii) Cheque payment of K1,340 for Motor expenses entered only in Cash
Book

iii) Purchases K440 from C. Kondwe entered in Purchases account and Sup-
plier‘s account as K404

iv) Wages account added up incorrectly and was overstated by K10.

A (i) and (iv)
B (i) and (iii)
C (ii) and (iv)
D (iii) and (iv) ZiCA Dec 2012

7 The trial balance of ABC, a limited liability company, did not agree and a
suspense account was opened for the difference. Checking in the
book-keeping system revealed a number of errors. Which of the following
errors will require an entry in the suspense account?
i) K5, 900 received from Peggy, a customer was credited in error to Paddy,
another customer.
ii) K6,050 paid for electricity was debited to electricity account as K6,500
iii) The total of the discounts allowed column in the cash book had been
debited in error to the discounts received account.
iv) K3,500 paid for motor van repairs was correctly treated in the cash book
but was credited to motor vehicle asset account.
A (iii) and (iv)
B (ii) and (iv)
C (i) and (iii)
D (i) and (iv) ZiCA Jun 2014
[Total: 14 marks]

The Financial Accountant 2019

119
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

Preparation Question 2
The trial balance of John Zulu failed to agree because the credit balances were
more than the debit balances by K1, 350. Consequently, the suspense account was
opened and after some investigations the following errors were discovered as at 30
June 2012 :
1 The sales Journal total was listed as K1,250 instead of K1,520.

2 Discount allowed was credited to discount received K1,050.

3 The purchases day book total K1,320. had been recorded properly in the ledger
but posted to the payables control twice.

4 Repair for furniture K560 was debited to furniture account.

5 Cash receipts from receivables K1,800 was debited in the cash book but not
posted to the receivables control account.

Required:

(a) State two (2) reasons for preparing the trial balance. (2 marks)

(b) Briefly explain two (2) errors that will be revealed by the trial balance. (2 marks)

(2 marks)

(d) Prepare:

(i) Journal entries to correct the above entries. (Narratives are not required)

(8 marks)

(ii) Suspense account showing the correction of the errors (3 marks)

(e) If the net profit calculated was K12, 570 before errors were discovered, what
could have been the corrected net profit after the discovery of
the mistakes? (3 marks)
[Total: 20 marks]
(ZiCA Jun 2013)

The Financial Accountant 2019

120
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

The Financial Accountant 2019

121
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

Suggested Solutions
Question 1
1 B
2 D
3 B
4 B
5 C
6 B
7 B

Question 2
(a) Two reasons for preparing the Trial Balance:
i) The trial balance tests the arithmetic accuracy of ledger accounts double entry.
ii) The trial balance is a means of detecting some accounting errors– Note that
some errors cannot be detected by the trial balance.
iii) Acts as a source of important information (e.g. vale of sales, Capital etc.) state-
ments
iv) It is a basis for the preparation of financial Statements.

(b) Two errors that will be revealed by TB

i) Error of single entry - only one account was posted
ii) Error of transposition - digits in a number were mismatched e.g. Posting K110
as K101

The Financial Accountant 2019

122
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

c) Two errors that will not be revealed by TB

i) Error of omission-The transaction was completely omitted
ii) Error of principle-Capital expenditure was treated as revenue expenditure.

d) Journal entries

Dr Cr
K K
1. Sales A/c 270
Suspense A/c 270
2. Discount Allowed A/c 1,050
Discount Received A/c 1,050
Suspense A/c 2,100
3. Payables A/c 1,320
Suspense A/c 1,320
4. Furniture Repairs A/c 560
Furniture A/c 560
5. Suspense 1,800
Receivables 1,800

e) Suspense Account Clearing

K K
B/f 1,350 Discount Allowed 1,050
Sales 270 Discount Received 1,050
Receivables 1,800 Payables 1,320
———— ————
3,420 3,420
———— ————
The Financial Accountant 2019
123
Study, understand and apply

The Financial Accountant

Trial Balance and correction of errors

f) Revised Profit K
Unadjusted profit 12, 570
Add sales undercast 270
Less discount allowed (10,50)
Less Discount Received overstatement (1,050)
Less furniture repairs (560)
————
10,180
————

The Financial Accountant 2019

124
Study, understand and apply

The Financial Accountant

Part C
Financial Statements
Adjustments

Session Detail Time allocation

8 Accounting for value added tax 30 min

9 Cost of sales and the treatment of inventory 30 min

Question Practice and assignments 1 Hour

10 Accounting for Depreciation 40 min

11 Intangible non-current assets 20 minutes

Question Practice and assignments 1 Hour

12 Irrecoverable debts and allowance for receivables 30 min

13 Accruals and Prepayments 30 min

Question Practice and assignments 1 Hour

14 Irrecoverable Debts 30 min

Question Practice and assignments 1 Hour

Assessment Two 2 Hours

The Financial Accountant 2019

125
Study, understand and apply

The Financial Accountant

Session 8
Accounting for Value Added Tax

Focus
All businesses registered for value added tax are required to collect, on behalf of the
government, a fixed amount of tax on their taxable supplies. These funds contribute
to government treasury thereby helping to stir up economic development through
the provision of public goods and services.

Learning objectives
Upon completion of this session you should be able to :

 Discuss the concept and scope of value added tax

 Account for sales tax

 Calculate value added tax using the VAT control account

 Explain the relief on irrecoverable debts available to tax payers

The Financial Accountant 2019

126
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

1 The Concept and Scope of Value Commentary

Added Tax (VAT) Value added tax is not a tax
Tax can be defined as a compulsory contribution on income, it is an
legally imposed by government on the gains and expenditure tax.
income of resident persons in a given country.
For the purposes of this session, we will restrict
our discussion to consumption taxes which is
VAT is also known as sales
commonly referred to as value added tax.
tax.
Value added tax is a type of expenditure tax.
VAT is suffered (or paid) on the purchase of
taxable supplies by the consumer of taxable Currently, the standard rate
supplies. This tax is collected by registered of VAT in Zambia is 16%.
traders and is administered by the tax authorities.
VAT is usually charged at standard rate on
taxable supplies. The standard rate of VAT in Please note the difference in
Zambia is currently 16%. This rate is not the two roles of VAT
expected to remain the same in the long term. It administration and VAT
is not uncommon for authorities to apply reduced collection. Authorities
or zero rates to taxable supplies to promote trade administer and traders collect
in a chosen industry. VAT.
Only VAT registered traders are allowed to
charge tax on their supplies by the authorities.
Most jurisdictions follow a criteria based on a Although Value added tax is
sales value threshold. Businesses that fail to a handy revenue collection
meet the sales thresholds have an option of method for most tax
registering voluntarily for sales tax purposes authorities, it has a
although this option does not come without costs. significant capacity to negate
business activity through
increased selling prices of
2 The Value Added Tax Cost goods on the part of
Structure consumers.

Under this topic, the examiner will seek to assess At the time of writing
the strength of the candidates detailed VAT government was still
knowledge at least in theoretical terms. The value engaging with key
added tax cost structure is a good starting point stakeholders on the
for appreciating how value added tax is implementation of a better
calculated. The value added tax cost structure in sales tax system which
its simplistic form will help you to understand how would enhance revenue
to extract value added tax from a VAT inclusive collection and minimize tax
amount as well as a VAT exclusive amount. This administrations costs.
is done by altering the VAT fraction. The table on
the next page gives us more details.

The Financial Accountant 2019

127
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

There is a difference between

VAT exclusive amount VAT inclusive amount
VAT inclusive figure means amount VAT exclusive figure means amount
without VAT with VAT
Assume the VAT rate is 16% and you have been given the following values which
Let us use the scenarios below…..
Purchase of K100 supplies vat Purchase of K116 supplies vat
exclusive inclusive

Required : find the VAT amount on both amounts

Solution:
16/100 x K 100= K16 16/116 x K116= K16

Tutor’s Guidance
 In both calculations the VAT amount is the same.

 For a VAT exclusive amount, we always use the fraction X%/100%

 For a VAT inclusive amount, we always use the fraction X% /(100%+X%)

 Therefore listen out for the language used in the question!

 VAT plus amount means the figure is VAT exclusive.

The table below shows you the four default postings for VAT trading transactions.
You are encouraged to learn these entries for future reference.

CASH SALES CREDIT SALES

DR Cash/Bank (VAT inclusive) DR Receivables (VAT inclusive)
CR Sales Tax Control account CR Sales Tax Control account
CR sales CR sales
CASH PURCHASE CREDIT PURCHASE
DR Purchases DR Purchases
DR VAT Control Account DR VAT Control Account
CR Payables CR Bank/Cash

The Financial Accountant 2019

128
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

Value added Tax Postings

Again, Trade is all about:
Buying (Purchases) Selling (Sales)
You have two types of purchases You have two types of Sales

i) Cash Purchase for K200 (VAT exclusive) i) Cash Sale sales for K600 (VAT exclusive)

ii) Credit Purchase for K480 (VAT Inclusive) ii) Credit Sales for K1,200 (VAT Inclusive)

Purchases A/c Sales A/c

Note that for registered
K K K K
traders, the purchases
Cash 200 and the sales account Cash 600
should always be
Payables 400 Bal. c/ 200 posted with tax Bal. c/d 1,600 Receiva- 1,000
d bles

600 600 1,600 1,600

Bal. b/f 600 Bal. b/f 1,600

Receivables Payables
Cash
K K K K
K K
Sale 1,200 Bal. c/d 1,200 Bal. c/d 480 Purchase 480
Cash 720 Pur- 240
chase Bal. b/f 1,200 Bal. b/f 480
Bal. c/d 480

720 720

Bal. b/f 480

Notice that the Cash, Receivables and Payables which all relate to
the statement of financial position are posted with VAT inclusive
amounts. This questionable treatment may change in future.

Value added Tax Control Account

Trial Balance check
K K
K K
Cash 40 Cash 120
Purchases 600
Payables 80 receivables 200
Sales 1,600
Tax payable 200
Cash 480
320 320
Receivables 1,200
Bal. b/f 200
Payables 480

Tax Payable 200

2,280 2,280

The Financial Accountant 2019

129
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

3 The VAT Control Account

The VAT control account is a liability account used to establish the amount of VAT
payable to or refundable from the government. The VAT control account exhibit is
given below.

VAT Control Account

Input tax K Output tax K
Opening Balance b/f X Opening Balance X
Credit Purchases X Credit sales X
Cash Purchases X Cash Sales X
Sales Returns X Purchases Returns X
Bad debt Relief X X
Closing Bal. (VAT Payable) X Closing Bal. (VAT
—— ——
X X
—— ——
4 Relief for VAT
In most jurisdictions, value added tax is collectable on both cash and credit sales.
There is therefore potential for tax payers to pay VAT on credit sales that eventually
become irrecoverable debts. It is only fair to refund taxes paid on uncollected debts
but the government will obviously require that certain conditions should be met
including the following:
 The supply should have been made for consideration.

 The trader should have fully accounted and paid for the output tax in question.
 The trader should have written off the debt in full in his books.

 A minimum of 18 month should have elapsed from the date of sale.

Taxes recovered from the government as a result of the irrecoverable debt relief
should be debited to the VAT control account as indicated above.

The Financial Accountant 2019

130
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

Session Summary
 VAT is tax on expenditure, not income.

 VAT is administered by the government but collected by registered

traders.

 For most goods and services, VAT is largely charged at standard rate.

 The VAT control account is used to establish or calculate VAT

payable or refundable amount.

 Bad debt relief is available in most jurisdictions and can be used by

traders to reduce their tax obligations.

The Financial Accountant 2019

131
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

Preparation Question 1
Objective Test Questions
1 Mizinga had the following transactions for the month of March 2014.

 March 1 bought goods K200 (VAT exclusive) on credit from Zango.

 March 3 bought goods for cash K350 (VAT inclusive)

 March 10 returned goods to Zango K50 (VAT exclusive)

 March 15 sold goods for cash K300 (VAT inclusive)

Assuming all items are subject to VAT at 16%, what was the balance on
the VAT account of Mizinga at 31 March 2014?
A K32.00 receivable
B K33.20 payable
C K30.90 receivable
D K30.90 payable
ZiCA Jun 2014
2 In the month of November John bought goods costing K4,000 plus VAT
and his VAT Inclusive sales amounted to K12,000. The rate of VAT is 20%.
Calculate the VAT payable or receivable from the government.
A K1,200
B K1,600
C K1,500
D K2,000

3. The sale of VAT inclusive goods on credit to a customer by a VAT

registered supplier is recorded in the books of the seller as_________
A Credit Sales account and Debit Customer‘s account
B Credit Sales and VAT control account and Debit Customer‘s account

The Financial Accountant 2019

132
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

C Debit Purchases account and Credit Supplier‘s account

D Debit Purchases account, Credit Supplier & VAT accounts
ZiCA Jun 2010
4 Anna is a VAT registered trader and she had the following
balances on her VAT control account for the month of December 2017.
VAT inclusive sales K130,616
Vat exclusive Purchases K105,300
On 1 December, she had a debit balance of K1,522 on her account. She
closed with a credit balance of K1,023.Assuming a rate of tax of 16%, How
much did Anna pay/recover from the tax authorities for the month of
December 2017?
A K1168 Payable
B K1876 receivable
C K18,016 Receivable
D K16,848 Payable

5 Which of the following statements is correct with regards to value added

tax:
i) Output tax, is tax on business sales
ii) Input tax is not usually recoverable from the government for non-registered
traders.
A (i) only
B (ii) only
C Both (i) and (ii)
D Non of the above

6 Tuchili is NOT registered for value added tax. He bought goods costing
K920 vat inclusive on credit. If VAT is charged at 15%, What is the double
entry of the transaction above in Tuchili’s books?

The Financial Accountant 2019

133
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

A DR Purchases K920 , CR Cash K920

B DR Purchases K800 , DR VAT 120 CR Payables K920
C DR Purchases K920 , CR Payables K920
D DR Purchases K800, CR Cash K800

7 Nkunika’s output tax for the month of October exceeded input tax but he
closed with a debit balance on his tax account. What can be a possible
explanation for the above.
A The Business deals in zero rated supplies
B The tax authorities owed the business a substantial amount at the start of
the month of October
C The business bought expensive goods
D The business sold tax exempt goods
[Total: 14 marks]

136
Study, understand and apply

The Financial Accountant

Accounting for Value added Tax

iv)

Value added tax control account

K K
Zero rated Purchases
(200,000 x 0%) 0 Bal b/f 7,245
Std Rated purchased Sales
(350,000x16%) 56,000 696,000x16/116) 96,000
Bank Purchases Ret
20,000 (80,000x16/116) 11,034.48
Sales Returns
(127,600x16/116) 17,600
Bad Debt Relief
(3,000x16/116) 480
Tax payable 20,199.48
————-- ————--
114,279.48 114,279.48
————-- ————--

v) Three items of data found on the tax invoice

 Name of the business (the seller)

 The tax payer‘s identification number

 The invoice number

 The name of the customer

 The transaction date

The Financial Accountant 2019

137
Study, understand and apply

The Financial Accountant

Session 9
Cost of Goods Sold and the
Treatment of Inventory

Focus
Proper inventory management is a major concern in business. From the accounting
point of view, the correct treatment of inventory reduces the risk of reporting false
profits and net assets. In this session we will learn how to account for cost of sales
and inventory.

Learning objectives
Upon completion of this session you should be able to:
 Calculate the cost of sales
 Account for inventory at the start, during and end of a financial year
 Apply the prudence concept theory in valuing inventory
 Identify and describe the three major classes of inventory

The Financial Accountant 2019

138
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

1 Cost of Sales Commentary

Cost of sales refers to the cost of goods sold in The idea of cost of sales
the normal course of carrying out trading assumes that a sale is made
activities. Under financial accounting the following at a cost. There is no
formats should be followed when calculating the business without expenses; it
cost of sales for a business. costs something to supply a
unit of inventory.

Cost of sales Format A

K
Opening inventory 15,000 Notice that in the two
Purchases 25,000 formulas opening inventory
and purchases increase cost
Closing inventory (15,000)
of sales.
————
Cost of Sales 25,000
Observe also, and this is very
———— important, that all unsold
Cost of sales Format B inventory reduced cost of
sales. This is because only
K
the sold units of inventory
Opening inventory 15,000 qualify to be treated as cost
Purchases 25,000 of sales.

Add carriage inwards 5,000

Add direct labour cost 15,000 If the business owner makes
———— drawings of inventory, the
cost of sales should be
Cost of inventory 60,000 reduced by the value of
Less returns outwards (1,500) goods withdrawn at cost. In
other words the bookkeeper
Less Damages (700)
should deduct the value of
Less Drawings (800) goods withdrawn from the
Less stolen goods (1300) value of purchases.

Closing inventory (12,000)

————
43,700
————

The Financial Accountant 2019

139
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

Activity 9.1
Mathew is a trader who specializes in selling hardcover books. The unit cost of one
book is K10 and the selling price is K15. On 1 January 2017, he only had a batch of
100 books in stock. During the mentioned month he bought 500 books and on 31
January, he only had 70 books in inventory.

Required:
i) Calculate Mathew‘s cost of sales
ii) Calculate Mathew‘s gross profit
Solution
Mathew,
Trading Account for the month of January 2017

K K
Sales (100+500 - 70) x 15 7,950
Opening Inventory (100 x10) 1,000
Purchases (500 x10) 5,000
———
Total cost of inventory 6,000
Closing inventory (70 x 10) (700)
———
Cost of Sales (i) (5,300)
————
Gross Profit (ii) 2,650
————

Cost of Sales and the treatment of Inventory

Activity 9.3
Mr. King had the following movements of inventory for the month of January.

Date Detail
01.01.17 Bought 100 pots at a unit cost of K30 each

15.01.17 Sold 70 pots at a unit price of K50 each

30.01.17 Bought 30 pots at a unit cost of K35 each

31.01.17 Sold 40 pots at a unit price K50 each

Required:
Calculate the value of inventory using FIFO and AVCO methods.
Check for the suggested solution on the next page.

5 Classes of Inventory
At this stage of your studies, you will concern yourself with three major classes of
inventory.
i. Raw materials: inventory which has not been subjected to a
manufacturing process e.g. tree logs earmarked for conversion into furniture.
ii. Work in progress: refers to partly processed units of inventory e.g. a
piece of incomplete furniture.
iii. Finished goods: units of inventory which are ready for consumption or use e.g.
complete piece of furniture ready for dispatch.

The Financial Accountant 2019

144
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

Date Detail # Units Unit cost Balance

FIFO K K
01.01.17 Receipt 100 30 3000
15.01.17 Issue (70) 30 (2100)
——— ———
Balance 30 900
30.01.17 Receipt 30 35 1050
——— ———
Balance 60 1950
31.01.17 Issue 40 30 900
——— ———
Value of inventory 20 35 1050
——— ———
AVCO
01.01.17 Receipt 100 30 3000
15.01.17 Issue (70) 30 (2100)
——— ———
Balance 30 30 900
30.01.17 Receipt 30 35 1050
——— ———
Balance 60 32.5 1950
31.01.17 Issue (40) 32.5 (1300)
——— ———
Value of inventory 20 32.5 650
——— ———

The Financial Accountant 2019

145
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

Session Summary
 Inventory refers to goods held for sale and therefore require special
accounting treatment.

 The inventory asset is a special asset for a business because it is

bought with an intention of making a sale.

 Inventory costs include purchase price, delivery cost and conversion

costs.

 Inventory should be valued at the lower of cost or net realizable value.

 There are three major methods of valuing inventory, FIFO, LIFO and
AVCO. The standard IAS 2 specifically prohibits the usage the LIFO
method.

 There are three types of inventory, raw materials, work in progress and
finished goods.

The Financial Accountant 2019

146
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

Preparation Question 1
Objective Test Questions
1 According to IAS 2, inventory should be valued at the lower of its cost or
net realizable value. Which accounting concept is directly related to the
statement above?
A Going concern
B Accruals concept
C Historical valuation concept
D Prudence concept

2 You are preparing the final accounts for a business. The cost of the items
in closing inventory is K128,450. This includes some items costing
K35,000 which got damaged in transit. You have estimated that they could
be sold for K36,500, if K10,000 is spent to repair them. What is the correct
inventory value to be included in the final accounts?
A K128,450
B K164,950
C K119,950
D K138,450 ZiCA Jun 2014

3 In times of inflation which inventory valuation method will report the

highest profit.
A Last in first out
B Periodic average cost
C First in first out
D Continuous Average cost

The Financial Accountant 2019

147
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

4 Which of the following costs would NOT be included in the cost of

inventory:
i Purchase price
ii Delivery cost
iii Abnormal wastage
iv Conversion cost
v Carriage outwards

A (i) and (v)

B (v) and (iii)
C (iv) and (v)
D (iii) and (i)

5 Skip-flop limited did not carry out an inventory count at the year end. The
company’s year end is 31 December 2017, but management only
conducted inventory count on 7 January 2018 and established that
inventory had a value of K320,600.

Purchases of inventory K50,000

Sales Returns K35,000
Stolen goods K5,000
Purchases returns K20,000

Calculate the value of inventory as at 31 December, 2017

A 260,600
B 380,000
C 210,000
D 430,000

The Financial Accountant 2019

148
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

6 If closing inventory is overstated what is the impact on reported profits

and net assets.

Profits Net assets

A Understated Overstated
B Understated Understated
C Overstated Overstated
D Overstatement understatement

7 On 1 June 2017, G limited had 70 units of inventory valued at K80 each.

During June, the following transactions took place.

 15 June, purchased 50 units at a cost of K90 per unit

 30 June, sold 60 units at a selling price of K110 per unit

Using the average cost method of valuing inventory, calculate G limited
value of inventory on 30 June 2017.
A 5,400.00
B 5438.30
C 5,050.20
D 6,100.00
[Total: 14 marks ]

The Financial Accountant 2019

149
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

Preparation Question 2
Inventory is one of the most important assets in a company‘s statement of financial
position. To this effect, IASB issued IAS 2 dealing with the valuation and presenta-
tion of inventory in the accounting books and financial statements.
Required:
a) Explain how the accrual principle applies in the way inventory is treated in the
Income Statement. (2 marks)

b) You operate a hardware shop. You are given the following information
regarding movement of cement stocks during the year ended 31 March 2013.

Unit Price
(K)
1 April 2012 Opening Inventory 200 Units K55
15 June 2012 Purchases 500 Units K58
08 August 2012 Sales 300 Units
03 October 2012 Sales 300 Units
05 December 2012 Purchases 200 Units K63
05 January 2013 Purchases 300 Units K66
02 February 2013 Sales 200 Units
20 March 2013 Sales 200 Units

Show how the issues and closing inventory would be determined, using
i) FIFO, and (9 marks)
ii) AVCO (9 marks)

[Total: 20 marks]

ZiCA Mar 2014

The Financial Accountant 2019

150
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

The Financial Accountant 2019

151
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

Suggested Solutions
Question 1
1 D
2 C
3 C
4 B
5 A
6 C
7 C

Question 2
(a) Application of accruals to inventory
Accrual requires costs to be matched with associated revenues for the same period.
To achieve this, costs incurred for goods which remain unsold at the year-end must
be carried forward in the statement of financial position and matched against future
revenues.

The Financial Accountant 2019

152
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

i) FIFO
Date Detail # Unit price Balance
1/04/12 Opening Bal. 200 55 11,000
15/06/12 Receipts 500 58 29,000
—— ————
15/06/12 Closing Balance 700 40,000

08/08/12 Issue 200 55 11,000

Issue 100 58 5,800
—— ————
Total Issue (300) (16,800)
08/08/12 Closing Balance 400 23,200

03/10/12 Total Issue (300) 58 (17,400)

—— ————
03/10/12 Closing Balance 100 58 5,800

05/12/12 Receipt 200 63 12,600

05/01/13 Receipt 300 66 19,800
—— ————
Total Receipts 500 32,400
Closing Balance 600 38,200

02/02/13 Issue 100 58 5,800

issue 100 63 6,300
—— ————
Total issues (200) (12,100)
Closing Balance 400 26,100

20/04/13 Issue 100 63 6,300

100 66 6,600
Total issues (200) (12,900)
—— ————
Closing Balance 200 66 13,200
—— ————

The Financial Accountant 2019

153
Study, understand and apply

The Financial Accountant

Cost of Sales and the treatment of Inventory

ii) AVCO
Date Detail # Unit price Balance
1/04/12 Opening Bal. 200 55 11,000
15/06/12 Receipts 500 58 29,000
—— ————
15/06/12 Closing Balance 700 57.14 40,000

08/08/12 Issue (300) 57.14 (17,142)

—— ————
08/08/12 Closing Balance 400 57.14 22,856

03/10/12 Issue (300) 57.14 (17,142)

—— ————
03/10/12 Closing Balance 100 57.14 5,714

05/12/12 Receipt 200 63 12,600

05/01/13 Receipt 300 66 19,800
—— ————
Closing Balance 600 63.52 38,114

02/02/13 Issue 100 63.52 6,352

issue 100 63.52 6,352
(200) 63.52 (12,704)
—— ————
Closing Balance 400 63.52 25,410

20/04/13 Issue 100 63.52 6,352

100 63.52 6,352
—— ————
(200) 63.52 (12,706)
—— ————
Closing Balance 200 63.52 12,704
—— ————

The Financial Accountant 2019

154
Study, understand and apply

The Financial Accountant

Session 10
Accounting for Depreciation
Focus
Businesses use tangible non-current assets in their daily activities in order to
generate income. IAS 16 defines tangible non-current assets as assets which are
used in the production and supply of goods and services. Generally, these assets
will lose value overtime. In this session we will discuss the accounting treatment of
tangible non-current assets, depreciation and revaluation of assets among other
things.

Learning objectives
Upon completion of this session you should be able to explain:

 The difference between capital and revenue expenditure

 The concept of depreciation

 Causes of depreciation

 How to account for depreciation

 How to account for disposals of non-current assets

 The purpose and content of the non-current asset register

The Financial Accountant 2019

155
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

1 Capital and Revenue Expenditure Commentary

As a matter of starting on the right foundation, we There are two main
will do well to distinguish capital expenditure from accounting concepts that
revenue expenditure as highlighted in the table underpin the idea of
below : depreciations namely the
accruals and going concern
Capital Revenue concepts. With regards to the
expenditure expenditure accruals concept,
accountants assert that it is
not right to expense the cost
Expenditure Expenditure
of a non current asset
which results in incurred for
the acquisition maintaining the because benefits arising from
the usage of the asset
Definition or earning
usually last for more than one
improvement capacity of
accounting period. Under the
of non-current non-current
going concern concept it is
assets. assets
assumed that the economic
useful life of the depreciable
asset is less than the life
This type of Examples here span of the business.
expenditure include repairs, Further, if a company is not a
includes maintenance going concern, then the
Descrip- purchase of costs, utility assets will be sold off at their
tion land, buildings, bills, salaries, enforceable net realizable
machinery and purchases to value.
office mention but a
equipment. few.
Capital The failure to make a
expenditure Revenue difference between capital
should not be expenditure and revenue expenditure will
expensed, but should be inevitably result in countless
Account- must be initially expensed in the errors of principle which
ing recognized in correct misstates reported profits and
treatment the statement accounting net assets. For a trained
of financial period in the Accountant, this distinction is
Position in the statement of a basic competence.
year of profit or loss.
acquisition.

DR Asset DR Expense
Double
CR Bank or CR Bank or
entry
Payable Payable

The Financial Accountant 2019

156
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

The need to recognize the difference between capital and revenue expenditure is a
basic competence in accounting. the table below gives more insight on the above
thought.

Error of principle Implications

 Understated expenses
Revenue expenditure treated as
capital expenditure  Overstated profits
(The bookkeeper omitted an  Overstated assets
expense and created a false asset)
 Overstated Capital

Capital expenditure treated Revenue  Overstated expenses

expenditure
 Understated profits
(The bookkeeper omitted to record an
asset and created a false  Understated Assets
expense)
 Understated Capital

If you bought a Machine, you will need to classify it’s component costs
into capital or revenue expenditure as highlighted below.
Capital Revenue
Expenditure detail
expenditure expenditure
Yes Purchase price of asset

Yes Delivery Cost

Yes Installation Cost

Yes Legal costs

Yes Non-refundable taxes

Repairs/maintenance Yes

Lubricating oil Yes

Insurance Yes

The Financial Accountant 2019

157
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

2 Depreciation defined Commentary

Depreciation is the gradual loss in the Many students find it easy to
depreciable value of a tangible remember that depreciation
non-current asset. It is the systematic allocation is simply the incremental loss
of the cost of an asset over its useful life. in asset value over a period
of time.

What depreciation is not !

The depreciation policy
 Depreciation does not involve saving cash adopted by a business is
for the eventual replacement of an asset. largely subjective.
 Depreciation is not a cash expense but is
rather an accounting expense.
Accounting for depreciation
 Depreciation is not a means of calculating is influenced by two major
the market value of an asset. accounting concepts; the
going concern and accruals
concepts.
Causes of Depreciation
There several causes of depreciation including:
 Wear and tear resulting from continued The above factors will
reduce the value of a
usage of the asset.
depreciable tangible non-
current asset overtime. It is
 Rust resulting from changes in the weather therefore necessary for
pattern. accountants to reflect the
loss in asset value in their
reports. That said, not all
 Obsolescence resulting from technological/ assets should be subject to
fashion changes. depreciation. Freehold land
for instance is an
appreciating asset and
 Change in law which prohibits the
should therefore not be
production of certain goods or services. depreciated.

 Depletion of wasting resources such as

copper or oil.

 The passage of time which will reduce the

value of leased assets as the lease contract
contains an expiry date.

The Financial Accountant 2019

158
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

Depreciation Methods

Professional examinations focus on two depreciation methods namely:

 Straight line and

 Reducing balance
Other depreciation methods such as the sum of digits, double reducing balance and
machine hours will not be discussed in this session. In the table below we make a
distinction between the first two depreciation methods. Students are encouraged to
use alternative sources of information for the aforementioned depreciation methods.
The depreciation method used should as far as possible reflect a reasonable
estimate of benefits derived from the usage of an asset overtime.

Straight line method Reducing balance

A depreciation method which A depreciation method which

Description charges a fixed amount of charges a variable amount of
depreciation against profits. depreciation against profits.

Cost – Scrap Value Depreciation=(Cost –

Formula Dep= ——————————- Accumulated depreciation) x
Years Depreciation rate

Alternative Depreciation = Cost x Depreciation = Net book Value x

formula depreciation rate Depreciation rate

 Scrap value or disposable value is the amount at which a business is likely to

sale an asset after it has out lived its useful value.
 Net book value is cost less accumulated depreciation.
The choice of depreciation to be used depends on the professional judgment of an
accountant. It is also generally agreed that the rates of depreciation for different
assets varies. Assets like machinery and motor vehicles whose value reduces
significantly overtime, are likely to be depreciated using reducing balance. Assets
such as furniture and buildings whose value remain relatively stable overtime, are
likely to be depreciated using the straight line method.

The Financial Accountant 2019

159
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

We now turn to accounting for depreciation and so far we have really been biased
towards depreciation theory; an arithmetic example will be helpful here.

Activity 10.1
Clement Plc. bought a machine for K20,000 whose economic useful life is expected
to be 4 years on 1 January 2014. The scrap value of the asset after four years will
be K4,000.
You are required to compute:

i) Depreciation using the straight line method for four years.

ii) Depreciation using the reducing balance assuming the depreciation rate is 10%
for four years.
iii) Compute the profit or loss on disposal if the asset is sold at the end of year one
for K15,000.
Solution :
(i) Straight line method
=20,000-4,000/4yrs
=K4,000

The four years depreciation will look as follows

Year Cost Depreciation Net book

Value
K K K
2014 20,000 4,000 16,000
2015 20,000 8,000 12,000
2016 20,000 12,000 8,000
2017 20,000 16,000 4,000

 The depreciable amount in this case was K16,000 (K20,000 - K4,000)

 The K4,000 at the end of year four represent the scrap value (estimate) of this
Machine. The scrap value of K4,000 should not be depreciated!

The Financial Accountant 2019

160
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

(ii) The Reducing balance method

Extracts of the reducing balance are given below:

Details Values Dep

K K

Cost 20,000
Dep @10% (Yr. 1) (2,000) 2,000

———— ————
Net Book Value 18,000
Dep@10% (Yr. 2) (1,800) 1,800

———— ————
Net Book Value 16,200
Dep @10% (Yr. 3) (1,620) 1,620

———— ————
Net book Value 14,580
Dep @10% (Yr. 4) (1,458) 1,458

———— ————
Net Book Value 10,206

3 The Disposal Account

Before we look at the last question in our example above, let us take some notes on
the all important disposal account.
The disposal account is a temporal account used to establish the profit or loss that
arises on the sale or disposal of a non-current asset. The profit or loss arising on the
sale of an asset does not result in a cash movement it is simply an accounting gain
or loss. The standard format of a disposal account is given on the next page.

The Financial Accountant 2019

161
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

(iii) Disposal Account

Once completed, the disposal account will look like the account below!

Disposal Account
K K
Cost 10,000 Depreciation 2,000
Profit on disposal 7,000 Bank/Trade in 15,000
———- ———-
17,000 17,000
———- ———-

Trade in value
A business in need of a new asset may not have enough resources to meet a
required offer price. It is easy to suggest that such a business should simply get a
loan to make up for the shortfall. Although such a proposal is persuasive, it may not
be the best solution. Perhaps an ideal solution to such dilemmas is to negotiate for
a trade in transaction with a supplier. In a trade in deal the customer buys a new
asset from a supplier by making payments in two modes, a cash payment and
payment in kind.

An illustration will do here:

Let us assume that Banda who is a tailor by profession, decided to replace his old
manual tailoring machine with an electric machine. Banda knows a supplier who is
willing to sell him a new machine at K15,000 but he only has K11,000 in his
business bank account. Banda has an option of giving up his old tailoring machine
to make up for the shortfall of K4,000 (15,000-11,000). It is this difference that is
known as the trade in value. Building on the illustration above, we may ask the
question did Banda make a loss or profit on the disposal of the old machine? The
answer can only be found if we know the carrying amount (Net Book Value) of the
old machine.

Carrying Value Trade in Value Outcome

K4,000 K4,000 Nil loss/Nil profit (K4000 - K4000)
K5,000 K4,000 Loss of K1000 (K4000 - K5000)
K3,000 K4,000 Profit of K1000 (4000 - K3000)

The trade in value (K4,000) is usually credited to the disposal account!

The Financial Accountant 2019

162
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

If a business makes an asset disposal, the steps below are to be followed :

Step Detail Double entry
 Transfer the cost of the asset to
disposal account.
DR Disposal account
1
 A disposed asset must be CR Asset account
removed from the asset
account.
 Transfer the accumulated
depreciation of the asset to the
disposal account. DR Accumulated depreciation
2 account
 The total depreciation of the
disposed asset must be CR Disposal account
removed from accumulated
depreciation account.

 Establish the cash received

from the buyer of the asset or
the trade in value of an old
DR Bank Account
3 asset and slot it on the credit
side of the disposal account. CR Disposal account

 Disposal proceeds are normally

given in the question.

Close off the account!

DR Profit or Loss
 If the account is a debit balance
4 then there is a loss on disposal. CR Disposal account

 If the account is a credit balance DR Disposal account

then there is a profit. CR Profit or Loss

4 Non-Current Asset Revaluation

Asset revaluation is a process of restating asset values. Asset revaluation can result
from many factors. For instance a decrease in market values of related assets may
affect the value of assets held. Damage to an asset may force management to alter
the value of the affected asset. Two possible revaluation movements are discussed
here.

The Financial Accountant 2019

163
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

Upward revaluation

Involves increasing the carrying value of an asset

K
Debit Asset account X
Credit Revaluation Surplus X

Downwards revaluation
Involves decreasing the carrying value of an asset

K
Debit Revaluation Surplus X
Credit Asset account X

5 The Non-Current Asset Register

For internal control purposes, some organizations maintain a non-current asset
register. This register is a handy tool for periodic physical verification of
non- current assets. It is important to note that the register does not form part of
double entry. Some of the details found in the register include.
 The description of the asset

 The location of the asset

 The purchase price of an asset

 The date of purchase

 The accumulated depreciation of the asset

 The net book value

 The tag number

 The manufacturer’s serial number

 Movements of assets within the organization

The non-current asset account in the general ledger should be reconciled with the
non-current asset register total on a regular basis and any discrepancies identified
should be rectified by management to minimize the risk of asset abuse or theft.

The Financial Accountant 2019

164
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

Session Summary
 Businesses use tangible non-current assets in the provision of goods
and services.

 The key thought under this session is that the loss in value of assets
(depreciation) must be accounted for.

 Many assets (with the exception of land) gradually lose value an idea
commonly known as depreciation.

 Capital expenditure usually gives rise to a non-current asset.

 There are many causes of depreciation including, wear and tear, rust,
obsolescence to mention but a few.

 Depreciation is simply an accounting expense and is not a cash

expense.

 The two major methods of depreciation are straight line and reducing
balance.

 Revaluation is a process of restating asset values.

 The non-current asset register records details of non-current assets

held by a firm which does not form part of double entry.

The Financial Accountant 2019

165
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

Preparation Question 1
Objective Test Questions
1 A machine cost K9,000. It has an expected useful life of six years and an
expected residual value of K1,000. It is to be depreciated at 30% per
annum on the reducing balance basis. A full year’s depreciation is
charged in the year of purchase, with none in the year of sale. During year
4 it is sold for K3,000. The profit or loss on disposal is:
A Loss K87
B Loss K2,000
C Profit K256
D Profit K1,200 ZiCA Jun 2013

2 The accounting concept which requires that non-current assets should be

recorded at cost, less accumulated depreciation, rather than their
enforced saleable value, is the:
A Net selling price concept
B Going concern concept
C Realisation concept
D Prudence concept ZiCA Jun 2013

3 An asset was bought on 1 April 2010 for K800,000. It is being depreciated

for 20% reducing balance method, with full year depreciation in the year
of purchase and none in the year of disposal. On 20 November 2014, the
asset was sold at a profit of K67,000. How much were the proceeds from
the sale of the asset. The accounting year ends on 31 December every
year.
A. K327,680
B. K394,680
C. K260,680
D. K329,144 ZiCA Dec 2015

The Financial Accountant 2019

166
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

4 A non current register showed a carrying amount for non current assets
of K90,570. It is later discovered that a non current asset costing K50,000
had been sold for K15,250, making a profit of K3,500. This was not
reflected in the asset register.
What is the correct balance on the non-current asset register after taking
the disposal in to account?
A K71,820
B K78,820
C K91,750
D K102,320 ZiCA Dec 2014

5 On 1 January 2004, a business sold a van which it bought on 1 January

2001 for K6,000 and has depreciated each year at 25% per annum using
the straight-line method. It trades this van in for a new one costing
K10,000 and pays the supplier K9,200 by cheque.
What is the profit or loss on the disposal of the old van?
A K700 loss
B K800 profit
C K1,500 profit
D K1,500 loss

6 What is the main reason for charging depreciation in the financial

statements?
A To save money for eventual replacement of the asset in use
B To calculate the market value of an asset at each year end
C To calculate the replacement value of an asset
D To allocate the cost of an asset over its economic useful life

The Financial Accountant 2019

167
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

7 Which ONE of the following options is an example of capital expenditure?

A Replacement of old sits in a motor vehicle
B The cost of painting a building with a different color
C The cost of building an extension to already existing premises
D The cost of comprehensive insurance of an asset
[Total: 14 marks]

The Financial Accountant 2019

168
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

Preparation Question 2
a) Explain the distinction between revenue expenditure and capital expenditure.
Give examples. (4 Marks)

b) State whether each of the following items should be classified as ‗capital‘ or

‗revenue‘ expenditure.

i) Purchase of additional high capacity hard disk drive for the computer server.

ii) Computer maintenance costs.

iii) Cost of new plant.

iv) Customs duty charged on the plant when imported.

v) Installation cost of new plant.

vi) Cost of wages for plant operators.

vii) Carriage costs of transporting the new plant from the suppliers‘ factory to the
premises of the business purchasing the plant.

viii) Replacement of broken shelves in administration offices.

ix) Legal fees in respect of purchase of land.

x) Ground rent paid annually for the piece of land. (5 Marks)

c) Identify the three (3) components that comprise the cost of property, plant and
equipment, according to IAS 16.
(3 marks)
d) The following information was provided relating to tangible assets for Walasa
Limited.

Cost Accumulated depreciation

1 January, 2013 1 January, 2013
K‘000 K‘000
Land and buildings 600 100
Machinery 200 128
Motor vehicles 150 75

The Financial Accountant 2019

169
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

You are also furnished with the following information.

The cost of land was K200,000. Depreciation was provided as follows:

Buildings 5% straight line

Machinery 40% reducing balance
Motor vehicles 25% straight line.

Land and buildings were revalued on 1 January 2014, land K350,000 and buildings,
K500,000.
Required:
(i) Show the accounting treatment of the revaluation. (3 marks)

(ii) Show how the non-current assets will be disclosed in the accounts as at 31
December, 2013. (5 marks)
[Total: 20 marks]
ZiCA Jun 2016

The Financial Accountant 2019

170
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

Suggested Solutions
Question 1
1 A
2 B
3 B
4 B
5 A
6 D
7 C

Question 2
a) Distinguishing between revenue and capital expenditure
Revenue expenditure is expenditure incurred:
 for the purpose of the trade (goods bought for resale and day-to-day
operating expenses).
 to maintain the existing earning capacity of the business.

 This cost is charged as an expense to the profit or loss account in the

period incurred.
Capital expenditure:
 This is expenditure for the acquisition of non-current assets or to improve their
earning capacity.
 Results in the appearance of non-current assets in the statement of
financial position.

 The cost of which is charged to income statement over the useful life
(depreciation).

The Financial Accountant 2019

171
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

b) Classifying expenditure
i) Capital
ii) Revenue
iii) Capital
iv) Capital
v) Capital
vi) Revenue
vii) Capital
viii) Revenue
ix) Capital
x) Revenue

c) State the three Components of cost

1. Purchase price, less any trade discount or rebate.

2. The initial estimate of the costs of dismantling and removing item and restoring
the site on which it is located.
3. Directly attributable costs of bringing asset to working condition for its intended
use e.g. installation costs, professional fees.

d) Accounting treatment of revaluation.

Journal entries

DR CR
K‘000 K‘000
Buildings cost (K500, 000 – K400, 000) 100,0000
Accumulated Depreciation on buildings (100,000+20,000) 120,000
Land –cost (350,000 – 200,000) 150,000
Revaluation reserves (100,000 + 20,000 +150,000 370,000

The Financial Accountant 2019

172
Study, understand and apply

The Financial Accountant

Accounting for Depreciation

e) Disclosure of non-current assets

Statement of financial position (extract only)

Cost Depreciation NBV

K‘000 K‘000 K‘000

Land and Buildings 600 (120) 480
Machinery 200 (156.8) 43.2
Motor vehicles 150 (112.5) 37.5
———— ————— ————
Total 950 389.3 560.7

———— ————— ————

The Financial Accountant 2019

173
Study, understand and apply

The Financial Accountant

Session 11
Intangible Non-Current Assets

Focus
Many businesses today control intangible non-current assets which can significantly
contribute to income generation. IAS 38 requires that such assets should be
recognized in the financial statements only if a specific criterion is met.

Learning objectives
Upon completion of this session you should be able to:

 Define Intangible non-current asset assets

 Distinguish between research and development expenditure

 Account for intangible non-current assets

The Financial Accountant 2019

174
Study, understand and apply

The Financial Accountant

Intangible non-current assets

1 Intangible Non-Current Asset Commentary

According to IAS 38 an intangible The standard IAS 38
non-current asset is a non-monetary asset discourages the recognition
without physical substance. of internally generated
intangible assets because
At this stage in your studies it helps to remember such assets cannot be
that an intangible non-current asset can be reliably measured and it‘s
evidenced by written contract or ownership of an difficult to ascertain or
asset which cannot be touched. quantify the benefits to be
Examples of intangible non-current assets derived from such assets
over time. The general
include:
guideline therefore is that all
 Goodwill internally generated
intangible assets should be
 Patents expensed in the period of
incurrence unless the
 Copyrights expense can meet the PIRAT
criteria which is discussed on
 Trademarks the next page.
 Brands Purchased intangible assets
can be capitalized because
 License there is an objective price tag
attached to them. The
bookkeeper knows the
Probably a major problem under this session is transaction price of the
the valuation of intangible assets which tends to intangible asset through
be subjective rather than objective, especially reference to a source
when we consider internally generated intangible document.
assets. Internally generated intangible assets
such as goodwill will not be valued objectively
due to potential for management bias. That is Examples of purchased
precisely the reason why the standard IAS 38 intangible non-current assets
discourages the recognition of internally include, licenses, goodwill,
generated goodwill. This rule applies to all patents, mining rights,
internally generated intangible assets. As a reult, copyrights to mention but a
only purchased intangible assets are to be few.
recognized in the financial statements because
values for such assets can be objectively
measured.

The Financial Accountant 2019

175
Study, understand and apply

The Financial Accountant

Intangible non-current assets

2 Research and Development expenditure

A distinction between research and development expenditure is vital. The table
below shows us the basic differences between research and development costs.

Research expenditure Development expenditure

Research is initial investigation

Development expenditure is the
carried out to obtain new knowledge
application of research knowledge which
and understanding about new
improves current products or processes.
products and processes.

Capitalize development expenditure in

the statement of financial position under
Expense research costs in the the heading intangible non-current
income statement in the relevant assets.
accounting period. This is because
the reporting entity is not in a position The pirate criteria must be fully met
to derive long term economic before a cost is deemed to be
benefits from this cost. development expenditure.
 Probable flow of future economic
benefits
(Caution!)
 Intention to complete asset for use
Its important to note that or sale
non-current assets such as motor
vehicles, computers, laboratory  Reliable cost measurement
facilities used in research should be
treated as capital expenditure  Adequate technical, financial and
because the business can still use other resources to complete asset
these assets for other beneficial
activities on a long term basis.  Technical feasibility

3 Accounting for Intangible Assets

Most intangible assets with the exception of goodwill are amortized over their useful
economic life. Amortization, which is similar to depreciation, can be defined as the
systematic allocation of the cost of an intangible non-current asset over its useful
life. The formula for amortization is given below :
Cost
Amortization = ————
Years

The Financial Accountant 2019

176
Study, understand and apply

The Financial Accountant

Intangible non-current assets

4 Goodwill Commentary
We cannot close this session without discussing
the unique intangible asset known as goodwill. Without goodwill, unless a
Goodwill is probably one of the most important firm enjoys monopolistic
asset that any business can possibly have. advantage, it will eventually
fail to survive.
Goodwill which is many times crudely defined as
an intangible asset of a business, can only be Goodwill is the difference
reliably measured when a buyer turns up and between the selling price of a
offers to buy an entity at a price above the value business and the value of its
of its separable net assets. The constitutes of separable net asset.
goodwill include;

 business contact base

 strategic physical location
 quality of staff
 Public perception of the company

Business experts argue that the value of a Again goodwill recognition is

business with a future cannot be restricted to restricted to purchased
what meets the eye, because all progressive goodwill and not internally
businesses have the so called invisible value generated goodwill.
which the new owners of the business should pay
for. Goodwill can therefore be seen to be that
extra value over and above the net asset value of
a business.

The goodwill asset once recognized, should not It is assumed that goodwill
be amortized at all, but should be tested for will last for as long as the
impairment at least once in a year. Impairment is business thrives and so
a substantial loss in the value of an asset. If the goodwill will not lose value
market value of a business is lower than its net gradually like other intangible
assets value then we can safely conclude that assets and should therefore
goodwill has been impaired. not be amortized but only
tested for impairment at least
The double entry of purchased goodwill is given once per year.
below.
Impairment here refers to the
DR Goodwill substantial (one off) loss in
asset value.
CR Bank

The Financial Accountant 2019

177
Study, understand and apply

The Financial Accountant

Intangible non-current assets

Session Summary
 Intangible assets are assets without physical substance.

 Internally generated intangible assets are generally not recognized in

the financial statements.

 Purchased intangible assets such as goodwill, patents etc. can be

recognized according to IAS 38.

 Research expenditure is treated as revenue expenditure and is

accordingly expensed in the statement of profit or loss.

 Development expenditure can be treated as capital expenditure only if

the PIRAT criterion is fully met.

 Infinite intangible assets such as development expenditure are

supposed to be amortized over their useful economic life.

 Indefinite intangible assets such as goodwill are not supposed to be

amortized but should be tested for impairment at least once in a
year.

The Financial Accountant 2019

178
Study, understand and apply

The Financial Accountant

Intangible non-current assets

Preparation Question 1
Objective Test Questions
1 Which of the following is NOT an example of an intangible asset?
A Computer Software
B Patents
C Goodwill
D None of the above ZiCA Jun 2010

2 The standard IAS 38 prohibits the recognition of internally generated

intangible assets. Which ONE of the following reasons justifies the above
statement.
A Intangible assets do not generate economic benefits
B Intangible assets can easily be scrapped off
C The economic benefits of intangible assets cannot be reliably measured.
D Intangible assets are non monetary assets

Learning objectives
Upon completion of this session you should be able to:

 Explain the concept of accruals and prepayments

 Account for accruals and prepayments

 Account for differed income

The Financial Accountant 2019

185
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

1 The Concept of Accruals Commentary

Accounting
The accrual concept literally
The accruals concept of accounting, also known compels an Accountant to
as the matching concept is a single important
concept in your accounting studies. If you recall, consider two important
this concept states that expenses and income factors when preparing the
should be recognized in the relevant accounting financial statements. Firstly,
period upon occurrence regardless of whether there is need to recognize
cash is paid or received. credit transactions. The
default approach to
Accruals Prepayment
accounting until recently has
An expense An advance
payment. been, if cash has not
incurred not yet
changed hands, then there
invoiced or paid Service or
Definition would be no need to
Service is product is paid
(expense recognize the transaction.
enjoyed or used for now but
point of The accrual concept
now and used or
view)
payment is enjoyed in the acknowledges the fact that
made on a later near future income can be earned before
date. it is received and that an
Type of An accrued An advance expense can be incurred
business expense is a payment is a before payment is made.
transac- credit cash
tion transaction! transaction. Secondly, there is need to
pay attention to the time or
Impact on period in which a transaction
A prepaid took place. Every accountant
assets An accrued
expense gives must know when his
expense gives
and rise to an accounting period begins and
rise to a liability!
liabilities. asset! when it ends.
To simplify the thinking
Effects on the financial statements behind accruals and
prepayments it is better to
Increase Decrease discuss the two words side by
Impact on expenses expenses side using a table. Note that
Income
we have deliberately started
state-
with expenses in illustrating
ment. Reduce profits Increase profit the points below. The
concept of accruals also
Impact on applies to income.
Reduce net Increase net
the assets assets
statement
of
Financial Increase Reduce
Position liabilities liabilities

The Financial Accountant 2019

186
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

Accounting for accruals and prepayments

The examiner is likely to test the student‘s knowledge on how to accrue for
expenses and incomes which are paid or received in periods which are different
from the accounting period under consideration. It really helps to know that accruals
and prepayments will arise at the financial year end. Therefore knowledge of the
year end and of course year start, is critical for getting easy marks on this topic. In
other words, you must know your calendar dates. The default ledger accounts below
are a good starting point for working out amounts to transfer to the statement of
profit or loss.
Accruals and prepayments standard formats

Expense Account
K K
b/f prepayment X b/f Accrual X
Bank or Cash X Profit or loss X
Accrued expense X c/d prepayment X
—— ——
X X
—— ——

Income Account
K K
b/f income (arrears) X b/f prepayment X
Profit or loss X Bank or Cash X
Prepaid income X c/d accrued X
—— ——
X X
—— ——

The usage of a timeline can go a long a way in resolving accruals and

prepayments related questions. That said, the student needs to practice several
questions in order to have a fair chance of succeeding in this topic.

The Financial Accountant 2019

187
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

Notes on the expense account

 The brought forward (b/f) prepayment represents an amount paid in advance
from the previous accounting period. This amount, although paid last year is a
cost incurred in the current year and therefore appears on the debit side of the
expense account.
 The brought forward (b/f) arrear, represents a cost incurred in the previous year
but only paid in the current accounting period. This expense must be credited to
the expense account because the expense was incurred in a different year. If
you debit this amount, you will overstate your current year expenses and
understate reported profit.
 The bank entry on the debit side of the account represents cash payment
towards an expense. Remember that the credit entry is always entered in the
bank account.
 The carried down (c/d) accrual on the debit side represents an amount incurred
in the year under consideration but not yet paid up and so a corresponding
credit entry is entered on the accrual account which is a current liability.
 The balance carried down (c/d) prepayment represent an advance payment
made for an expense to be incurred in the following year. This expense relates
to a different year and is credited accordingly.

Notes on the Income Account.

 The income account operates in a similar way to the expense account but this
time we pass opposite entries like always, from the default position.
 The b/f prepayment (CR balance) represent receipts received in the previous
year but earned in the current year.
 The b/f arrear (DR Balance), represents income earned last year but only
received in the current year. This income does not relate to the current year and
hence it is debited to the income account.
 The bank credit entry represents amounts received during the year-remember
to debit the bank account.
 The balance c/d arrear represents Income earned in the period but not yet
received. This is current year income and is credited to the account.
 The balance c/d prepayment represents income relating to the following year
although paid in the current period. This is different year income which should
be debited to the account.

The Financial Accountant 2019

188
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

2 Differed Income
Let us close this session by looking at the equally important idea of differed income.
Sometimes customers pay suppliers for goods yet to be supplied and this gives rise
to an advance payment. When a client pays for goods in advance, a supplier should
recognize in their books, cash received with a corresponding differed income liability.
It is important to observe here, that while the cash is received the supply has not yet
been made. This income will only be earned when the supply is made. Thus it is
rightly referred to as differed (future) income with a condition to supply.
The double entry for differed income is:
DR Bank
CR Differed Income

The Financial Accountant 2019

189
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

Session Summary
 The key behind understanding the content of this session lies in
appreciating the requirements of accruals concept of accounting.

 The accruals concept reinforces the need to recognize credit

transactions and the timing of transactions which are crucial for
reporting credibility.

 Remember, both income and expenses can be accrued but you need
to know the default entries of income as well as expenses.

 All established current year expenses must be debited and different

year expenses should be credited to the expense account.

 All calculated current year income must be credited and different year
income should be credited to the income account.

 Differed income arises when there is an advance receipt from a

customer before a supply is made.

The Financial Accountant 2019

190
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

Preparation Question 1
Objective Test Questions
1 KPG occupied a building from 31 March 2011. The annual rental obligation
was agreed at K2,400 until 30 September 2011 when it was revised to
K3,600 per year. KPG undertook to be paying the rent on a semester basis
in advance on 1 April, and 1 October.
What amounts were shown in the financial statements for the year ended
31 December 2011? .

Income Statement Statement of Financial Position

Prepayment Accrual
A K3,000 K900
B K2,700 K900 -
C K3,000 - K900
D K2,100 K900 ZiCA Jun 2012

2 If accrued insurance of K600 was incorrectly treated as prepaid insurance

in the books of Ponga limited, what is the effect on net profit, assets and/
or liabilities.
A Profit overstated by K600 and assets overstated by K600
B Profit understated by K600 and assets understated by K600
C Profit overstated by K1,200 and assets overstated by K1,200
D Profit understated by K1,200 and assets understated by K1,200
ZiCA Dec 2012

The Financial Accountant 2019

191
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

3 Expenses incurred in the period should be matched with incomes earned

in the same period, in order to ascertain profit for the period.
Which accounting concept relates to the above statement?
A Duality concept
B Business entity concept
C Accruals concept
D Substance over form concept ZiCA Jun 2014

4 A company receives rent for subletting part of its office block. Rent
receivable quarterly in advance is received as follows:

Date of receipt Period covered K

1 October 3 months to 31 December 2012 75,000

30 December 3 months to 31 March 2013 75,000

05 April 3 months to 30 June 2013 90,000

07 July 3 months to 30 September 2013 90,000

01 0ctober 3 months to 31 December 2013 90,000

What figures, based on these receipts, should appear in the company’s

financial statements for the year ended 30 November, 2013?
A K340,000 credit Rent received in advance K30,000
B K340,000 debit Rent in arrears K30,000
C K340,500 credit Rent received in advance K60,000

D K340,000 credit Rent in arrears K30,000

The Financial Accountant 2019

192
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

5 Incurring an expense before cash is paid is an example of what kind of

adjustment?
A Accrued Liability
B Deferred Expense
C Accrued Asset
D Deferred Revenue

6 Pendo’s electricity account showed a prepayment of K1,200 and an

accrual of K800 on 1 January 2014. The posting to the profit or loss
account for the year ended 31 December 2014 was K24,500. The account
shows a prepayment of K700 and an accrual of K650 on 31 December
2014.
How much had been paid for electricity during the year ending 31
December 2014?
A K24,050
B K24,150
C K24,500
D K24,850 ZiCA Dec 2015

7 On 29 December 2017, Mike received an order with an advance payment

from one his regular clients. Mike only fulfilled the order five days after
the payment to ensure that his client gets the best possible value for their
money. What is the double entry for the above transaction if Mike
prepared his final accounts on 31 December 2017.
A DR Mike CR Customer
B CR Customer DR Mike
C DR Bank CR Differed Income
D DR Bank CR Sales
[Total: 14 marks]

The Financial Accountant 2019

193
Study, understand and apply

The Financial Accountant

Question 2

Receivable ledger control account

K K
Balance b/f 40,120 Balance b/f 285
Sales 318,640 Bank 276,060
Discount allowed 11,640
Returns inwards 5,010
Irrecoverable debts 1,630
Contra 2,170
Allowance-damaged 1,060
goods
Balance c/f 285 Balance c/f 61,190
————— —————
359,045 359,045
————— —————

The Financial Accountant 2019

196
Study, understand and apply

The Financial Accountant

Prepayments and Accruals

Payable ledger Control account

K K

Balances 525 Balance b/f 31,175

Discount received 7,375
Cash paid to suppliers 186 535 Purchases 199,870

Returns outwards 2,675 525

Contra 2,170
Balance c/f 32,290
———— ————

23,170 23,1570

———— ————

Rental Income Account

K K
Arrears b/f 21,150 Prepayments/f 51,300
Statement of profit and 429,300 Received 419,300
loss
Prepayments c/f 44,350 Arrears c/f 24,200
————- ————-
494,800 494,800
————- ————-

The Financial Accountant 2019

197
Study, understand and apply

The Financial Accountant

Session 13
Irrecoverable debts and
Allowance for Receivables

Focus

It is now common for most business houses to supply goods and services on credit.
This gives rise to a receivable asset which is essentially a promissory note that gives
the supplier a right to receive cash in future. This session looks at the possible
implications of a credit supply and the need to anticipate losses that may arise there
on.

Learning objectives
Upon completion of this session you should be able to explain :

 The impact and management of credit risk

 How to account for irrecoverable debts

 How to account for allowance for receivables

The Financial Accountant

Receivables and Allowance for Receivables

3 Allowance for Receivables Commentary

(Provision for Irrecoverable
Debts)
In addition to accounting for irrecoverable debts,
a business will need to provide for potential future The prudence concept states
losses arising on the year end receivable balance that assets should not be
because of the simple fact that some of its credit overstated. If management
customers will not pay up their balances. Again, has a good reason to believe
this cold reality compels us to remember the that a debt will not be
prudence concept which requires the full recovered, a loss must be
recognition of anticipated material losses which recognized in full
may arise on a receivable balance. immediately.

There are two categories of allowances for

receivables namely; specific and general
allowance. A Specific allowance is a provision
made on a specific credit customer and a general
allowance is a provision made on the year end
outstanding receivable balance.

Accounting for Receivables Allowance

It is important to master the
Specific allowance machination behind the two
types of allowances above in
DR Receivable‘s expense order to pick up easy marks
CR Allowance for receivables on this topic during your
exams.
General allowance
For the general allowance on receivables, we
must first establish whether there was an
increase or decrease in the allowance for
receivables and then proceed accordingly :
An increase in allowance for
If there is an Increase in the General allowance receivables will result in
for receivables you should : working capital decrease.
DR Receivable‘s Expense
CR Allowance for Receivables

If there is a Decrease in the General allowance

for receivables we should :
DR Allowance for Receivables
CR Receivable‘s Expense or credit the income
statement by increasing gross profit with the
amount.

The Financial Accountant 2019

201
Study, understand and apply

The Financial Accountant

Receivables and Allowance for Receivables

Below is a suggested format for tackling questions which involves irrecoverable

debts and allowance for receivables.

Detail Values Comment

Km’

Normally given in the question or trial

Year end Receivables 2500
balance.
Remember to treat this amount as an
Less Irrecoverable debt (100)
expense
Less specific allowance
(20) Also treated as an expense
for Receivables

————

Outstanding This figure is the basis for the closing

2380
Receivables allowance

————

Closing allowance @ The examiner will give you the closing

238
10% allowance percentage(%)
Given in the question or check the credit
Opening allowance (200)
column of the trial balance

————

Increase/Decrease in If the answer is (+) you have an increase in

38
allowance allowance for receivables which must be
treated as an expense.
————
If the answer is (-) you have a decrease in
allowance for Receivables which must be
treated as sundry income

The Financial Accountant 2019

202
Study, understand and apply

The Financial Accountant

Receivables and Allowance for Receivables

Session Summary
 Credit risk is a business reality and its effects should be recognized in
accounting books in order to avoid the consequences of inflating
profits.

 An irrecoverable debt is one which is unlikely to be collected.

 An irrecoverable debt is an accounting expense.

 Recovered debts which where written off are to be treated as sundry

income.

 Businesses must provide for future losses on potential delinquent

clients in accordance with the prudence concept.

 There are two types of allowance for receivables; a specific allowance

6 ____________risk is the risk that a credit sale will not be collected.

A Financial risk
B Customer risk
C Business risk
D Credit risk

7 In a typical organization the credit control department is responsible for

assessing the credit worthiness of customers so as to manage credit
risk. An effective credit control department will approve credit supplies to
a qualifying customer based on which ONE of the following options.
A Customers willingness to pay
B Past customer relations
C The credit limit of the company
D The ability of the customer to pay off his or her debt
[Total: 14 marks]

The Financial Accountant 2019

206
Study, understand and apply

Receivables and Allowance for Receivables

iv) The prudence concept requires the full recognition of anticipated future losses
which may arise on the receivable asset. If management is aware of any
irrecoverable debts on its list of receivables, a loss should be recognized
immediately. Four ways of managing credit risk include;
 Proactive customer credit worthy screening
 Prompt invoicing
 Offering attractive discounts
 Prioritizing the collection of old debts
 Providing high quality goods/services
vi)
K
Outstanding receivable balance 690,000
Year end irrecoverable debts (25,000)
————-
665,000
Apply closing allowance 5%
————-
Closing allowance 33,250
Opening allowance 32,250
————-
Increase in allowance for receivables 1,000
————-
vii)

Receivable expense a/c

K K
Receivable Control A/c 35,000
Receivable Control A/c 25,000
Allowance for receivables 1,000 Income statement 61,000
———-- ———--
61,000 61,000
———-- ———--
State-
ment of financial position balance=K665,000-33,250=631,750
The receivable balance is treated as a current asset.

The Financial Accountant 2019

209
Study, understand and apply

The Financial Accountant

Part D
Reconciliations

Session Detail Time allocation

14 Control Accounts 1 Hour

Question Practice and assignments 1 Hour

15 Bank Reconciliations 45 min

Question Practice and assignments 1 Hour

The Financial Accountant 2019

210
Study, understand and apply

The Financial Accountant

Session 14
Control Accounts

Focus

In a less advanced accounting system, control accounts are used to check (or
control) the accuracy of entries made in sub-accounts commonly known as ledger
accounts. This session specifically looks at how a businesses can manage the
receivable asset and the payable liability through the usage of control accounts.

Learning objectives
Upon completion of this session you should be able to :

 Explain the purpose of control accounts

 Prepare basic Control accounts for receivables and payables

 Reconcile Control accounts to ledger accounts.

The Financial Accountant 2019

211
Study, understand and apply

The Financial Accountant

Control Accounts

1 Control Accounts and Ledger Commentary

Accounts
A firm can keep as many
A control account is basically an account in the control accounts as
general ledger which is used to record a sum necessary but for the
total of similar but individual assets and liabilities. purposes of this handbook
Control accounts are kept for several reasons we will restrict ourselves to
including the following : the trading control accounts
A. Control account totals can be used to check which are the payable ledger
control account and the
the accuracy of entries made in the personal
receivable ledger control
accounts. This is done by comparing the account.
total on the control account against the total
on the personal account record.
B. Control accounts provides a readily
available balance for either receivables or
payables for management control purposes.
The control account balance is said to be
administratively convenient because it is Most firms now use
readily available for management‘s accounting software
immediate use. packages which omit the
need for control accounts
C. The control account closing balance at the because entries made in the
year end is used in the financial statements. personal accounts
Therefore the figure for receivables and automatically updates the
payables in the financial position is total receivables
extracted from the relevant control accounts.
D. The control account closing balance is used
for reconciliation purposes through
comparisons made between the receivable
ledger control account total and the total
balance of customer personal accounts to
ensure accuracy and completeness.
Control accounts have the
E. Where there is a separation of roles capacity to strengthen
between an individual who records data in internal controls which relate
to receivables and payables.
the personal accounts and the individual
who posts totals in the general edger, the
usage of control accounts can improve the
internal checks of an accounting system.

The Financial Accountant 2019

212
Study, understand and apply

The Financial Accountant

Control Accounts

2 The Receivable and Payable ledgers

As indicated in our preamble, in a traditional accounting system control accounts are
maintained with sub-accounts known as ledger accounts. Ledger accounts contain
customer and supplier personal accounts. Many would agree that record keeping
cannot be fulfilled without the maintenance of personal account records for both
suppliers and customers.
From time to time the examiner may give you phrases like ―list of supplier or
customer balances‖, ―subsidiary accounts‖, memorandum accounts or ―personal
accounts‖. All these phrases mean the same thing. It is important to note that ledger
accounts in a less advanced accounting system do not form part of the double entry.
They are solely kept for reference purposes. In an integrated accounting system
however, the ledger accounts do form part of the double entry system. The table
below shows the reasons for maintaining the payable and the receivable ledgers.

Reasons for keeping payable ledger Reasons for keeping payable ledger
(personal accounts for suppliers) (personal accounts for customers)
 Provides information relating to  Provides information relating to
how much the business owes how much each customer owes
each individual supplier. the business.

 Record is compared against  Record is compared against

supplier statement before payments received from
payment is made to avoid customers to avoid potential
overpayments. underpayments.
 Used to generate the payable  Used to generate the receivable
aged analysis which is used to aged analysis which is used to
help priorities supplier payments. help priorities debt collections.

 Used to resolved supplier related  Used to resolve customer related

queries. queries.

 Kept for reconciliation purposes  Used to check customer credit

against the payable control limit before advancing more credit
account to customers.

 Kept for reconciliation purposes

against the control account

The Financial Accountant 2019

213
Study, understand and apply

The Financial Accountant

Control Accounts

3 Receivable and Payable ledger control accounts standard

formats
Receivable ledger Control account
K K
Opening Balance ( returns/
Opening Balance X X
advance/errors/overcharge)
Credit sales (SDB) X Bank (customer Receipts) X
Dishonored Cheques X Sales Returns (SRDB) X
Refund to customers X Discount Allowed X
Interest charges on
X Irrecoverable debts X
overdue Bal.
X Contra (Set-off) X
Balance c/d ( returns/
X Balance c/d X
advance/errors)

—— ——
X X
—— ——

Payable ledger control account

K K
Opening balance ( returns/
X Opening balance X
advance/errors/overcharge)
Bank (supplier payments) X Purchases (PDB) X
Purchases returns X Dishonored cheques X
Discount received X Refund from suppliers X
Interest charge on supplier
Contra entry X X
invoice
Balance c/d ( returns/advance/
Balance c/d X X
errors)
—— ——
X X
—— ——

The Financial Accountant 2019

214
Study, understand and apply

The Financial Accountant

Control Accounts

Tutor’s Notes Commentary

 firstly, we note in the formats above that the
receivable ledger control account is an This is a rare place to pick up
asset account. easy marks during your
forthcoming exams.
 We increase (or add) the asset in this
account by debiting and we reduce (or
deduct) the asset in this account by The formats above can be
crediting. learnt and even mastered
particularly if the scholar
 Debit entries increase and credit entries pushes themselves to think
reduce the receivable asset. about the corresponding
double entry for each entry.
 Secondly, the payable ledger control
account is a liability account.
 We increase (or add) the liability in this In fact we suggest that you
account by crediting and we reduce (or less) make a list, through research
the liability in this account through debit or group work the
entries. corresponding entries for the
entries made in the control
 Credit entries increase and debit entries account excluding opening
reduce the payable liability. and closing balances.

4 Contra entry (set-off)

A contra entry arises when a payable is also a
receivable at the same time . Although this is
rare, a business may supply goods to its
suppliers or receive goods from its customers! If Even though a contra
this occurs a contra has to be recognized. The removes the need for cash
underlying point is this, in all the control exchange, it cannot exclude
accounts, contra entries should be posted on the the need for accounting. All
reducing side (Debit payables and credit contras should therefore be
receivables). accounted for in the relevant
ledger accounts.
An illustration would do here. If A owes B a K100
and B owes A K100 the transacting parties needs
not to pay each other. They only need to record
or account for a contra entry in their books.
The double entry for a contra is:
DR Payable ledger Control
CR Receivable ledger Control

The Financial Accountant 2019

The Financial Accountant

Control Accounts

Session summary
 Control accounts like the phrase suggests, are accounts used to check
entries made in the personal accounts of a business.

 Remember that control accounts are only summary accounts.

 Personal accounts contain detail of transactions involving a business

and its customers and suppliers.

 Periodically, the personal accounts total (ledgers) must be reconciled

to the control account total.

 A contra arises when a customer is also a supplier.

The Financial Accountant 2019

217
Study, understand and apply

The Financial Accountant

Control Accounts

Preparation Question 1
Objective Test Questions
1 Which of the following is an output from the receivables ledger system?
A End of month statements for customers
B Copies of supplier accounts
C List of payables balances
D Aged accounts payable list ZiCA Dec 2015

2 DD has received a statement of account from one of its suppliers, which

shows that DD owes them K5,359. Reconciliation of the accounts revealed
the following:

 DD made a payment after the allowed credit period and the supplier
has charged interest of K450 to the account

 The supplier has not adjusted for returns of K840 in the period.

 DD sent a cheque for K675 which the supplier has not yet received.

Taking the above matters into account Calculate the balance shown on
DD’s supplier’s account in the purchases ledger?
A K5,974
B K6,424
C K4,294
D K3,394 ZiCA Jun 2012

3. The following figures relate to receivables control for the year

ended 31 March 2014 :

The Financial Accountant 2019

218
Study, understand and apply

The Financial Accountant

Control Accounts

K
Opening balance 1 April 2017 35,000 debit
Credit sales 165,000
Receipts from customers 148,000
Cash discount allowed 7,500
Refunds to customers 10,800
Irrecoverable debt 14,600
Allowance for receivables - 31 March 2018 2,900

What was the net receivables figure in the Statement of Financial Position
as at 31 March 2018.
A K19,100
B K40,700
C K37,800
D K16,200 ZiCA Jun 2016

K
Total sales for the month 62,550
Cash received from trade receivables 36,500
Discounts allowed to customers during the month 1,200

4 The following information was extracted from the books of Kasimba

before any adjustments were made:

Additional information:
The Sales Day Book has been overcast by K2,200. Cash sales for the
month amounted to K7,800. The Trade Receivables account reflected a

The Financial Accountant 2019

219
Study, understand and apply

The Financial Accountant

Control Accounts

Which one of the following amounts represents the correct

balance on the trade receivables account at 28 February, 2011?
A K41,850
B K43,350
C K44,100
D K42,900 ZiCA Dec 2012

5 The opening balance on the receivables control account at 1 May 2014

was K12,400. During the year, the following data is available:
K
Credit sales 57,951
Irrecoverable debts written off 3,155
Cheques received from receivables 55,111

Dishohnoured cheques 4,240

Discount allowed 4,176
Returns inwards 1,005
Set offs with payable ledger balances 989

What is the closing balance at the year ending 30th April 2015?
A K12,133
B K10,155
C K6,653
D K11,144 ZiCA Jun 2015

The Financial Accountant 2019

220
Study, understand and apply

The Financial Accountant

Control Accounts

6 Maybin owes his client K15,600 and his client owes him K10,000 only.
Maybin has agreed with his client to recognize a contra in their books and
only exchange cash on the outstanding balance. Show how the above
transactions will be recorded in Maybin’s books immediately after paying
the outstanding balance to his client.
A DR Receivable ledger control CR Payable ledger control K10,000
K10,000

B DR Payable ledger control K5,600 CR Receivable ledger control K5,600

C DR payable ledger K5,600 CR Receivable ledger K5,600
D DR payable ledger control K15,600 CR Receivable ledger Control
K10,000
CR Bank K5,600

7 Stone Broke has carried a supplier balance named Don Banda for 18
months to date without paying a single coin. As a result Don Banda has
ceased part of stone broke inventory in order to recover what was owed to
him.
What is the double entry for the above event in the books of Stone Broke.

A DR Don Banda CR Cash

B DR Don Banda CR Payables
C DR Inventory CR Stone Broke
D DR Done Banda and CR Inventory
[Total: 14 marks]

The Financial Accountant 2019

221
Study, understand and apply

The Financial Accountant

Control Accounts

Preparation Question 2
The following information relates to Washala limited.
K‘000
Sales 260
Purchases 185
Cash received from customers 180
Cash paid to suppliers 150
Discount received 12
Discount allowed 18
Returns outward 3
Returns inward 7
Irrecoverable debts 4
Customer‘s cheque dishonored 3.5
Cash refund to customer 1.5
Cash received in respect of debit balances in payables ledger 5.5

On 1 April 2012 the receivable ledger balance were K14,800 debit and K2,600
credit and the payable ledger balance on the same date were K27,000 credit and
K5,900 debit. On 31 March 2013, there was no credit balance in the receivable
ledger except for the balance the outstanding on 1 April 2012 and no debit
balances on the payables ledger.
Required:
(a) Explain three (3) purposes of control accounts. (3 marks)

(b) Write up the Receivables Control Account and the payables Control Account,
bringing down the balances on 1 April, 2013. (13 marks)

(c) Explain the difference between

(i) Trade discount and cash discount (2 marks)

(ii) Dishonored cheque and irrecoverable debts (2 marks)

[Total : 20 marks]

The Financial Accountant 2019

222
Study, understand and apply

The Financial Accountant

Control Accounts

Suggested solutions
Question 1
1 A
2 D
3 B
4 D
5 B
6 D
7 D

Question 1
a) Purpose of control accounts

i) Control accounts provide a check on the accuracy of entries made in the per-
sonal accounts in the receivables and payables ledgers.

ii) Assist in the faster location of errors as there are fewer entries to check against
in the control accounts.

iii) Provides an internal check where there is separation of book-keeping duties.

iv) To provide total receivables and total payables balances more quickly for pro-
ducing a trial balance or statement of financial position.

The Financial Accountant 2019

223
Study, understand and apply

The Financial Accountant

Control Accounts

Receivable ledger control acount

K K
Balance b/d 14,800 Balance b/d 2,600
Sales Cash received from
260,000 customers 180,000

Dishonored cheque 3,500 Discount allowed 18,000

Refund to customer 1,500 Sales returns 7,000
Contra – payables con-
trol 5,500

Bad debt 4,000

Balance c/d Balance c/d (balancing
2,600 fig.) 65,300

———— ————

282,400 282,400

———— ————

The Financial Accountant 2019

224
Study, understand and apply

The Financial Accountant

Control Accounts

c) Differences between
(i) Trade discount – A reduction in the cost of goods owing to the nature of the
trading transaction. It usually results from buying goods in bulk.
It is not recorded in the accounting books.
Cash discount – is a reduction in the amount payable to supplier or by customer, in
return for quick settlement of amount owing.
It will be recorded in the books of account. = 2
(ii) Dishonored cheque – a cheque presented to bank for payment but unpaid due to
reasons such as insufficient funds, amounts in words and figures differ, no signature
by drawer.
Irrecoverable debt – a debt that has been outstanding for some time and is not
expected to be paid and a decision is made to write off the debt as an expense in
the income statement. = 2

The Financial Accountant 2019

225
Study, understand and apply

The Financial Accountant

Session 15
Bank Reconciliation
Focus
Most businesses maintain a bank account as a way of improving controls over their
cash asset which is kept with the bank. Truth be told, cash is one of the most
vulnerable assets in the business world because of its unique qualities which
include, high value content, portability and easy convertibility into other assets.
The logic behind bank reconciliation is that if the cash asset has been entrusted into
the safe custody of a third party, the depositor should regularly check his record
against the third party‘s record to prevent potential loss of cash through fraud or
errors.

Learning objectives
Upon completion of this session you should be able to:

 Describe the purpose of bank reconciliation

 Identify causes of the difference between the cash book and the bank
statement closing balances.
 Write up a revised cash book

 Complete a bank reconciliation statement

 Describe key banking terminologies used by accountants

Opening Balance X Opening Balance ( overdraft) X

Dividends received X Bank charges X

Direct Credit X standing Orders X
Interest Received X Direct debit X

Supplier-dishonored cheque Customer-dishonored Cheque X

Interest Charges X
Balance c/d ( overdraft) Balance c/d X

—— ——

X X

—— ——

The Financial Accountant 2019

229
Study, understand and apply

The Financial Accountant

Session Summary
 Cash control is a key aspect of business management.

 A bank reconciliation can be a single important internal control

measure that helps a business to track its cash resource physically
held by a third party i.e. the bank.

 Differences (variances) between the cash book and the bank

statement balances can be identified and explained through a bank
reconciliation.

 Causes of difference between the cash book and bank balances are
grouped in three broad categories; errors, updating items and timing
differences.

 Errors and updating items are corrected from the cash book or general
ledger. Timings differences should be corrected from the bank
reconciliation statement.

 Key terms such as interest, dividend, current and deposit accounts

used in a bank reconciliation exercise, must be known in order to avoid
misinterpretation of financial events and transactions.

 Available to a business, are several payment modes including standing

orders, direct debit, bank transfers, salary projects etc.

The Financial Accountant 2019

232
Study, understand and apply

The Financial Accountant

Control Accounts

Preparation Question 1
Objective Test Questions
1 On 31 March 2009, Milton’s bank statement showed a favourable balance
of K4,526. On comparing it with the cash book balance the two balances
differed. The difference was due to two unpresented cheques totalling
K4,099

 A cheque for K1,712 received from a customer was entered twice in the
cash book.

 Bank charges of K1,262 not yet entered in the cash book.

What was the cash book balance on the same date?
A K3,939 unfavorable
B K5,651 favourable
C K3,401 favourable
D K427 favourable ZiCA Jun 2010

2 At 31 January 2006, Mupeta’s bank statement shows a credit balance of

K1,500. In comparing this with his cashbook, Mupeta has found the
following:

 Cheque payments amounting to K450 have not yet been presented at the
bank for payment.

 Bank charges of K20 have not been recorded in his cashbook.

 Cheque receipts amounting to K200 are not shown on the bank statement.

What amount should appear in Mupeta’s statement of financial position

for cash at the bank?
A K1,500
B K1,250
C K1,750
D K1,230 ZiCA Dec 2010

The Financial Accountant 2019

233
Study, understand and apply

The Financial Accountant

Control Accounts

3 Kalima’s Cash book bank account balance at the end of May 2012 was
K36,200 overdrawn. Her bank sent a statement which showed a credit
balance of K28,250. This favourable balance is due to a payment by a
customer who has just deposited a cheque directly into the bank account.
Given that her bank reconciliation showed unpresented cheques totaling
K31,750 and unposted bank charges of K12,244, what would be the value
of the customer’s payment?
A K44,944
B K48,444
C K64,450
D K67,950 ZiCA Jun 2012

4 After checking a business cash book against the bank statement, which
of the following items could require an entry in the cash book?
1 Standing order entered in bank statement only.
2 Credit transfer entered in bank statement only.
3 Deposits not credited.
4 Cheques not presented.
5 Error by bank.
6 Bank charges.
7 A cheque from a customer dishonored.
A 1, 2, 6 and 7
B 3, 4 and 7
C 2, 3, 4 and 5
D 3 and 4 ZiCA Jun 2014

The Financial Accountant 2019

234
Study, understand and apply

The Financial Accountant

Control Accounts

5 Which of the following is NOT likely to result in the cash book and bank
statement failing to agree?
A Timing difference
B Bank charges
C Error
D Cash payments posted to receivables

6 A credit entry on a bank statement will have which effect on the level of a
bank overdraft and a bank balance?

Bank Overdraft Bank Balance

A Increase Increase
B Decrease Decrease
C Increase Decrease
D Decrease Increase

7 Precious a trainee Accountant, prepared a bank reconciliation statement

below and escalated her work to you for your review.

K
Overdrawn bank statement balance 53,510
Unpresented cheques 2,656
Outstanding lodgments (3987)
————
Revised cash book balance 55,804
————
Assuming all the figures given above are correct , calculate the revised
balance in the cash book?
A 55,804
B 55,866
C 52,179
D 59,200

The Financial Accountant 2019

235
Study, understand and apply

The Financial Accountant

Control Accounts

Preparation Question 2
On 30 November 2013, the bank column of Katote‘s Cash Book showed a debit
balance of K4,400. The Bank Statement on the same date showed a balance of
K8,785 credit. You have been recently recruited to help with bank reconciliation.
You compare the Bank Statement and Cash Book and establish the following:
i) A standing order to Pang‘ono Building Society for K600 had been paid by the
bank.

ii) A direct credit amounting to K720 had not been entered in the Cash Book.

iii) The Bank Statement showed bank charges of K155 not recorded in the
business‘s books.

iv) Katote earned interest of K380 on her bank account. This has not been entered
in the account.

v) Katote‘s fixed deposit account had matured; K4,200 had been transferred into
her current account.

vi) An error was discovered in the cash book where a cheque received from a
customer, B. Banja, was credited to the cash book. The amount involved in this
error is K320.

vii) The bank statement showed an entry for a dishonored cheque of K210
returned from Nyiti, a customer.

viii) Two cheques issued in November 2013 had not been presented for payment,
payable to K. Kalati for K700 and another to B. Bwipe for K800.

ix) Katote also received cheques amounting to K2,090 which were deposited by
30 November 2013, but were only credited to her bank account on 4
December, 2013.

The Financial Accountant 2019

236
Study, understand and apply

The Financial Accountant

Control Accounts

Required:
a) Update the Cash Book balance as at 30 November, 2013. (6 marks)

b) Draw up a bank reconciliation statement as at 30 November 2013, starting

with the Bank Statement balance. (5 marks)

c) Give three (3) reasons why it is important to prepare a bank

reconciliation. (3 marks)

d) Explain the difference between;

i) Standing order and direct credit

ii) Fixed deposit account and current account

iii) Outstanding deposits and unpresented cheques (6 marks)

ZiCA Jun 2013

The Financial Accountant 2019

237
Study, understand and apply

The Financial Accountant

Control Accounts

Suggested Solution
Question 1
1 C
2 B
3 A
4 A
5 D
6 D
7 C

Session 16
Preparation of Financial
Statements for Sole traders

Focus

This session brings together much of the knowledge obtained from the sessions
covered so far. It is not unusual for a student to find the rest of the sessions
interesting particularly if they are happy with what has been covered so far. We will
look at the primary financial statements of a sole trader together with associated
adjustments.

Learning Objectives
upon completion of this session you should be able to:

 Define a sole trading business and its associated merits and limitations

 Account for the common period end adjustments for a sole trading
business.

 Prepare a sole trader‘s statement of profit or loss from given

information

 Prepare a sole trader‘s statement of financial position from given

information

The Financial Accountant 2019

241
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

1 What is a Sole Trading Business?

A sole trading business is business owned and controlled by one entrepreneur.
Again this is the most common type of business in the world.
Advantages
 Easy to set up and manage. For instance there is usually no need for huge
capital injection for this business category.

 Minimal administration costs, partly because the owner carries out major
business activities and may not spend a lot of cash on human resource related
expenses.

 Minimum legal requirements is a common feature in this type of business.

 Owner enjoys autonomy in decision making and may find this freedom quiet
useful when a straight forward business decision needs to be made without
undue delay.
Disadvantages

 Unlimited liability is perhaps the biggest risk this type of business pauses on to
the owner.

 Continuity problems may arise when the owner is absent from his business
affairs for a long period of time.

 Restricted access to capital as the business by and large depends on the

owner for refinancing.

 Poor or no financial controls are common in this type of business because the
entrepreneur will rationally want to minimize administration costs. Poor controls
affects a sole traders ability to access third party support in terms of credit,
quality human resource to mention but a few.

The Financial Accountant 2019

242
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

2 Year End Adjustments (Period End Adjustments)

Before preparing the accounts for a sole trader, the following adjustments should
be considered.

Adjustment Accounting treatment

The Financial Accountant

Preparation of Financial Statements for Sole Traders

Tembo
Statement of Financial Position as at 31 December 2017
Assets
Non-Current Assets K K
Land 500
Buildings 100
Plant and Machinery 200
———
800
Current Asset
Inventory 150
Trade Receivables 170
Cash And Bank 30
———
Total current assets 370
———
Total Assets 1,170
———
Capital and Liabilities
Capital 700
Profit 20
———
720
Less drawings (10)
———
710
Non-Current Liabilities
Bank Loan 390
Current Liabilities
Trade Payables 60
Tax 10
———
Total current liabilities 70

———
Total Capital and Liabilities 1,170
———

The Financial Accountant 2019

246
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

Session Summary
 A Sole trading business is the most common type of business to this
very day because it is easy to set up and manage.

 This business type is to a greater extent undocumented particularly

because of minimal exposure to regulatory requirements.

 Unlimited limited is possibly a major deterrent for using this type of

business to earn profit.

 The key in accounting for sole traders lies in appreciating the common
adjustments that occur at the end of an accounting period.

The Financial Accountant 2019

247
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

Preparation Question 1
Wezi‘s ledger accounts balances extracted for the year ended 31 March

K
Revenue 84,000
Returns outwards 2,300
Purchases 50,500
Discount allowed 3,200
Returns inwards 2,500
Discount received 2,100
Inventory at 1 April 2012 14,000
Motor van at cost 15,500
Office equipment 12,600
Provision for depreciation on:
Motor Van 1 April 2012 6,200
Office equipment 1 April 2012 2,394
Rent and rates (for 18 Months) 5,400
Salaries and wages 20,700
Sundry expenses 4,200
Irrecoverable debts 2,000
Allowance for receivables 1,500
Motor van running expenses 5,900
Receivables 14,800
Payables 11,100
Bank overdraft 10,200
Cash 8,800
Drawings 9,000
Capital 49,306

The Financial Accountant 2019

248
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

The following notes relate to Wezi as at 31 March 2013.

1 Closing inventory was valued at K18,100.

2 Cash purchases of K500 were completely omitted from the books of account.
3 Salaries and wages of K2,400 were accrued at the year end.
4 Rent and rates shown in the list of balances above includes a six months
prepayment to 30 September 2013.
5 Make an allowance for bad debts of 10% on receivables
6 Depreciation: Included in the cost of Motor van is a van which was bought on 1
April 2010 at a cost of K1,000. This van was sold for cash on 30 September
2012 for K1,500 and the cash amount was not included in the books of
accounts. The firm depreciates motor vans at 20% per annum on cost, using
one month‘s ownership. Office equipment is to be depreciated at 10% using
reducing balance method

Required:
a) Prepare Wezi‘s statement of comprehensive income for the year ended 31
March 2013. (12 marks)
b) Prepare Wezi‘s statement of financial position as at 31 March. 2013.
(8 marks)
[Total: 20 Marks]
ZiCA Dec 2012

The Financial Accountant 2019

249
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

Preparation Question 2
Chisenga, a sole trader, has given you the following Trial balance for adjusting
before preparing the Income Statement and Statement of Financial position for the
year ended 30 April 2011:

Debit Credit
K‘000 K‘000
Revenue 131,940
Purchases 33,000
Sales Returns 260
Purchases Returns 315
Opening Inventory 6,900
Trade Receivables 14,125
Trade Payables 16,070
Discount Allowed 755
Discount Received 559
Wages and Salaries 20,600
Electricity 1,000
General Expenses 2,340
Bank 13,710
Premises 70, 000
Motor Vehicles 5,000
Equipment 3,500
Capital 25,000
Drawings 3,000
Suspense 306
————- ————-
Totals 174,190 174,190
————- ————-

The Financial Accountant 2019

250
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

Chisenga has given you the following information:

1 Discount allowed of K55,000 was doubled but posted correctly to the ledger
accounts.

2 Purchases returns of K108,000 have been posted to the debit of sales returns.

3 Chisenga‘s bank informed him that a cheque for K400,000 from one of his
customers was dishonored on the grounds of insufficient funds. The customer
has, however, assured Chinsengwa that the debt will be settled.

4 The bank balance includes a fixed deposit account of K8,000,000 on which

interest of 6% has been credited by the bank. There is no record of this
transaction in Chinsengwa‘s books.

5 A customer who is also a supplier has agreed to an account set-off of an

amount he owes of K630,000

6 Closing inventory was valued at K9,069,000

7 It has been discovered that an electricity bill of K90,000 that had been accrued
at 30 April 2010 was not brought down as an opening balance on the
electricity account.
Required:
a) Prepare the suspense account showing the correction of the errors above.
(4 marks)
b) Prepare Chisenga‘s Income Statement for the year ended 30 April 2011, after
correcting all the errors and adjustments in 1 to 7 above.
(8 marks)
c) Prepare Chisenga‘s Statement of Financial Position as at 30 April 2011.
(8 marks)
[Total:20 marks]
Amended - ZiCA Dec 2012

The Financial Accountant 2019

251
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

Suggested Solution
Question 1 (A and B)
Wezi Statement of profit or loss for the year ended 31 March 2013
K K
Revenue 84,000
Less Sales returns (2,500)
————
Net revenue 81,500
Opening inventory 14,000
Purchases (50,500+500) 51,000
Less returns outwards (2,300)
Less closing inventory (18,100)
————
Cost of Sales (44,600)
————
Gross profit 36,900
Discount received 2,100
Profit on Disposal (W1) 1,000
————
Total income 40,000
Less Expenses
Rent and rates( 5,400 - 1,800) 3,600
Salaries and Wages( 20,700 + 2,400) 23,100
Sundry expenses 4,200
Irrecoverable debts (2,000 - 20) 1,980
Motor Van running expenses 5,900
Depreciation: Motor Van [(15,500-1,000) *20%+100] 3,000
Office equipment [(12,600 - 2,394)*10%] 1,021
Discount allowed 3,200 (46,001)
———— ————
Profit (6,001)
The Financial Accountant 2019 ————
252
Study, understand and apply

The Financial Accountant

Assets K‘000 K‘000
Non- current Assets
Premises 70,000
Motor Vehicles 5,000
Equipment 3,500
———-
78,500
Current Assets
Inventory 9,069
Trade Receivables (14 125+55+400-630) 13,950
Bank (13710-400+480) 13,790
——— 36,809
———-
Total assets 115,309
———-
Capital and Liabilities
Capital 25,000
Add: Net Profit 77,869
———-
102,869
Less: Drawings (3,000)
———-
99,869
Non current Liabilities
None -
Current Liabilities
Trade Payables (16 070-630) 15,440
———-
Total equity and liabilities 115 309
———-

The Financial Accountant 2019

256
Study, understand and apply

The Financial Accountant

Preparation of Financial Statements for Sole Traders

2 Incomplete Record Techniques

There are so many ways of resolving incomplete record problems. Basically without
a lead it is impossible to establish missing figures. Accountants therefore depend on
the availability of specific information for them to help their clients resolve
incomplete records dilemmas. In this session, we will isolate the common problem
areas under incomplete records which will include establishing the following missing
figures :

A. Opening Position (Opening net assets or Capital)

Payables Ledger Control Account

K K
Bank (Payments) X Bal. b/ f X
Discount Received X Credit (Mis.fig) X
Returns out X Purchase
Bal. c/d
—— ——
X X
—— ——

The Financial Accountant 2019

263
Study, understand and apply

The Financial Accountant

Incomplete Records

Activity 17.4
On 30 September 2017, Sepo‘s receivable balance stood at K65,345. On 1
October, 2016 his receivables balance was K78,955. during the year, Sepo
incurred irrecoverable debts amounting to K5,524, allowed discounts worth K1,555
and received cheques from credit customer's amounting to K92,722. The cash
sales for the year amounted to K34,892.
Required:
a) Calculate Sepo‘s value of credit sales for the year ended 30 September, 2016.
b) Calculate Sepo‘s total sales value
Solution:

Receivable ledger control account

K K
Bal. b/f 78,955 Irrecoverable debt 5,524
Credit sales *** 86,191 Discount allowed 1,555
Customer receipts 92,722
Bal. c/d 65,345
———— ————
165,146 165,146
———— ————

 Therefore, the value of credit sales is K86,191

 The total sales value is K86,191 + K34,892 = K121,083

Activity 17.5
During the accounting period 1 December 2016 to 30 Novembers 2017, Joel had
opening and closing payable balances of K65,255 and K73,500
respectively. In addition, he received discounts worth K6,660 from his suppliers and
made payments amounting to K156,888 to his credit suppliers.
Required:
Calculate the value of Joel‘s credit purchase for the year ended 30 November,
2017.

The Financial Accountant 2019

264
Study, understand and apply

The Financial Accountant

Incomplete Records

Solution

Payable ledger control

K K
Payments to suppliers 156,888 Bal. b/f 65,255
Discount received 6,660 Credit Purchases *** 171,793
Bal. c/d 73,500
———— ————
237,048 237,048
———— ————

E. Missing Cash
Many times Accountants are called upon to carry out the so called forensic audits
for their clients in order to establish the extent of the loss caused by theft of cash
by employees and other third parties. In order to calculate missing cash, we can
use the cash book and petty cash as shown below.

Bank Account
K K
Bal. b/f X Bal. b/f (overdraft) X
Receipts from customers X Payments to suppliers X
Bankings X Petty cash draw down X
Dishonored cheque X
Drawings X
Missing Cash *** X
Bal. c/d X
—— ——
X X
—— ——

Petty Cash Account

K K
Bal. b/ f X Petty cash voucher X
bank X Drawings X
Banking X
Missing Cash *** X
Bal. c/d X
—— ——
X X
—— ——

The Financial Accountant 2019

265
Study, understand and apply

The Financial Accountant

Incomplete Records

Sometimes missing cash can be detected through the petty cash record. If the petty
cash drawdowns is not equal to the amounts spent plus the remaining cash in the
petty cashier‘s tin then you have either a surplus or a shortage which needs to be
investigated. An illustration will do here.
Activity 17.6
Ms. Mayhem runs a small beautician business. In her first month of operations,
October 2017, She suspects that one of her workers has stolen cash from her
business but she is not sure about how much could have been stolen. She has
sought for your services in finding a solution to her problem and has provided the
following details for the month of October 2017.

K
Cash at bank 1 October, 2017 10,000
Petty Cash draw down 1,000
Cheque payment to ZY suppliers 1,500
Cash collected from customers 12,000
Coffee (Paid from cash in hand) 20
Purified water (Paid from cash in hand) 100
Taxi Fare (Paid from cash in hand) 200
Prepaid Electricity Bill (Paid from cash in hand) 1,000
Cheque payment-Lusaka Water and sewerage 500
Cheque payment-Salaries for the month of October 3,000
Cheque payment-Rent & Rates 7,500
Cheque from RT Entertainment 27,000
ATM withdraws made for personal commitments 5,000
Cash Banked 2,500
Cash at bank as at 30 October, 2017 16,000
Cash in Hand as at 30 October, 2017 50

Required:
Calculate how much cash went missing during the month of October for Ms.
Mayhem.

The Financial Accountant 2019

266
Study, understand and apply

The Financial Accountant

Incomplete Records

The Financial Accountant 2019

267
Study, understand and apply

The Financial Accountant

Incomplete Records

F. Prepayments and Accruals

Sometimes a question would focus on the correct amount to transfer to the profit or
loss by adjusting an expense or income account for prepayments and accruals. The
above was discussed under the relevant session.
For expenses, you can use the account below.

Expense Account
K K
b/f prepayment X b/f Accrual X
Bank/Cash X Profit or loss (Mis/fig) X
Accrued expense X c/d prepayment X
—— ——
X X
—— ——

For Income , you can use the account below.

Income Account
K K
b/f income (arrears) X b/f prepayment X
Profit/ loss X Bank/Cash X
Prepaid income X c/d accrued X
—— ——
X X
—— ——

G. Margin and Mark up

We wrap up this session with a discussion on mark and margin. Many
entrepreneurs out there, use these terms in assessing the profitability of their
business. The overall objective of every business is to maximize profit mark up and
margin overtime. It is important for the trainee Accountant to understand the
difference between margin and mark up.

The Financial Accountant 2019

268
Study, understand and apply

The Financial Accountant

Incomplete Records

The table below explains the difference between margin and mark up.

Margin Mark-up

 Is Profit on costs of sales or

 Is Profit on sales purchase costs

Define  Expressed as a  Expressed as a percentage

percentage of gross profit of gross profit over cost of
over sales sales

Gross profit X 100 Gross profit X 100

Formula Mark-up ————————
Margin —————————
Sales Cost

The reference for margin The reference for mark up

Note
computation is sales. computation is profit.

If we use a margin or mark up of 20%, the cost structures of the two measures of
profit will look like what we have below;

Margin K % Mark up K %
Sales 200 100 Reference Sales 240 120
Cost of sales 160 80 Reference Cost of sales 200 100
—— —— —— ——
Gross profit 40 20 Gross profit 40 20
—— —— —— ——

Look out for the wording margin and mark-up!

Margin means profit measured as a percentage of sales and mark up means profit
measured as a percentage of cost of sales.

The Financial Accountant 2019

269
Study, understand and apply

The Financial Accountant

Incomplete Records

Activity 17.7
The following information relates to Nyau‘s rental bills for the year ended 31
October, 2017

Accruals Prepayments
K K
01/11/2016 3,400 1,500
31/10/2017 2,900 1,700

Rental payments for the year ended 31 October, 2017 totaled K22,300.
Required:
Calculate the rental expense to be recognized in Nyau‘s statement of profit or loss
for the year ended 31 October, 2017

Solution

Rentals Expense Account

K K
b/f (Advance) 1,500 b/f (arrears) 3,400
Bank 22,300 Profit or loss 21,600
c/d (arrears) 2,900 c/d (Advance) 1,700
———-- ———--
26,700 26,700
———-- ———--
Bal. b/f 1,700 Bal. b/f 2,900

The Financial Accountant 2019

270
Study, understand and apply

The Financial Accountant

Incomplete Records

Let us conclude, with an example on margin and mark-up.

Activity 17.8
Jack makes a profit mark up of 20% on all his purchases. During the month of
January, his cost of sales totaled K80,000.
Required:
What was Jack‘s sales and gross profit values for the month of January?
Remember, mark-up is profit on cost

Mark-up= Gross profit x 100%/Cost of Sales

Use % Gross % Gross profit Use Values

On this side ———— = —————— On this side
Cost % Cost

20%/100% = GP/K80,000
GP = K16,000

Sales therefore is = Cost Plus Profit

Sales = K80,000+16,000
Sales = K96,000

The Financial Accountant 2019

271
Study, understand and apply

The Financial Accountant

Incomplete Records

Session Summary
 Incomplete records is a common reality that preparers of accounting
information grapple with on a daily basis.

 Despite the absence of information or data, the principles of double

entry should still be applied when preparing financial information.

 The accounting equation can be used to determined the opening

position of an organization (Capital and Accumulated fund)

 The receivables and payables accounts can be used to establish

missing credit sales and credit purchases respectively.

 Petty cash and cash book records can be used to establish missing
cash or indeed drawings.

 Margin and mark-up can be used to calculate cost of sales and sales
values.

The Financial Accountant 2019

272
Study, understand and apply

The Financial Accountant

Incomplete Records

Preparation question 1
Objective Test Questions
1 Which of the following would give you a gross profit mark-up of 25%?
A Sales of K100,000 and gross profit of K25,000
B Sales of K100,000 and cost of sales of K75,000
C Sales of K187,500 and cost of sales of K150,000
D Sales of K187,500 and cost of sales of K80,000 ZiCA Dec 2015

2 Bota’s business had net assets at 31 December 2014 amounting to

K34,500. The accountant informs you that the net assets have decreased
by K3,500 from 1 January 2014 and that Bota introduced his Lottery
winnings of K8,000 into the business while he took goods worth K200 per
month for personal use during the year to 31 December 2014.
Calculate Bota’s profit or loss for the year ended 31 December 2014.
A K9,100 loss
B K2,100 loss
C K9,100 profit
D K28,900 profit ZiCA Dec 2015

3 Bridget enterprises has opening inventory of K3,000, achieves a margin of

25% on sales. In a particular year, sales totaled K100, 000 and purchases
amounted to K84,000.
Calculate closing inventory.
A K7,000
B K20,000
C K1,000
D K12,000 ZiCA Jun 2017

Incomplete Records

Pepala Zulu Statement of financial position as at 31 December 2012

Assets Cost Dep NBV
Non-current assets K‘000 K‘000 K‘000
Motor vehicle 22,500 (4,500) 18,000
————- ————-
Current assets
Inventory 1,900
Receivables 3,000
Cash 5,250
————- 10,150
————
Total assets 28,150
————
Equity & liabilities
Equity
Capital (part a) 7,700
Add: net profit 5,060
Less: drawings (4,000 + 250) (4,250)
————
Total Capital 8,510
Non current liabilities:
10% loan 12,000
Current liabilities:
Payables 2,300
Insurance owing 240
Loan interest 1,200
Bank overdraft 3,900
————- 7,640
————
Total Capital and Liabilities 28,150
————
The Financial Accountant 2019
280
Study, understand and apply

The Financial Accountant

Incomplete Records

WORKINGS
1) Receivables control account
K'000 K'000
Balance b/d 4,000 Cash 450
Dishonored Cheque 1,400 Discount Allowed 120
Credit Sales (bal. figure) 27,480 Bank 28,000
Bad Debts 310
Sales returns 1,000
Balance c/d 3,000
———— ————
32,880 32,880
———— ————

TOTAL SALES = 27,480 + 13,200= 40,680

2) Payables control account

K'000 K'000
Bank 18,000 Balance b/d 2,100
Discount received 170 Purchases (Bal. figure ) 18,370
Balance c/d 2,300
———— ————
20,470 20,470
———— ————

The Financial Accountant 2019

281
Study, understand and apply

The Financial Accountant

Session 18
Preparation of Financial
statements for Partnerships
Focus

A partnership business is an ideal business class for parties with limited physical
and intellectual resources. Business alliances are popular among professionals such
as Accountants, Lawyers, Medical doctors, Engineers to mention but a few. The
problem of a partnership business is obvious; the business belongs to more than
one person. Therefore, there is need for equitable distribution of obligations and
benefits among the partners.

Learning Objectives
Upon completion of this session you should be able to:

 Define a partnership for accounting purposes

 Identify and explain the content of a standard partnership agreement

 Describe capital and current accounts and division of profits

 Calculate and record partners‘ shares of profits and losses, drawings,

salaries, interest on capital, interest on drawings

 Prepare Partners current accounts and capital accounts

 Prepare statement of profit and loss and the appropriation account for
a partnership

 Prepare the statement of financial position of partnership business

 Define goodwill in relation to partnerships

 Identify factors leading to the creation of goodwill in relation to

partnership accounts

The Financial Accountant 2019

282
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

1 Introduction to Partnerships Commentary

In a world where many are faced with the reality It is a common belief that two
of limited resources, a partnership business can
are better than one,
help overcome some of the problems faced by
sole traders who are willing to join other traders in assuming of course that the
business. A partnership business is formed when quality of the three
two or more people join together to carry out individuals is the same.
trading activities with a common view of making
profit. We discussed the attributes of this type of
business in the first session and made mention of
the following advantages and disadvantages:

Advantages
Shared business resources,
 Shared business risk among the partners knowledge and
which can greatly benefit the business if a competencies which ideally
risk event cannot easily be resolved by one can improve the efficiency of
person. the business. In light of the
above, a partnerships may
 Better continuity prospects compared to a not be suitable for certain
sole trader as the work of the absent partner types of businesses. This is
can be undertaken by the other partner (s) particularly true for a
business which generate
minimal income.
Disadvantages
The key to success in any
 The partners still suffer from unlimited liability worthwhile business alliance
unless they incorporate their business into a is common interest and
limited liability partnership. mutual trust, driven by a
 There is potential for disputes between strong sense of shared
partners which if not managed can negate or responsibility.
invalidate the very reason for coming
together.
 Delayed business decisions may result from
the need to achieve consensus among
partners before a decision is made.
 The Business may not continue if a key
partner decides to pull out.

The Financial Accountant 2019

283
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

2 The Partnership Contract Commentary

A partnership contract is a legally binding
agreement which among other things, stipulates It makes logical sense for
the benefits and obligations that partners carry in partners to document their
relation to the business. The contents of a economic relationship with
partnership contract includes: the business. Such
documentation which
 The amount of capital to be contributed by normally takes the form of a
each partner. contract can greatly prevent
avoidable disruptions to the
 The profit or loss sharing ratio of the smooth operations of the
partners. business.

 The interest to be earned on capital invested

by the partners.
 The interest to be charged on partners
drawings made during the accounting period.
 The salaries, if any, to be paid to partners
employed in the business.
 Procedures for joining and leaving the
partnership business.
Partners should ensure that
 Any other important item which is agreed
there dealings with the
upon by the partners. business are guided by a set
of written rules in the
absence of which the
In the absence of a partnership contract section authorities will impose there
24 of the 1890 partnership act provides for the own rules.
following:
 Profits or losses are to be shared equally
among the partners.

 No interest is to be allowed on capital. If partners cannot control

their own business affairs,
 No interest is to be charged on drawings. the government reserves the
right to intervene.
 No salaries are to be paid to partners.

 If a partner puts a sum of money into a firm,

in excess of the capital he has agreed to
subscribe, he is entitled to interest at the rate
of 5% per annum on that amount.

The Financial Accountant 2019

284
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

3 Accounting for Partnerships Commentary

The following general steps are required when Accounting for a partnership
preparing the financial statements of a business is not very different
partnership business. from accounting for a sole
trader; we only need to
appreciate one thing; the
i) Share the reported profit or loss accordingly business is no longer owned
in the appropriation account. The profit by one person.
sharing ratio which is normally highlighted in
the partnership contract can be used for this
The income statement of a
purpose. The profit sharing ratio is normally
partnership business is
given in the question. generally prepared in a similar
ii) Transfer all short term earnings and losses way compared to that of a sole
from the appropriation account to the trader.
partner’s current account. Short term
earnings include, interest on capital, salaries
and profit shares. Once the partnership profit or
loss is prepared, the
iii) Recognize the capital account in the names Accountant should proceed to
of the existing partners in accordance with share the profit or loss
how much was agreed to be contributed in incurred among the existing
the partnership contract. Again the capital partners in accordance with
account relates to at least two persons. the partnership contract rules
iv) Recognition of goodwill on the admission or
withdrawal of a partner. This is based on the
principle of fairness. Existing partners must
be rewarded with their allotted benefits or
entitlements from the business as they also
take a fair share of their obligations. In the
same way the new partner should never take
part in the partnership profits or losses
arising before he or she joined the business.
Before we discuss the above
v) Finally, prepare the partnership statement of
in detail, we will do well to
financial position. This is not very different
show the profit or loss format
from the sole trader‘s financial position. You
of a partnership business as
only need to remember that the business
highlighted on the next page.
belongs to more than one person therefore
the capital section should have more than
one name.

The Financial Accountant 2019

285
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

X and Y
Partnership Income Statement for the year ended 31 December 2016

K
Sales X
Cost of Sales (X)
——-
Gross Profit X
Selling and Distribution (X)
Administration expenses (X)
——-
Operating Profit/Loss X(X)
——-

X and Y
Partnership appropriation Account for the year ended 31
December, 2016
K K
Operating profit/loss X(X)
Add Interest charge on Drawings
X (value of drawings x rate) X
Y (value of drawings x rate) X X
——-
Less Interest On Capital
X (Capital x rate) X
Y (Capital x rate) X (X)
——-
Less Salaries (Normally given in the question)
Partner Y (X)
——-
Residual Profit X
Less Profit share
X (1/2) X
Y (1/2) X (X)
——- ——-
Nil
——-

The Financial Accountant 2019

286
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

The Appropriation Account

The appropriation account is an account used to ration or share the profits of the
business between the partners in accordance with the partnership contract. The
double entry below relate to the appropriation and current accounts.
Detail Double entry

X Y X Y

K K K K
Drawings (Principle amt) X X Balance b/f X X
Interest on Drawings X X Interest on Capital X X

Loss share X X Partners Salary X X

Balance c/d X X Profit Share X X

—— —— —— ——

X X X X

—— —— —— ——

5 Goodwill
Goodwill is an intangible asset that represents the difference between the value of
the business as a whole and its separable net assets. It is the premium invisible
value of the business over and above the value of the owner‘s interest (Capital) in
the business.

The components of goodwill include:

 The reputation (or good name) the business has built overtime.

 The strategic location of business.

 The quality of employees hired by the business.

 Business contacts base (customers/suppliers).

The Financial Accountant 2019

288
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

The subject of goodwill will arise when there is a change in ownership of a

partnership business which normally occurs if a partner leaves or joins the business.
It is important for us to discuss how to proceed when goodwill arises under two
conditions:
a. Where partners retain the goodwill in the books of accounts.
b. Where the partners recognize the goodwill on temporal basis and thereafter
write it off.

If the partners agree to retain the goodwill in the books of account

DR: Goodwill
CR: Capital Accounts (Use old ratio)

Consider here, that the goodwill will only be shared among the partners who were
there before the new partner (s) joined the business.

Where the partners decide NOT to retain the goodwill in the books of accounts
we proceed as follows:
Initially, we should share (allocate) the goodwill in the old profit sharing ratio among
the existing (old) partners
DR: Goodwill Account
CR: Capital Accounts (Use old ratio)

Secondly, reallocate the Goodwill in new profit sharing ratio (to ensure new partner
pays for their share of Goodwill.
DR: Partners Capital Account
CR: Goodwill Account (Use New ratio)

The Financial Accountant 2019

289
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Session Summary
 Business expansion may entail joining forces with others in a long term
trade partnership agreement.

 A Partnership business can in many ways avoids the trading limitations

that comes with setting out in business alone.

 A Partnership business benefit from pooled resources, skills,

experience, ideas and business network of the existing partners.

 There are demerits that comes with working together in business

including disagreements, the need for consensus on key business
decisions and shared risks.

 With regards to accounting, three special accounts must be considered

under this form of business namely, appropriation account, current
account and capital account.

 Goodwill is an intangible asset that should be accounted for when

there is a change in a partnership business.

The Financial Accountant 2019

290
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Preparation Question 1
Bwikalo and Machushi are in partnership sharing profits and losses in the ratio 5:3
respectively. The following information has been taken from the partnership records
for the financial year ended 30 May 2014.
Partners capital account balances:

Bwikalo K230,000
Machushi K170,000

Partners current accounts, balances as at 1st June, 2013:

Bwikalo K54,000
Machushi K85,000

During the year ended 31 May 2014 the partners made the following withdrawals
from the partnership bank account:

Bwikalo K 8,000 on 1 September 2013

K11,000 on 02 January, 2014
K 6,500 on 30 April 2014
Machushi K12,000 on 30 October 2013
K9,000 on 1st December, 2013
K12,000 on 1st May, 2014

Interest is to be charged on withdrawals at the rate of 9% per annum. Interest is

allowed on capital accounts and credit balances on current accounts at the rate of
10% per annum.
Machushi is to be allowed a salary of K42,000 per annum.
The net profit of the partnership for the year ended 31 May 20X9 is K88,374.
Required:
a) A computation of the amount of interest chargeable on each partner‘s
withdrawals for the year ended 31 May 2014. (6 marks)

The Financial Accountant 2019

291
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

b) The partnership appropriation account for the year ended 31 May 2014.

(7½ marks)

c) The partners‘ current accounts showing the balances carried down as at 31

May 2014. (6½ marks)
[Total: 20 marks]
ZiCA Jun 2013

Preparation Question 2
Haggs and Chips have been in partnership, selling computers and related
accessories. Their Agreement provides that each of them is entitled to interest on
capital of 5% per annum and is charged interest on drawings of 2% per annum.
Their profit sharing ratio is 3:2 respectively.
The firm‘s trial balance as at 31 March 2012, was as follows:

Dr Cr
K K
Carriage Inwards 16,700
Returns Inwards 15,200
Salaries and wages 45,000
Office expenses 3,200
Rent and rates 3,800
Postage and stationery 2,650
Irrecoverable debts 4,500
Allowance for irrecoverable debts 1 April 2011 780
Discounts Received 250
Sales 350,000
Trade Payables 38,400
Trade Receivables 48,500
Inventory at 1 April 2011 65,400

The Financial Accountant 2019

292
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Purchases 165,000
Motor Vehicles at cost 20,000
Office equipment at cost 18,000
Allowance for depreciation at1 April 2011:
Motor Vehicles 4,000
Office equipment 3,600
Cash at bank 16,900
Drawings:
Haggs 35,000
Chip s 15,500
Current accounts
Haggs 6,240
Chips 2,920
Capital accounts:
Haggs 45,000
Chips 30,000
————- ————-
478,270 478,270
————- ————-

Additional information:
i) Rent and rates paid in advance K990

ii) Arrears for postage and stationery are K360

iii) The allowance for irrecoverable debts is to be adjusted to K 500

iv) With effect from 1 July 2011 partners were entitled to a salary per annum as
follows: Haggs, K36,000, Chips K24,000.

v) Motor vehicles are to be depreciated at 20% per annum on a reducing balance

basis, and Office equipment at 10% on a straight line basis.

vi) Inventory at 31 March 2012 was valued at K82,80

The Financial Accountant 2019

293
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Required:
a) Prepare the Partnership Statement of Comprehensive Income. (8 marks)

b) Prepare the Appropriation Account and Current Accounts for the Partnership
for the year ended 31 March 2012 (4 marks)

c) A statement of Financial Position as at 31 March 2012 (8 marks)

[Total: 20 marks]
ZiCA Jun 2012

The Financial Accountant 2019

294
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

The Financial Accountant 2019

295
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Current Account
K K K K
Interest on Drawings 1,001.25 1,125.00 Balance b/d 54,000 85,000
Drawings 25,500 33,000 Interest on Capital 23,000 17,000
Salary 42,000
Bal. c/d 55,811.41 113,062.59 Profit share 53,12.66 3,187.59
________ _________ ________ _________
82,312.66 147,187.59 82,312.66 147,187.59
________ _________ ________ _________
Ba. c/d 55,811.41 113,062.59

The Financial Accountant 2019

296
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Haggs and Chips

Statement of comprehensive income for the year ended 31 March 2012
K K
Sales 350,000
Sales Returns (15,200)
————
Net Sales 334,800
Inventory at start 65,400
Purchases 165,000
Carriage inwards 16,700
————
247,100
Inventory at end (82,800)
————
Cost of sales (164,300)
————
Gross Profit 170,500
Discount received 250
Total Income ————
170,750
EXPENSES
Irrecoverable debts (4,500 - 280) 4,220
Wages and salaries 45,000
Office expenses 3,200
Rates and rates (3,800 - 990) 2,810
Postages and stationary (2,650 + 360) 3,010
Depreciation (W1) 5,000 (63,240)
———— ————
Net profit 107,510
————

The Financial Accountant 2019

297
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Haggs and Chips Partnership Appropriation account for the year ended
31 March, 2012
K K
Net profit 107,510
Add: Interest on Drawings
Haggs (2%x 35 000) 700
Chips (2% x 15 500) 310
————
1,010
less: Interest on capital
Haggs (0.05 x 45 000) 2,250
Chips (0.05 x 30 000) 1,500
————
Less: Salaries (3,750)
Haggs (9/12 x 36 000) 27,000
Chips (9/12 x 24 000) 18,000
———— (45,000)
————
Residue profit 59,770
Less: Share of profits
Haggs (3/5 x 59 770) 35,862
Chips (2/5 x 59 770) 23,908
————
(59,770)
————
Nil
————

The Financial Accountant 2019

298
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Haggs and Chips Current Account

Haggs Chips Haggs Chips

K K K K
Bal. b/f 2,920 Bal. b/f 6,240
drawings 35,000 15,500 Salary 27,000 18,000
Int. on 700 310 Interest 2,250 1,500
Drawings on Capital

Bal. c/d 35,652 24,678 Profit 35,862 23,908

share
———— ———— ———— ————
71352 43408 71,352 43,408
———— ———— ———— ————
Bal. b/f 35,625 24,678

Haggs and Chips

Statement of Financial Position as at 31 March 2012

Motor Vehicles (20,000-4000-3200) 12,800

Equipment (18,000 - 3,600 - 1,800) 12,600
25, 400
Current Assets
Inventory 82,800
Trade Receivables (48 500 -500) 48,000
Rent and rates prepaid 990
Bank 16,900
148,690

174,090

The Financial Accountant 2019

299
Study, understand and apply

The Financial Accountant

Preparation of Financial statements for Partnerships

Haggs and Chips

Statement of Financial Position as at 31 March 2012
Assets K K
Non-current assets
Motor Vehicles (20,000 - 4,000 - 3,200) 12,800
Equipment (18,000 - 3,600 - 1,800) 12,600
————
25, 400
Current Assets
Inventory 82,800
Trade Receivables (48,500 - 500) 48,000
Rent and rates prepaid 990
Bank 16,900 148,690
———— ————
Total assets 174,090
————
Capital and liabilities
Capital Accounts:
Haggs 45,000
Chips 30,000
———— 75,000
Current Accounts:
Haggs 35,652
Chips 24,678 60,330
———— ————
135 330
Current Liabilities:
Trade Payables 38,400
Accrued postage and stationery 360 38,760
———— ————
Total capital and liabilities 174 090
The Financial Accountant 2019
———— 300
Study, understand and apply

The Financial Accountant

Session 19
Preparation of Financial
Statements for Limited Liability
Companies

Focus

The expansion of a non incorporated business often results in increased concern on

the consequences of unlimited liability from the shareholders viewpoint. Unlimited
liability means that business creditors can still recover their debts from business
owners if the business fails to pay. Thanks to the legal concept of limited liability,
owners of incorporated entity‘s are legally protected from potential loss of private
property and even prosecution in some cases, by those who lend resources to the
company.

Learning objectives
Upon completion of this session you should be able to:

 Explain the concept of limited liability

 Describe the types of limited liability companies

 Discuss the advantages and disadvantages of limited liability
companies
 Explain Company accounts terminologies

 Describe the types of share capital

 Compute basic bonus and rights and issues

 Describe Debt finance

 Describe Company tax

 Explain the types of company reserves

 Prepare financial statements for a limited liability company in

compliance with IAS 1

The Financial Accountant 2019

301
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

1 The concept of Limited Liability Commentary

Limited liability basically means restricted loss. It The general definition of a
is a benefit exclusively enjoyed by company limited liability company as a
members who are commonly known as business that trades in
shareholders. In a limited liability company, the shares may not be applicable
shareholders loss is limited to the value of to private limited companies.
contributed capital and any earned profits.
Thanks to this concept, huge investments can
now be made in business ventures leading to Some financial lenders still
increased economic growth. require personal guarantees
from members of a company
Your understanding of limited liability company
when advancing loan facilities
accounts is crucial for future lessons particularly
to small firms. Such kind of
for the subjects financial reporting, tax and
actions are aimed at
auditing. Ensure that you are happy with this
minimizing the risk of dealing
topic, because you will need this foundational
with dishonest individuals
knowledge in future. You cannot afford to ignore
who may seek to use a
obvious things such as the formats financial
staged company as a means
statement and the key terminologies discussed in
of accessing debt capital
this session.
without the ability to repay.

Private companies are mostly

2 Types of Limited Liability common among family
Companies members or friends who are
not ready to share control of
In this book, we will look at two types of limited
the business with others.
liability companies namely, public limited liability
and private limited liability companies.
A public limited liability company is a company
which can trade its shares (and other securities)
with the public. The shares of such a firm can be
sold to eligible members of the public who are
willing to become part of a promising investment A private limited company
venture. can successfully avoid
A private limited liability company on the other dilution of control for as long
hand, is a company owned and controlled by as the business enjoys
private investors and may not sale its shares to steady organic growth.
the public.
One of the major concerns of a member of a
limited liability firm is dilution of control a state
that primarily results from having a lot of
shareholders in a company.

The Financial Accountant 2019

302
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

3 Advantages and Disadvantages of a Limited Liability

Companies
The above was discussed in chapter one. We are simply reciting here.
Advantages
 Owners enjoy limited liability cover.

 The business has separate legal identity.

 The company has wider access to capital.

 Better continuity prospects for the business through share transferability.

Disadvantages
 Increased compliance requirements.

 Increased administration costs.

 The need to file annual returns as per 1994 company act.

 For a public limited liability company, there is need for an independent audit
exercise.

4 Share issue progression

The maximum number of shares that a company

Authorized share Capital can issue. A firm cannot issue shares in excess of
the authorized shares without changing its articles

The number of shares issued to existing

Issued share Capital shareholders. Issued shares are usually less than
the authorized number of shares.

The number of allotted shares earmarked to be

Called up share Capital
paid up.

The number of shares fully paid for by the existing

Paid up shares Capital
shareholders.

The Financial Accountant 2019

303
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

5 Company Accounts Key Terms

Terminology Details

1 Share holder A person who owns shares in a limited liability Company.

A share is tradable equity security which confers a right

2 Share
of ownership on its holder in a limited liability company.

Nominal or Par
The original value of one share or amount at which a
4 value of one
share is initially sold or issued.
share

The capital contributed by shareholders in a limited a

3 Share Capital
liability company.

Market share Price at which a share can be bought or sold on a

4
price recognized stock exchange market.

The difference between the market share price and the

5 Share premium
nominal value of a share.

6 Dividend A return on investment.

Cost of borrowed funds which is usually paid in fixed

7 Interest
installments at regular intervals.

A compulsory contribution made to the authorities

8 Tax
charged on business profits.

Share capital plus reserves of a company. Equity is also

9 Equity
known as net assets.

An act of increasing the number of shares owned by

10 Share issue
shareholders usually done in exchange for cash.

The Financial Accountant 2019

304
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

6 Types of Share Capital

We now turn to types of shares usually found in the books of limited liability
companies. The two major classes of share capital constitutes ordinary shares and
preference shares. Let us use the table below to appreciate the differences
between these two financial instruments.

Ordinary shares Preference shares

Share held by persons who

Shares held by Members (or
Position are usually seen as Debt capital
owners) of the company
providers

Paid a variable dividend

Paid a fixed dividend before an
Return After a preference dividend has ordinary dividend is paid
been paid

Rights Carry Voting rights Usually do not carry voting rights

Paid after all the obligations

Principle including preference shares Paid before ordinary shares
have been paid

 Carries a higher risk

partly because shares  Carry moderate risk partly
attracts a return after a because they receive their
preference dividend is paid return before an ordinary
dividend is paid.
Risk
 The premium risk on  The moderate risk above, is
ordinary shares should reflected in the moderate
rationally be return paid to preference
compensated with a higher shareholders.
return.

The Financial Accountant 2019

305
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

7 Redeemable and irredeemable Commentary

preference shares
Preference dividends are
Preference shares are further divided into two normally treated as finance
broad categories; redeemable and irredeemable costs. This is because
preference shares. Redeemable preference preference shares carry
shares are shares which have a redemption date. characteristics of debt
The principle value of redeemable preference capital. If preference shares
shares will eventually be repaid to the given in a question are said
shareholder at a future date depending on the to be redeemable be sure to
mutual agreement between the preference share treat the dividends as a
holder and the company. Irredeemable finance cost.
preference shares on the other hand are shares
which are bought in perpetuity and do not have a
date of redemption or repayment.

Activity 19.1 A bonus issue is not purely

Carry out a research on the advantages and free, management is merely
disadvantages of both ordinary and preference increasing the number of
shares from the perspective of the company and shares for existing
an investor. shareholders by reducing a
target reserve and increasing
share capital. More often
than not, the share premium
8 Rights Issue and Bonus Issue account is used to finance a
bonus issue.
A rights issue is an issue of shares to existing
shareholders at a discount in proportion to the Although shareholders do
number of shares held by individual shareholders. not have to pay for the bonus
The idea behind this issue is that before shares issue, they can only benefit
can be sold to new investors, the existing when they have an increased
shareholders should be given first preference to dividend based on the
buy the shares in a bid to avoid unnecessary increased number of shares
control dilution over the company. It is only fair to owned. A bonus issue is
give existing shareholders an opportunity to unlikely to dilute the control
increase their current shareholding in a business enjoyed by shareholders in a
before selling the shares to outsiders. In any company unless a
case, the existing shareholders have a right to be shareholder elects not to
informed about any attempt to sale more shares have their shares increased
by the company. A rights issue is usually made at through this issue.
a discount to encourage existing shareholders to
fully subscribe for the issue.
A bonus issue of shares on the other hand, is an At this level of your studies it
issue made to existing shareholders in proportion helps to remember that
to the number of shares held by individual bonus issues are always
shareholders without a cash exchange between made at par value.
company and the shareholders.

The Financial Accountant 2019

306
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

Activity 19.2
On 1 January, 2017 GHT company held 10,000 ordinary shares with a nominal
value of K1 and share premium of K1,000 only. The average market value of one
share during the year was K2, and the following issues were made.

 On 31 March 2017, GHT made a 1 for every 2 rights issue at a price of K1.8 to
its shareholders.

 On 30 June 2017, GHT further made a 1 to 5 bonus issue to its shareholders

which was financed by the share premium account.
Required:
Show how the above transactions will affect the share capital and share premium
accounts of GHT.
Solution:
Firstly, we must account for the rights issue.
1 for every 2 shares means, a shareholder with two shares will be able to increase
his shares to 3. We just have to replicate the same idea on the 10,000 shares. The
key thought is, if two shares can buy one share, then you will end up with 15,000 in
this case. A share premium of K4,000 [(1.8 - 1) x 5,000] was earned on the right
issue.
Secondly the bonus issue of 1 for 5 will be based on revised number of shares
which now stands at 15,000 (10,000+5,000).
The two transactions will look as follows :

Ordinary Share
shares premium
K K
1 January Bal. b/f 10,000 1,000
31 March Right issue 5,000 4000
———— ————
15,000 5,000
30 June Bonus issue 3,000 (3,000)
———— ————
31 Dec Bal. c/f 18,000 2,000
———— ————
The Financial Accountant 2019
307
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

9 Debt Finance
Limited liability companies like any other business may find it necessary to borrow
funds in order to finance their short term or long term projects. Banks and other
institutions can provide such funds at a cost to the borrower commonly known as
interest. Borrowed funds must be paid back at a future date and the ability to pay
rationally depends on the proper utilization of advanced funds.
The common examples of debt finance are loan notes and debentures. A loan note
is a written acknowledgement of borrowed funds. This note can be issued by a
company in need of funds and in exchange the lender is entitled to a fixed return
(interest) and repayment of the advanced principle. The timing of the payments
mentioned will be subject to agreement between the lender and the borrower.
Loan notes are therefore classified in the financial statements as long term liabilities
unless the period of repayment falls below twelve months. If a loan note is due
within twelve months, it should be treated as a short term obligation.

When a firm issues a loan note the following double entry will apply:

Principle amount borrowed

DR Bank
CR Loan Note

Interest payment
DR Interest expense
CR Bank

10 Corporate Income Tax

Corporate tax is a type of income tax charged on the taxable profits of a limited
liability company. The rate of this tax will vary from one jurisdiction to another.
When a firm estimates the value of tax payable on its profits the following double
entry will apply:

DR Tax expense
CR Tax payable

The Financial Accountant 2019

308
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

11 Company Reserves
A Reserve is an equity component that has not been distributed to the members of
the company in form dividends. It is a liability owed by the business to the
shareholders. A company can have different types of reserves including, retained
earnings, general reserves, revaluation reserves, etc.
There are two major types of reserves; statutory and non-statutory reserves.
Statutory reserves are reserves required by law and may not be available for
distribution in form of dividends. An example of a statutory reserve is the share
premium account. Non-statutory reserves are reserves not required by law and can
include retained earnings, revaluation surplus etc. Company reserves are normally
highlighted in the statement of changes in equity.

12 Limited liability Company Financial Statements

As discussed in session three, a complete set of financial statements comprise of
the following:
A. Statement of profit or loss
B. Statement of Financial Position
C. Statement of cash flows
D. Statement of changes of equity
E. Explanatory notes

In this session we will focus on the statements of profit or loss, statement of

financial position and statement of changes in equity. The statement of cash flows
will be discussed in a later session. Take a closer look again at the formats of the
primary financial statements on the pages that follow.

The Financial Accountant 2019

309
Study, understand and apply

The Financial Accountant

 Limited liability is therefore a signal that serves to caution all

stakeholders who may want to trade with the company because they
may suffer lose if the company fails to discharge what owes to them.

 There are many limitations of this business type although, where a

huge capital outlay is required many business experts would suggest
that forming a limited liability company would reduce personal
bankruptcy risk of a shareholder.

 It is important to know that a company is a legal person and is

therefore able to sue and be sued in its own right.

 Limited liability firms are exposed to more regulations compared to the

other two types of vehicles.

 The financial statements of a limited liability company should conform

to IFRSs, the law and GAAP among other things.

 A dividend is a return on investment.

 Interest is the cost of borrowed funds.

 A rights issue is an issue to existing shareholders in proportion to their

existing shareholding proportions.

 A bonus issue is an issue aimed at increasing the number of shares

held by existing shareholders in proportion to their existing
shareholding proportions and does not involve any payment.

 Statutory reserves are reserves required by law.

 Non statutory reserves are reserves which are not required by law.

The Financial Accountant 2019

313
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

Preparation Question 1
Bonilinda, a limited liability company, produced the following trial balance at 31
December 2016
Dr Cr
K’000 K’000
Ordinary shares of K1 each 5, 000
Share premium 500
Revaluation reserve as at 1 January 2016 675
Retained earnings as at 1 January 2016 950
12% Loan notes 1, 250
Land at valuation 2, 475
Buildings at cost 1, 750
- depreciation to 1 January 2016 100
Plant and machinery at cost 1, 100
- depreciation to 1 January 2016 150
Inventory at 1 January 2016 1, 050
Receivables 4, 375
Cash in hand 1, 010
Payables 1, 590
Bank 450
Administration expenses 1, 320
Selling and distribution expenses 1, 460
Dividends paid 175
Loan note interest paid 75
Sales revenue 12, 000
Purchases 8, 725
Carriage inwards 75
Carriage outwards 50
Returns outwards 170
Discounts allowed and received 40 845
———— ————
23, 680 23, 680
———— ————

The Financial Accountant 2019

314
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

1) The following additional information at 31 December 2016 is available:

2) Inventory at the close of business has been valued at K970,000.
3) Prepaid administration expenses K60,000 and accrued selling and distribution
expenses K85,000.
4) The land is to be revalued by K275,000.
5) Depreciation is to be provided as follows:

 Buildings at 4% per annum on their original cost.

 Plant and machinery at 10% per annum of their carrying amount.

6) Income tax of K40,000 is to be provided for the year.
7) The 12% loan notes was acquired on the 1st of July 2016. K250,000 of the loan
notes is redeemable by 31st December 2017 and K1,000,000 by 30 June 2020.
8) A customer ceased trading owing the company K140,000 the debt is not ex-
pected to be recovered and an adjustment should be made.
Required:
Prepare the following:
a) Statement of profit or loss and other comprehensive income for the year ended
31 December 2016. (10 marks)
b) Statement of financial position as at 31 December 2016. (10 marks)
[Total: 20 marks]
ZiCA Jun 2017

The Financial Accountant 2019

315
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

Preparation Question 2

Chunyunyu, a limited liability company, produced the following trial balance at

31 October 2011:
Dr Cr
K’m K’m
Ordinary shares of K1 each 800
5% preference shares 200
Share premium 100
Revaluation reserve 135
Retained earnings at 1 November 2010 190
12% Loan notes, repayable 2016 250
Land at valuation 495
Premises at cost 350
- depreciation to 1 November 2010 20
Plant and machinery at cost 220
- depreciation to 1 November 2010 30
Patents and trade marks 200
Inventory at 1 November 2010 210
Receivables 875
Cash in hand 2
Payables 318
Bank 90
Administration expenses 264
Selling and distribution expenses 292
Dividends paid 35
Loan note interest 15
Sales revenue 2569
Purchases 1,745
Carriage inwards 15
Carriage outwards 18
Returns outwards 34
——— ———
4,736 4,736
——— ———

The Financial Accountant 2019

316
Study, understand and apply

The Financial Accountant

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

Bank overdraft 450

Accrued Selling and Distribution 85
Income tax 40 2,415
———— ————
11,460
————

Workings
W1) Cost of Sales K‘000
Opening inventory 1, 050
Purchases (8,725 + 75 – 170) 8, 630
Closing inventory (970)
———-
8710
———-
W2) Depreciation
Buildings 4% x K1, 750 70
Plant and machinery 10 % x (K1, 100 -K150) 95
———-
165
———-
W3) Finance cost
K1, 250,000 @ 12% x 6/12 75,000
———-

The Financial Accountant 2019

320
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

Questions 2

Chunyunyu,
Income statement for the year ended to 31 October, 2011.
K’m K’m
Sales 2,569
Less: Cost of sales
Opening inventory 210
Purchases (1,745 + 15 – 34) 1,726
————
1936
Closing inventory (194)
———— (1,742 )
————
Gross profit 827
Less Expenses
Administration (264 – 12 + 17) 269
Selling and distribution (292 – 28) 264
Loan note interest (W2) 30
Carriage outwards 18
Depreciation(W1) 36 (617)
———— ————
Net profit before tax 210
Income tax expense (40)
————
Net profit for the year 170
————

The Financial Accountant 2019

321
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

Chinyunyu
Statement of financial position at 31 October 2011
Assets Cost Dep NBV
Non-current assets K‘m K‘m K‘m
Land (495 + 55) 550 - 550
Premises (Acc. Dep. =20 + 14 w1)* 350 *34 316
Plant and equipment (Acc. dep.30 +22 w1)** 220 **52 168
Patents and trade marks 200 - 200
——— ——— ———
1320 86 1,324
——— ———
Current Assets
Inventory 194
Receivables 875
Prepayments (12+28) 40
Cash 2 1,111
——— ———
Total assets 2345
———
Capital and Liabilities
Ordinary shares K1 800
Preference Shares 200
Share Premium 100
Revaluation reserve 190
Retained earnings (190+170-35) 325
———
1,615
Non-Current Liabilities
12% Loan Notes 250

The Financial Accountant 2019

322
Study, understand and apply

The Financial Accountant

Preparing financial Statements for Limited Liability Companies

Current Liabilities
Payables 318
Bank overdraft 90
Accrual (17+15 W2) 32
Income Tax 40 480

——— ———

Total equity and liabilities 2345

———

Workings Km‘

Premises 4% x K350m = 14

Plant and machinery 10 % x K220m 22

———

(W2) Loan note interest

K250m@ 12% = 30

———

K15m paid, so accrual for K15m is needed!

Cash Compared with Profit

From the accruals accounting point of view, it can be safely argued that cash is not
the same as profit. A business can have one without the other. The table below
provides us with more insight into the thought above.

Cash is Profit is

Financial point of
An Asset or Property Income
view

Not a medium of
A medium of exchange exchange
Legal tender
(Can be spent)
(Cannot be spent)

Objective Objectively measured (Has Subjectively measured (it is

measurement an exact value) simply an estimate)

Additional viewpoint A fact An Opinion

It is clear from the comparisons above that cash is more important than profit. Cash
is used to finance business expenses and obligations which include salaries,
purchases, tax, supplier invoices, loan repayments, dividends, to mention but a few.
Profit is also essential, but only to the extent that it can help a business in generating
the much needed cash. Profit is a means to an end and the end of course is cash. In
short, profit without cash is useless because if there is no cash, no organization can
survive. Cash is therefore the life blood of any standing organization.

For the purposes of this topic, we can safely adopt the motto, ―disregard
everything but cash”. This means you must deliberately think about the changes to
the cash asset (increase/decrease) resulting from capital and revenue business
transactions. By so doing, this session will not be as difficult as many scholars claim.
Additionally, your double entry knowledge as well as incomplete record knowledge
will be of great use here.

The Financial Accountant 2019

327
Study, understand and apply

The Financial Accountant

Statement of Cash flows

2 Cash flow terms

IAS 7 gives us the key terms which we are supposed to use when computing an
entity‘s statement of cash flows as highlighted in the table below.

Term Description

Cash in hand and demand deposits (i.e. notes and

Cash
coins).

Cash inflows and cash outflows of an entity during

the reporting period. Positive cash flow means cash
Cash flow is increasing. Negative cash flow means cash is
reducing. The terms receipts and payments can be
used for cash inflow and outflow respectively.

Short term, highly liquid investments with a maturity

Cash equivalent period of less than three months, which are
convertible into known amounts of cash.

Principle (core) revenue generating activities of an

Operating activities entity. The core activity of a tuition Centre like
ZABTUC is the provision of tuition services.

 Activities which result in the acquisition or

disposal of non-current assets.
Investing activities
 Investment activities include returns (dividends
or interest received) on financial assets.

Activities that alter the size and composition of long

Financing activities term finance of an entity. The issuance of additional
shares is a good example of a financing activity.

The Financial Accountant 2019

328
Study, understand and apply

The Financial Accountant

Statement of Cash flows

3 Methods of Cash Flow Computation

The two methods of computing cash flows are :
 The direct and the
 Indirect method
The direct method uses expense and revenue receipts received and given
throughout the year to ascertain the cash surplus or deficit for a financial period.
From the above explanation, it is clear to see that usage of this method can be at
the very least a tedious exercise.
Under the indirect method on the other hand, the accountant uses the financial
statements and incomplete records skills to establish amounts of cash generated
and spent during a reporting period.
The formats for investing and financing activities under both methods are the same.
The examiner of cash flow questions has for the past few years been biased
towards the indirect method of cash flow computation.
An example of the direct method of the operating activities section of a statement of
cash flows is given below.

ABC Co
Statement of Cash Flows for the Year Ended 31 December 2017

Operating Activities Km’

Cash receipts from customers (cash sales or receivables) X
Cash paid to Suppliers (X)

Cash paid on behalf of employees (X)

Interest paid (X)

Tax paid (X)
——-
Net cash generated from operating activities
X

——-

The Financial Accountant 2019

329
Study, understand and apply

The Financial Accountant

Statement of Cash flows

MM Statement of Cash flows for the year ended 31 December 2018

Operating activities Km Km
Profit/Loss before after Tax X(X)
Adjustment
Add interest paid X
Less interest income (X)
Operating Profit/Loss (X)/X
Add Depreciation X
Add Amortization X
Add loss on disposal X
Less profit on Disposal (X)
——-
Cash from operating activities before changes in working X
capital

Increase/Decrease in Inventory (X)/X

Increase/Decrease in Receivables (X)/X
Increase/Decrease in Payables X/(X)
——-
Cash from operating activities after changes in working capital X
Less Interest Paid (X)
Less Tax Paid (X)
Less Dividend Paid (X)
——-
Net cash generated from operating activities X(X)

Investing Activities
Less Purchase of additional Non-current assets (X)
Add Proceeds from sale of non-current assets X
Add dividend received X
Add interest received X
——-
Cash used in investing activities (X)

Financing activities
Issue of shares X
Issue of Loan notes/Debentures X
Redemption of shares (X)
Redemption of Loan notes (X)
——-
Cash from Financing Activities X
——-
Net Increase/Decrease in Cash and Cash Equivalents X(X)
Add Opening Bank Balance or Overdraft X/(X)
——-
Closing Balance of Cash and Cash Equivalents/Overdraft X(X)
——-
The Financial Accountant 2019
330
Study, understand and apply

The Financial Accountant

Statement of Cash flows

4 Further Discussions
Operating activities
Profit or loss before interest and Tax
The profit before interest and tax is a starting point of the indirect method cash flow
computation. Profit before tax is an accounting profit which must adjusted for non-
cash expenses and income for us to arrive at net cash from operating activities. Under
cash flows, profit before tax is effectively treated as a positive cash flow and a loss is
treated as a negative cash flow.
Interest Expense and Interest Income
It is important and more safer to know that we should first adjust the profit before tax
with the interest expense and income for us to arrive at the operating profit.
Accordingly, interest expense is treated as a positive cash flow but interest income is
treated as a negative cash flow for the purposes of cash flow reconciliations.
Depreciation, Amortization and Loss on disposal
We normally add back depreciation, amortization and loss on disposal because these
items are not negative cash flows but simply accounting expenses.
Profit on Disposal
Profit on disposed non-current assets results in accounting income but is not a
positive cash flow. Profit on disposal once established, is accordingly deducted from
the operating cash flows.
Changes in working Capital
Working capital is the difference between current assets and current liabilities. You
are likely to face three major components of working capital in your exam, inventory,
receivables and payables.
To derive cash flows for these components, we must compare the values of inventory,
receivables and payables for the current and previous year financial positions given
by the examiner in the question.
An increase in inventory is indicative of a negative cash flow. This is because fewer
goods were sold and cash is still tied in inventory. Based on the above reasoning a
decrease in inventory is treated as a positive cash flow.
An increase in receivables is indicative of decreasing cash and is therefore a negative
cash flow. More goods were sold on credit and therefore we have less cash. A
decrease in receivables on the other hand reflects the fact that most credit clients paid
up and therefore there is an increase in cash.
An increase in payables results in a positive cash flow. We bought more goods on
credit and therefore we still have cash. A decrease in payables is a negative cash
flow.

The Financial Accountant 2019

331
Study, understand and apply

The Financial Accountant

Statement of Cash flows

Interest Paid
This is a negative cash flow, representing the cost of borrowed funds. We must
ascertain the actual amount paid if it has not been given. Notice that there is a
difference between interest incurred and interest paid. The examiner is likely to ask
you to calculate interest paid if he gives you interest incurred.

Tax Paid
Companies are required to pay income tax on taxable business profits. This is a
negative cash flow. Students are usually required to compute this figure using their
incomplete records skills. This figure is not usually provided by the examiner.

Dividend Paid
Dividends paid refer to a return given to investors in form of cash and is therefore a
negative cash flow. Some writers may prefer to include this item under financing
activities but you will not be penalized if you treat it as an operating activity item.

Investing activities
Acquisition of non-current assets
This is a cash outflow item representing amounts spent in buying non-current
assets. This amount will need to be worked out using the non current asset account.

Proceeds from the Sale of Non-Current Assets

This is a cash inflow representing cash received from the sale of non-current assets
or financial assets.

Dividend Received
This is a return on investment made by the reporting firm. Dividends received are
treated as inflows under investing activities.

Interest Received
This is the amount of interest received by the reporting entity for the funds lent out
to third parties. Like dividends received, interest received is a cash inflow under
investing activities.

The Financial Accountant 2019

332
Study, understand and apply

The Financial Accountant

Statement of Cash flows

Financing activities
Issue of Shares /Share Redemption
A share issue results in a cash in-flow while redemption of shares reduces cash.
Loan notes Issue /Loan notes redemption
A loan note issue is a straight cash inflow but, redemption of loan notes results in a
cash outflow.

5 Advantages and Disadvantages of Statement of cash flows

Advantages

 The cash flow statement is fairly easy to prepare.

 It is relatively easy to understand particularly by non financial users.

 Cash is more objective than profit and is therefore less open to manipulation.

 Cash is relatively easy to audit compared to profit.

 The statement of cash flows may also be a tool that helps management to
understand the activities which generate cash for the business as well as those
activities which reduce the cash asset of the business. This knowledge can
positively affect business decisions.
Disadvantages

 Cash flows can be misleading because of the disregard for accruals

accounting.

Solution
Panji statement of cash flows for the year ending 30 June 2016:
Operating activities: K K
Profit from operations 42,500
Adjustments for:
Depreciation 1,000
————
Operating cash flows before movements in workings capital 43,500
Increase in inventory (14,000)
Increase in payables 1,000
Decrease in receivables 2,500
————
Operating cash flows after movements in workings capital (10,500)
33,000
Cash generated by operators:
Tax paid -
Interest paid -
Net cash flow from operating activities - 33,000
Investing activities:
Payments to acquire non-current assets (15,000)
————
Net cash used in investing activities (15,000)
Financing activities:
Capital introduced 10,000
Drawings (40,000)
————
Net cash used in financing activities: (30,000)
————
Net decreases in cash and cash equivalents (12000)
Cash and cash equivalents at beginning of the year. 7500
————
Cash and cash equivalents at end of the year (4,500)
————

The Financial Accountant 2019

336
Study, understand and apply

The Financial Accountant

Statement of Cash flows

Session Summary
 Cash is perhaps the most vulnerable asset in an organization.

 A profitable business cannot survive long enough without cash.

 Under cash flows, the preparer disregards everything but cash.

 The standard IAS 7 gives us guidance on how to account for cash and
cash equivalents.

 There are two methods of accounting for cash flows, the direct and the
indirect method.

 The indirect method has three (3) sections, operating, investing and
financing activities.

 Cash flow statements is easy to prepare and understand.

 Cash flow statements may not give an accurate amount if amounts

used are based on window dressed accounts.

The Financial Accountant 2019

337
Study, understand and apply

The Financial Accountant

Statement of Cash flows

Preparation Question 1
The following information relates to Nuka Limited for the year ended 31
December, 2013.
K
Profit before tax for the year ended 31 December 2013 19,500
Debentures issued by the company in 2010 with an interest of 12% p.a. 20,000
Interim dividend paid on ordinary shares in 2013 1,500
Cost of motor vehicle TV3 purchased in 2013 45,000
Trade-in value of vehicle given in part-exchange against TV3 5,000
Ordinary shares of K100 each in Nuka Limited issued at par and fully 30,000
paid during 2013
Ordinary share dividend proposed in 2012 paid in 2013 2,500
Ordinary dividend proposed in 2013 2,000
Corporation tax paid 10,500
Cash and bank balance 1 January 2013 6,900
Cash and bank balance 31 December 2013 12,200

During the year ended 31 December 2013,

(i) Receivables decreased by K3,800
(ii) Payables increased by K2,700
(iii) Inventory increased by K4,200
Depreciation charged was K8,000.
Debenture interest is not in arrears.
Required:
a) Prepare a Statement of Cash Flow for Nuka Limited for the year ended 31 De-
cember, 2013. (12 marks)

b) Explain the term ‗cash equivalents‘. (2 marks)

The Financial Accountant 2019

338
Study, understand and apply

The Financial Accountant

Statement of Cash flows

c) Name three (3) headings which would be used when calculating Net Cash In-
flow from Operating Activities using the direct method. (3 marks)

d) List three (3) advantages of cash flow accounting. (3 marks)

[Total: 20 marks]

Preparation Question 2
The financial statements of Zombe Plc. have been prepared below for two years:
Zombe Plc. Statement of profit or loss for the year ended 31 December 2015.

K
Revenue 12,765
Cost of sales (9,070)
————
Gross profit 3,695
Distribution costs (625)
Administrative expenses (1,320)
————
Operating profit 1,750
Interest received 125
Interest paid (375)
————
Profit before taxation 1,500
Taxation (700)
————
Profit for the year 800
————

Zombe Plc. Statement of financial position as at 31 December 2015.

The Financial Accountant 2019

339
Study, understand and apply

The Financial Accountant

Statement of Cash flows

Assets 2015 2014

Non-current assets: K K
Property, plant and equipment 1,900 1,525
Intangible assets 1,250 1,000
Investments - 125
————- ————-
3,150 2,650
Current assets:
Inventories 750 510
Receivables 1,950 1,575
Short-term investments 250 -
Cash in hand 10 5
————- ————-
2,960 2,090
————- ————-
Total assets 6,110 4,740
————- ————-
Equity and liabilities:
Equity:
Share capital K1 ordinary shares 1,000 750
Share premium 800 750
Revaluation reserves 500 455
Retained earnings 1,300 900
————- ————-
Total net assets 3,600 2,855
Non- current liabilities
Loan 850 250
Current liabilities
Trade payables 635 595
Bank overdraft 425 490
Taxation 600 550
————- ————-
1,660 1,635
————- ————-
Total equity and liabilities 6,110 4,740
————- ————-

The Financial Accountant 2019

340
Study, understand and apply

The Financial Accountant

Statement of Cash flows

The following additional information is available:

i) The proceeds of the sale of non-current asset investments amounted to
K150,000.
ii) Fixtures and fittings, with an original cost of K425,000 and a carrying amount of
K225,000 were sold for K160,000 during the year.
iii) The following relates to property, plant and equipment:

31 Dec 31 Dec
2015 2014
K K
Cost 3,600 2,975
Accumulated depreciation 1,700 1,450
———- ———-
Carrying amount 1,900 1,525
———- ———-

iv) 50 000 K1 ordinary shares were issued during the year at a premium of K100
per share.
v) Dividends amounting to K400,000 were paid during the year.
Required:
Prepare the cash flow statement in accordance with IAS 7 (Statement of cash flows).
[Total: 20 marks]
ZiCA Dec 2016

The Financial Accountant 2019

341
Study, understand and apply

The Financial Accountant

Statement of Cash flows

Suggested Solutions
Question 1
NUKA LIMITED
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2013
Operating activities K K
Profit before tax 19,500
Adjust for:
Depreciation charges 8,000
Interest paid 2,400
————
Cash from operating activities before changes in working 29,900
capital
Increase in inventory (4,200)
Decrease in receivables 3,800
Increase in payables 2,700
————
Cash from operating activities before changes in working 32,200
capital
Interest paid (2,400)
Tax paid (10,500)
Dividend paid (2012) (2,500)
Interim dividend paid (2013) (1,500)
————
Net cash inflow from operating activities 15,300
Cash flows from investing activities
Property plant equipment addit (45,000 – 5,000) 40,000 (40,000)
————
Net cash outflow from investing activities (40,000)
Cash flows from financing activities
Issues of share capital 30,000
————
Net cash inflows from financing 30,000
————
Increase in cash and cash equivalents 5,300
Opening Bal. 6,900
————
Closing Bal, 12,200
————
The Financial Accountant 2019
342
Study, understand and apply

The Financial Accountant

Statement of Cash flows

b) Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant
risk of changes in value.
c) Headings (Direct Method) to compute cash inflow from operating activities

 Cash receipts from customers

 Cash paid to suppliers
 Cash paid to employees OR
 Interest/income taxes paid.

d) Advantages of cash flow accounting

 Determines how solvent or liquid a business is – as liquidity is a key factor to

the long-term success of the business.

 Cash flows are more easily understood.

 Shows how cash/funds injected into a business in a given year are used. Clear
information is given on movement of cash in a business.

 Cash flow is more comprehensive than ‗profit‘ which is dependent on

accounting conventions and concepts.

 Cash flow forecasts are easier to prepare.

 Provides a better means of comparing the results of different companies than

traditional profit reporting.

 Satisfies the needs of different users (e.g. shareholders, creditors, employees,

auditors, management).

The Financial Accountant 2019

343
Study, understand and apply

The Financial Accountant

Statement of Cash flows

Question 2
Zombe Plc.
Statement of cash flows for the year ended 31 December 2015
K K
Net cash flows from operating activities:
Profit before tax 1,500
Add back non-cash items:
Depreciation charge (w1) 450
Interest expense 250
Loss on sale of PPE (225 – 160) 65
Profit on sale of non-current asset investment (150 – 125) (25)
———
Changes in working capital: 2240
Increase inventories (240)
Increase in receivables (375)
Increase in payables 40
———
Cash generated from operating activities 1,665
Interest received 125
Interest paid (375)
Dividend paid (400)
Tax paid (w3) (650)
———
Net cash flow from operating activities 365
Cash flows from investing activities:
Purchase of PPE (W2) 1,005
Purchase of intangible non-current assets (125 – 1,000) (250)
Proceeds from sale of PPE 160
Proceeds from sale of non-current investment 150
———
Net cash flows from investing activities (945)
Cash flows from financing activities:
Issue of share capital (1000 + 800 – 750 – 750) 300
Long term loan (850 – 250) 600
———
The Financial Accountant 2019
344
Study, understand and apply

The Financial Accountant

Statement of Cash flows

Net cash flows from financing 900

———
Increase in cash and cash equivalents 320
Cash and cash equivalent at 1 Jan 2014 (485)
———
Cash and cash equivalent at 31 December 2015 (165)
———

Working

W1 Accumulated depreciation
K K
Disposal 200 B/f 1,450
Bal. c/d 1,700 I/S charge 450
———— ————
1900 1900
———— ————
W2 Property Plant and equipment
K K
1 Jan 15 Balance b/f 2,975 Disposal 425
Revelation (500 – 455) 45
Purchases (balance fig) 1,005 Balance c/d 3,600
———— ————
4 025 4 025
———— ————

W3 Tax

K K

Tax Paid 650 Bal. b/f 550

Bal. c/d 600 I/S charge 700

———— ————

1,250 1,250

———— ————

The Financial Accountant 2019

345
Study, understand and apply

The Financial Accountant

Session 21
Interpretation of Financial
Statements

Focus

You may have heard of the common saying ―figures don‘t lie‖. Indeed figures don‘t
lie. figure movements are caused by underlying factors which must be identified and
explained to users of accounting information. This session looks at financial ratio
analysis and how accountants can use their analytical skills to explain changes to
key financial variables.

Learning objectives
Upon completion of this session you should be able to:

 Explain the concept of comparability

 Calculate basic financial ratios

 Provide reasonable comments on calculated ratios

 State Advantages and disadvantages of ratio analysis

The Financial Accountant 2019

346
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

1 Comparability Commentary
Let us begin by looking at the term comparability Borrowing from the
which crudely involves comparing two or more
conceptual framework idea
variables in the financial statements of a business
of comparability, analysis are
in order to identify trends. Information is
made possible where you
comparable if it is capable of being analyzed for
have consistence in the
expected trends. application of accounting
Broadly speaking, most business analysts policies as well as adequate
undertake what is known as overtime disclosures.
comparisons of like for like variables in the
financial statements of their clients. Overtime
comparisons involve the analysis of accounting Ratio analysis should never
information relating to the same business for two be used to arrive at
or more consecutive years. However, if the decisions in isolation. The
financial ratios of one entity are being compared financial analyst should as
against the financial ratios of another entity we far as possible, endeavor to
are making comparisons between two different collaborate his insights
entities; preferably those that relate to the same based on calculated ratios,
industry. Under this analysis type, the compared with the plausible views of
firms will usually carry the same dates or period non-financial managers.
for consistency purposes. Given the above, it is
conceivable to think that
You can therefore compare the principle financial ratios are persuasive and not
ratios of a given business against the several conclusive. The results of
benchmarks or standards including: analytical procedures under
 Previous (past) year (s) ratios ratios cannot be treated as
an end because ratio
 Similar entity‘s ratios analysis is simply a means to
an end. It is therefore
 Industry ratios dangerous and reckless to
make a financial decision
 Target ratios among others. that is solely informed by
ratio analysis.

It is important to note that ratios are meaningless

without comparisons but comparisons should
never betray basic logic. It is not logical for
instance, to compare companies from different
industries. Further, it is not helpful to compare a
big company against a small company.
Remember, to get meaningful conclusions, we
must compare like with like in keeping with the
consistency concept mentioned above.

The Financial Accountant 2019

347
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

2 Ratio Categories
Ratios can be grouped into four (4) major categories as follows:
A. Profitability ratios
B. Short term solvency and liquidity ratios
C. Gearing ratios
D. Investor ratios

A. Profitability ratios
Profitability ratios show users how well the company performed during the reporting
period compared to the previous accounting period (s). Profitability ratios include
return on capital employed, gross profit margin and net profit margin.

B. Short term solvency and Liquidity

These ratios show users the entity’s ability to offset its short term obligations.
Examples here include current ratio, quick ratio, receivables days, payable days
and inventory days.

C. Gearing ratios
These ratios show the proportion of debt capital in the total capital structure of a
business. Equity gearing, total gearing and interest cover are good examples of
gearing ratios.

D. Investor ratios
These ratios assist investors in making investment decisions as well as assessing
the potential for growth of the investee company. Under investor ratios we have
earnings per share, dividend yields, price earning ratio to mention but a few.

We have come up with a model table below that can help the student to identify,
compute and interpret a ratios in general terms.

The Financial Accountant 2019

348
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Ratio analysis Formula Table

Profitability ratios
Possible Reasons for movement
Ratio Formula Increase in the Ratio Decrease In the Ratio
PBIT x 100%
——————-
 Increase in gross  Decrease in gross
Return on Capital Profit Profit
Employed
Capital
employed PBIT means profit
 Decrease in  Increase in Capital
(ROCE) before interest Capital Employed Employed
and tax
CE= Total assets
 Decrease in  Increase in
less Total current Operating Costs Operating Costs
liabilities

PAT x 100%  Increase in net

—————— Profit  Decrease in net
Return on Profit
Equity Equity  Decrease in
(ROE) Equity  Increase in Equity
PAT means
profit after tax  Decrease in  Increase in
Operating Operating expenses
Expense

Gross GP x 100%  Increased Selling  Decrease in Selling

Profit Price per unit Price per unit
——————
Margin
Sales  Increased sales  Decrease in sales
(GPM) Volume Volume
 Bulk purchase  Increased material
discounts cost

 Reduction in
 Increase in
overhead costs
overhead costs
Net profit PBIT x 100%  Acquisition of
Margin  Acquisition of other
—————— property leading
entities.
(NPM) to reduced rentals
Sales
 Redundancy
 Recruitment of more
employees
exercise .

The Financial Accountant 2019

349
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

 High Sales  Low sales

revenue value.
Sales
 Lower value  Higher value of
———————
Asset Turnover of capital capital
Capital employed
employed employed

Liquidity Ratios

Possible Reasons for Movement

Increase in the Decrease In the
Ratio Formula
Ratio Ratio

 increase in
 Decline in
Current Assets Current
Current assets
assets
———————
Current Ratio  Increase in
 Decrease in
Current Liabilities Current
Current
Liabilities
Liabilities

 increase in
Current  Decline in
assets Current assets
Current Assets less
Inventory
Quick Ratio or  Decrease in  Increase in
————————- Current
Acid test Current
Liabilities Liabilities
Current Liabilities
 Low  High inventory
inventory levels
levels

The Financial Accountant 2019

350
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Efficiency Ratios
Possible Reasons for:
Increase in the Decrease In the
Ratio Formula
Ratio Ratio

 worsening
 improved debt
debt
collection
collection
period
Receivables x365 period
Receiva- ————————  delayed
 prompt
bles Days invoicing
Credit Sales invoicing
 Better credit
 Poor credit
control
control
policies
policies

 slow
moving
items  efficient
Average Inventory x 365 Operations
Inventory  Change in
days ——————————-- customer
Cost of sales  Increased mar-
Base ket share
 Change in
product line

 More credit
supplies
were taken  Less credit
supplies were
 decrease in
taken
the value of
Payables Payables x 365 cost of  Increase in
days ————————— sales cost of sales
Cost of sales  Business is  Change in
failing to supplier credit
meet the policy
terms of
payments

The Financial Accountant 2019

351
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Gearing Ratio
Possible Reasons for Movement
Increase in the Decrease In the
Ratio Formula
Ratio Ratio

Debt x 100%  increase in  Decrease in

debt Capital debt Capital
Total Gearing ———————
 Decrease in  Increase in
Equity + Debt Equity Equity

Debt x 100%  increase in  Decrease in

debt Capital debt Capital
Equity Gearing ———————
 Decrease in  Increase in
Equity Capital Capital
Employed employed

 High
 Low
operating
operating
profit
profit
 Low
 High
operating
operating
PBIT Costs
Interest Cover Costs
———————  High
(Number of times)  Reduced
Interest Payable Contribution
gross profit
(gross profit)
 Low interest
 High interest
cost due to
cost owing to
high gearing
low gearing

The Financial Accountant 2019

352
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Investor Ratios
Possible Reasons for Movement

Increase in the Decrease In the

Ratio Formula
Ratio Ratio

Profit attributed to
ordinary  increase in  Decrease in
shareholders profit profit
Earnings per
share (Ngwee) ————————  reduction in  Increase in
number of number of
Number of ordinary shares shares
shares

Earnings per
share  Increase in
share price  Decrease in
———————— share price
Dividend per  Reduction
share (Times) Dividend per dividend per  Increase in
share share dividend per
share


Earnings per  Increase in  Decrease in

Share earnings per earnings per
Dividend Yield
share share
(%) ————————
 Decrease in  Increase in
Share Price share Price share Price

 Increase in  Decrease In
Share Price Share Price share Price
Price Earnings
————————
Ratio (Times)  Decrease in  Increase in
Earnings per Earnings per Earnings per
share share Share

The Financial Accountant 2019

353
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

3 Advantages and disadvantages of ratio analysis

Advantages
 Ratios are relatively easy to compute if the preparer knows the formulas.

 Ratios are easy to understand particularly by non-financial managers.

 Ratios can help to identify underperforming departments, products and ser-
vices.
 Rations Can be used to proactively correct underperformance related
problems in a business.

Disadvantages

 Ratios are meaningless without comparisons.

 Without follow up action by management, ratio analysis is a waste of time.

 Where there is no consistency (in accounting policies, size of companies com-

pared, disclosures) ratios will be less meaningful.

 Creative accounting (deliberate falsification of accounting information) will make

ratio analysis less useful.

Tutors Note
Now that you have learnt the basic ratios, please apply your knowledge on your
most recent past examination paper to check your understanding.

The Financial Accountant 2019

354
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Session Summary
 Ratio analysis is widely used by accountants and financial analysts to
help explain movements in underlying business variables.

 The qualitative characteristic comparability is very much associated

with ratios because without consistence and disclosures ratios are less
useful.

 There are four categories of ratios namely profitability, liquidity,

gearing and investor ratios.

 Ratio analysis can help the financial analyst to communicate key

changes in business performance and position over a period of time.

 Ratios are easy to compute and understand.

 Perhaps a major limitation of ratio analysis is the fact that ratios are not
an end in themselves but simply, a means to an end.

 Accountants and managers should not base any major decision on

ratio analysis only!

The Financial Accountant 2019

355
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Preparation Question 1
Lukundo plc. is a Public Limited company. Its most recent financial statements for
two years are as follows:
Statement of profit or loss for the year ended 31 March

2015 2014
K K
Revenue 510,000 345,000
Cost of Sales (296,000) (207,000)
————— —————
Gross profit 214,000 138,000
Distribution costs (54,000) (37,000)
Administration costs (42,000) (29,000)
Finance costs (13,000) (2,000)
————— —————
Profit before tax 105,000 70,000
Tax (45,000) (20,000)
————— —————
Profit for the year 60,000 50,000
————— —————
Statement of Financial position as at 31 March
Assets 2015 2014
Non-current assets K K K K
Property plant and
Equipment 314,000 108,000
Current assets
Inventory 72,000 36,000
Trade receivables 88,000 28,000
Bank - 160,000 80,000 144,000
————— ————— ————— —————
Total assets 474,000 252,000
————— —————
The Financial Accountant 2019
356
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Equity and liabilities K K K K

Equity
Equity Shares of K1 100,000 100,000
Retained earnings 90,000 45,000
————-- ————--
190,000 145,000
Non-current liabilities
6.5% Loan Notes 200,000 30,800
Current liabilities
Trade payables 36,000 52,200
Bank Overdraft 4,000 -
Current tax payable 44,000 84,000 24,000 76,200
————-- ————-- ————-- ————--
474,000 252,000
————-- ————--
Required:
a) Calculate the following ratios for Lukundo Plc., Clearly stating the formula used
for each ratio.
Profitability ratios
i) Gross profit margin
ii) Operating profit margin
iii) Asset turnover ratio
iv) Liquidity ratios
Liquidity ratios
i) Quick ratio
ii) Receivables collection period
iii) Inventory holding period
iv) Long term solvency ratios

The Financial Accountant 2019

357
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Gearing
i) Interest cover (12 marks)
b) Comment on the performance of the company for the two years as indicated by
the ratios calculated in (a) above. (8 marks)
[Total :20 marks]
ZiCA Dec 2015

Preparation Question 2
Solution Computers (SC) Limited and High Land Meat Centre (HLMC) Ltd are
companies in the same industry. You have been asked to review the financial
performance of both companies using the financial statements summarized below:

SC Limited Income statements for the year ended 31 October 2009

SC Ltd HLMC

K‘m K‘m
Sales 17,000 8,000
Costs od sales (13,000) (5,000)
————- ————-
Gross profit 4,000 3,000
Less expenses (2,300) (1,200)
————- ————-
Profit before tax 1,700 1,800
Tax (800) (700)
————- ————-
Profit after tax 900 1,100
Dividends (600) (300)
————- ————-
Retained profits 300 800
————- ————-

The Financial Accountant 2019

358
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Statement of financial position

Assets SC Ltd HLMC Ltd
Non-current assets K‘m K‘m K‘m K‘m
Property plant and equipment 11,200 4,800
Current assets
Inventory 1,500 300
Trade recievables 2,100 500
Cash 0 150
————- 3,600 ————- 950
————- ————-
Total assets 14,800 5750
————- ————-
Equity and liability
Capital and reserves
K1 ordinary shares 8,000 3,600
Reserves 450 900
————- ————-
8,450 4,500
Non-current liabilities
10% Debentures 3,000 650
Current Liabilities
Trade payables 2,200 150
Bank overdraft 350 -
Tax payable 800 3,350 450 600
————- ————- ————- ————-
Total equity and liabilities 14,800 5,750
————- ————-

The Financial Accountant 2019

359
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Required:
a) Prepare a table that shows the following ratios for both companies.
i. Gross profit percentage;
ii. Return on capital employed (Return on net assets);
iii. Acid test ratio (quick ratio);
iv. Earnings per share;
v. Dividend cover.
(You are advised to clearly show your workings.) (10 marks)
a) Comment on the performance of the two companies as indicated by the ratios
you have calculated in (a). (5 marks)
b) Define the nature and purpose of an accounting conceptual framework.
(5 marks)
[Total: 20 marks]
ZiCA Dec 2010

The Financial Accountant 2019

360
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Suggested Solutions
Question 1
Unless otherwise indicated, figures are in Kwacha
Profitability
2015 2014
Gross profit margin = gross profit/revenue x 100
214,000/510,000 x 100=41.96% 138,000/345,000 x100=40%
Operating profit margin = operating profit/Revenue x 100
118,000 /510,000 x 100=23.12% 72,000/345,000 x100=20.90%
Asset turnover ratio = revenue/capital employed
510,000/390,000=1.31 T 345,000/175,800 =1.96 T
Liquidity ratios
Quick ratio = current assets – inventories/current liabilities
160,000- 72,000/84,000=1.05 T 144,000 – 36,000/76,200=1.42 T
Receivables collection period = receivables/credit sales x 365 days
88,000/510,000 x 365 =63 Days 28,000/345,000 x 365 =30 Days
Inventory holding period = inventory/cost of sales x 365 days
72,000/296,000 x 365 =89 Days 36,000/207,000 x 365 =63 Days
Long term solvency

Gearing = interest bearing debt/interest bearing debt + shareholders‘ funds

200,000/200,000 + 190,000 x 100 30,800/30,800 + 145,000 x 100
=17.52%
=51.28%
Or Debt/Equity=Debt/Equity x 100%
200,000/190,000=105% 30,800/145,000=21%
Interest cover = operating profit/interest expense
118,000/13,000=9.1 T 72,000/20,000=36T

The Financial Accountant 2019

361
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

b) Comment on the performance of Lukundo Plc.

Profitability
The gross profit is reasonably high in both years. However, the higher sales revenue
in 2015 appear to have contributed to the slight improvement in the gross profit
margin of about 42% compared to 40% in 2014.
The picture is different when it comes to operating profit margin. This is low in both
years at 23.12 in 2015 and 20.9% in 2014. It seems operating expenses were
slightly better controlled in 20 15 compared to 2014. This is seen from calculation of
cost to sales ratio for both years, that is 18.8% [(96,000/510,000)] x 100 in 2015 and
19.13 % [(66,000.345,999 ) x 100 in 2014. The low level operating margin could
mean that probably expenses have been uniformly too high for the size of sales
Asset turnover ratio shows that there was more efficient use of assets in 2014 than
in 2015. However, these efficiency levels did not lead to better profitability as
indicated by the first two ratios. The inefficiency in 2015 could partly be due to
working capital tied up in inventory as shown by higher inventory days of 88 days
compared to 17 days in 2015.
Liquidity
Quick ratios for both years are quite similar and greater than one. This means in
both years, the company has sufficient current assets to meet its current liabilities. In
2015 the quick ratio is lower due to working capital tied up in inventory for longer
periods. With lack of cash balance in 2015, but an overdraft, coupled with low quick
ratio, the company could face problems meeting their obligations as they fall due.
The higher receivables collection period further worsens the position of liquidity. The
credit control department needs to improve in order to reduce collection period in
future years.
Long term solvency ratios
The gearing is high in 2015 at about 51% compared to 17% in 2014. It appears, the
company acquired additional borrowings as the loan notes and interest expenses
are both high in the current year. At 51%, the gearing is within acceptable limits. Any
further borrowing before repaying part of existing borrowing may increase gearing to
too high levels and hence erode investor confidence. It is hoped that the investment
in loans will bring in future returns.
The interest cover has fallen from 36 times to 9 times. This may be due to rise in
interest expense arising from new issue of shares.

The Financial Accountant 2019

362
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

Question 2
Ratio S C Ltd HLMC Ltd Comments

Gross HLMC Ltd is able to achieve a considerably

profit higher gross profit than SC Ltd, This may be
23.55% 37.5%
percent- due to a number of factors e.g. an effective
age purchasing strategy or premium pricing.

The management of HLMC Ltd appears to be

much more efficient at utilising its assets to
Return
generate profit. However, more information is
on capital
14.8% 35% required on the individual companies e.g. their
em-
policies on asset valuation, depreciation and
ployed
assets revaluation before drawing any firm
conclusions.

SC Ltd has a lower acid test ratio than HLMC

Ltd. It is likely that SC Ltd is experiencing
Acid test
0.6:1 1.1:1 liquidity problems and finding it difficult to meet
ratio
commitments as they fall due. This view is
further supported by the size of the overdraft.

HLMC Ltd appears to have a stronger EPS

than SC Ltd, which might suggest that HLMC
Earnings Ltd is a better investment. However, more
11n 31n
per share information is required on the accounting
policies adopted by both companies, before
drawing any firm conclusions.

HLMC Ltd was able to pay its dividend fairly

comfortably and it is likely that this level of
Dividend 1.5
3.7 times dividend can be sustained as a significant
cover times
amount of profit has been retained for future
investment. SC Ltd.'s dividend cover was m

The Financial Accountant 2019

363
Study, understand and apply

The Financial Accountant

Interpretation of Financial Statements

c) Nature and purpose of an accounting conceptual framework

An accounting conceptual framework can be defined as a coherent system of inter-
related objectives and fundamentals. Such a framework should lead to consistent
standards that prescribe the nature, function and limits of financial accounting and
financial statements.
The purpose of a conceptual framework is to provide a basic structure for
answering some of the fundamental questions of financial reporting such as:

 What is the purpose of preparing financial statements?

 For whom are the statements prepared?

 What are their information requirements?

 What statements should be produced?

In addition a conceptual framework should prevent the profession from establishing

conflicting accounting rules and practices.

The Financial Accountant 2019

364
Study, understand and apply

The Financial Accountant

Part G
Non-trading
organizations and
other special
accounting needs

Session Detail Time allocation

22 Income and expenditure accounts 1 Hour

Question Practice and assignments 1 Hour
23 Manufacturing and departmental accounts 30 min
Question Practice and assignments 1 Hour

The Financial Accountant 2019

365
Study, understand and apply

The Financial Accountant

Session 22
Income and Expenditure
Accounts

Focus

Non-profit seeking organizations are now common in present day society.

A non-trading organization exists to provide a service to their members and not to
make profit. These organizations may finance some of their activities through
trading activities which may involve operating a canteen, cafeteria, bar or school but
these are simply means to an end. This session looks at the accounting needs of
non-profit seeking organizations.

Learning objectives

Upon completion of this session you should be able to:

 Describe the content and purpose of receipts and expenditure accounts

 Explain the key non-trading organization terminologies

 Compute major adjustments for inclusion in the financial statements of a

non-trading organization.
 Prepare the primary financial statements of a non-trading organization.

The Financial Accountant 2019

366
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

1 The Receipts and payments Account

In most cases, the minimum record that a non-profit seeking organization will keep is
a receipts and payments book which usually falls under the charge of a treasurer.
The treasurer will of course be interested in recording cash movements in this book.
If we use a ledger account to demonstrate how the treasurer records the cash
transactions of a non trading organization, we may end up with an account similar
to the one below.

JK Foundation Receipts and Payments account for the year ended 31

December 2017
Receipts Km‘ Payments Km‘
Balance b/f 20 Canteen expenses 20
Subscriptions 100 Postage 9
Grants 50 Lawn Mower 7
Canteen takings 40 Heat and lighting 5
Rent 24
Stationary 10
Balance c/d 135
——— ———
210 210
.
——— ———

The table below highlights the advantages and disadvantages of a receipt and
payments account.

Advantages Disadvantages

 Relatively easy to prepare and  Disregards accrued income or

understand expenses
 Shows the amount of cash
received and used in a period
 Disregards the difference
between capital and revenue
which may be useful for cash
expenditure
control purposes
 Forms the basis of preparing  Ignores the depreciation
income and expenditure of non-current Assets
accounts  May not show the obligations and
assets of the organization in full

The Financial Accountant 2019

367
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

The treasurer of a non-profit seeking organization effectively carries out what we

may term as cash accounting. An accountant engaged to prepare financial
statements of a non-profit seeking organization has to convert the cash accounts
prepared by a treasurer into accruals based accounts. In other words the
accountant will include the effects of credit transactions, provisions, depreciation,
estimates and professional judgment among other things to the receipts and
payments accounts.

2 Income and Expenditure Account

The income and expenditure account measures the economic performance of a non
-trading organization for a specific period. This statement is similar to the income
statement. Since Non-trading organization do not exist to make profit but to provide
a service the income and expenditure account is used to establish a surplus or
deficit. Below is a basic format of the income and expenditure account of King Jones
Foundation.

JK Foundation Income and Expenditure Account for the year ended 31

December 2017.

Income K K
Subscriptions X
Life membership X
Canteen X
Donations X
Investment Income X
Competition prizes X
——--
Total income X
Expenditure
Rent X
Electricity X
Printing Stationary X
Donation X
Subscription X
X (X)
——-- ——--
Surplus/Deficit X(X)
——--

The Financial Accountant 2019

368
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

3 Major Adjusting Items

Under this syllabus portion, the examiner will seek to test the understanding of
students on the following items.
Annual Subscriptions
Most non-trading organizations require their members to pay a regular amount
known as subscriptions as consideration for enjoying membership rights.
Subscriptions are accounted for in the subscriptions income account. An example of
the subscriptions account is shown below.

Jones King Foundation Subscriptions Income account

K K
Bal. b/f (arrears) X Bal. b/f (advance) X
Income/Expenditure A/c X Total Subscriptions Paid X
Bal. c/d (advance) X Bal. b/f (arrears) X
——- ——-
X X
——- ——-
Explanatory notes:
 The opening advance subscriptions from the previous accounting period should
always be credited in the subscriptions account.
 The opening accrued subscriptions from the previous accounting period should
be debited in the subscriptions account.
 All subscriptions payments from bonafide members of the organization should
be credited in the account.
 The closing unpaid (Accrued) subscriptions should be credited to the account
and treated as current assets for the non-trading organization.
 The closing prepaid (advance) subscriptions should be debited to the account
and treated as current liabilities for the non-trading organization.
Life Membership Subscriptions
A non-trading organization may allow its members to pay life membership
subscriptions. Life membership subscriptions confers long term membership rights
on a member. Accounting for life membership subscriptions has two definite views
as proposed by accounting scholars.
Proponents of the first view suggest that the life membership fee should be treated
as non-current liability until the life member dies. In essence when the member pays
up we proceed as follows:

The Financial Accountant 2019

369
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

DR Bank
CR Life membership account
Being payment for life membership fees.

Upon the demise of the life member, the life membership fee is transferred to the
accumulated fund account.

DR Life membership account

CR Accumulated fund
Being transfer of funds from the life member to the organization.

The approach above may not be in the interest of the organization and the life
member if the member lives longer or ceases to be a member sooner than
expected. If the member lives longer, the club may lose out because the member‘s
life membership fee like all payments carries a limited time value. On the other hand,
if the member is unable to continue deriving benefits from the club in the short term,
they will not fully utilize their benefits based on a higher contribution.
The second approach seeks to resolve the above problem. It involves amortizing the
life membership subscription over an agreed number of years thereby putting a time
limit on the life membership contribution. This is perhaps the best approach of
accounting for life membership subscription. A fixed sum will be transferred from the
life membership account to the income and expenditure account until the life
membership subscription is fully amortized.
Like in the first viewpoint when a member pays we proceed as follows:

DR: Bank
CR: Life Membership Account
Being payment of life membership

For annual transfer to the income and expenditure account

DR: Life Membership Account
CR: Income & Expenditure Account
Being annual amortization of life membership subscriptions.

The Financial Accountant 2019

370
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

Special Funds
A special fund account may be maintained by a non-trading organization for a
special project or for investment purposes. The double entry for such special funds
is given below:
Reception of Funds double entry
DR Bank
CR Special Fund Account (Non-Current Liability)

Investment of Funds double entry

DR Investments
CR Bank

Interest Earned on investments double entry

DR Bank
CR Income and Expenditure

Bar trading Profits

A non-trading organization may operate a bar, a restaurant or a cafeteria in order to
raise additional funds to finance their operations. Students may be asked by the
examiner to compute the income generated from such activities for inclusion in the
income and expenditure account. Knowledge of incomplete records for establishing
missing figures for sales, Purchases will be handy here. A basic format of the
trading account is given below:

Jone King Foundation

Bar trading account for the year ended 31 December 2017
K K
Sales X
Opening Inventory X
Purchases X
Closing Inventory (X)
——-
Cost of sales X
——-
Gross Profit X
Bar man‘s Wages (X)
——-
Profit (Transfer to income & Expenditure X
——-

The Financial Accountant 2019

371
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

Depreciating assets
The loss in value of non-current assets of a non-trading organization should be
reflected in the financial reports. Non trading organization should therefore
depreciate the non-current assets under its control.

The double entry for depreciation is as follows:

DR Income and Expenditure account

CR the asset Account

The Financial Accountant 2019

372
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

Session Summary
 The word organization includes non-trading bodies such as clubs,
societies, churches etc.

 A non profit seeking organization does not exist to make profit but to
meet some of the social needs and wants of its members.

 In most small non profit making entities, the treasurer usually acts as
the substantive financial officer.

 Non-trading organizations are financed by membership contributions

and other legitimate sources including real estate income, trading
income, donations, grants, fundraising events etc.

 In preparing the financial statements of a non-trading organization the

accountant essentially convents cash based accounts to accruals
based accounts.

 Under a non trading organization, the word profit is replaced with the
word surplus, a loss is replaced with the word deficit and capital is
replaced with the word accumulated fund.

The Financial Accountant 2019

373
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

Preparation Question 1
The following is a summary of the receipts and payments of Good Health Theatre
Club during the year ended 31 December 2011.
The Good Health Theatre Club (GHTC)
Receipts and payments accounts for the year ended 31 December 2011

Dr Cr
K K
Cash and bank balance 1,500 Secretarial expenses 340
Sales of competition tickets 750 Rent 2,520
Members subscriptions 4,800 Travel expenses 850
Donations 210 Donations to charities 45
Sale of refreshments 920 Prizes for competitions 270
Stationery & printing 179
Purchases of refreshments 440
Wages of bar attendant 230
Supplier of New Equipment 1,800
Balance c/d 1,506

———- ———-
8,180 8,180
———- ———-
Bal. b/d 1,506

The following account balances are also available:

As at 31 December 2010 2011
K K
Equipment (original cost K3,500) 2,000 5,500
Subscriptions in arrears 80 65
Subscriptions in advance 30 40

The Financial Accountant 2019

374
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

Owing to suppliers of refreshments 130 125

Inventory of competition prizes 42 38

Inventory of refreshments 150 180

During the year equipment worth K4,500 was bought on credit from Strong bones
Enterprises but no record of this transaction was made in the books.
Required:
a) Calculate the value of the accumulated fund of the club as at 1 January 2011.
(3 marks)
b) Calculate the amounts for:
i) Subscription earned

ii) Profit or loss on refreshments

iii) Surplus on competitions held (8 marks)

c) Prepare an income and expenditure account for the club for the year ended 31
December 2011; and (5 marks)

d) And a Statement of Financial Position as at that date. (4 marks)

[Total :20 marks]
ZiCA Jun 2012

The Financial Accountant 2019

375
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

Preparation Question 2
Kabwata Youth Empowerment Project (KYEP) is an initiative by the Citizens
Economic Empowerment Commission (CEEC) to overcome the challenges of youth
unemployment in the area. The project is to raise income through establishing a
tennis club, to be specialized in selling Tennis Game accessories and hosting the
game tournaments at a fee to competing teams. Registered member teams will use
the club facilities at no extra cost but non member teams will use the facilities at a
fee. Besides, KYEP hosts dances by various artists.
CEEC would make donations to the project depending on their performances in the
other income generating activities.
The Treasurer of the project has prepared the following receipts and payments
account for the year ended 30 September 2014:
K
Balance B/f 84,250 ‗
Receipts
Sales of tennis tables 2,250
Sale of tennis balls 1,000
Sale of dance tickets 53,875
Subscriptions
Annual subscription 2125
Life 5,000
CEEC Donation 10,000
————
74,250
————
Payments
Purchase of tennis table 1,125
Purchase of tennis balls 2,050
Printing of dance tickets 40,325
General cleaning 30,000
General expenses 3,500
Total payment ————
77,000
————
The Financial Accountant 2019
376
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

Other information available is as follows:

‗

30-09-2013 30-09-2014
K K
Buildings 75,000 71,250
Inventory of tennis tables 375 250
Fixtures and fittings 30,000 25,000
Subscriptions in advance 500 750
General expenses owing 875 1,375

Note:
There was no purchase or sale of non current Assets during the year ended 30
September 2014.
Required:
a) Compute of KYPE‘s accumulated fund as at 1 October 2013. (3 marks)
b) Draw up a life membership account, clearly stating the transfer to income and
expenditure account and deferred income as at 30 September 2014.
(2 marks)
Note: Life membership is the period of 10 years
c) Prepare an income and expenditure account for KYEP for the year ended 30
September 2014. (8 marks)
d) Prepare the statement of financial position as at 30 September 2014.
(7 marks)
[Total: 20 Marks]
ZiCA T1 Jun 2015

The Financial Accountant 2019

377
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

Suggestion Solution
Question 1
(a) Opening Journal (Calculation of Accumulated Fund at 1 January 2011):

Assets K K
Bank 1,500

Income and Expenditure Accounts

Question 2

A) KYEP’s accumulated fund as at 1 October 2013

K K
Cash 84,250
Buildings 75,000
Inventory-Tennis tables 375
Fixtures and fittings 30,000
Liabilities
Subscription 500
General expense owing 875
Accumulated fund 188,250
————- ————-
Total 189,625 189,625
————- ————-

B) Life Subscriptions A/c

Transfer to I/E a/c 500 bank 5,000
Bal c/d 4,500
————- ————-
5,000 5,000
————- ————-

The Financial Accountant 2019

381
Study, understand and apply

The Financial Accountant

Income and Expenditure Accounts

C) KYEP’s income and expenditure account for the year ended 30

September, 2014
Income K K

Annual subscription (W1) 1,875

Focus

Although most traders deal in finished goods, others still procure raw materials for
conversion into finished units of output for their markets. Such
entrepreneurs are commonly known as manufacturers. Manufacturing business is
associated with the phrase value addition which has in the recent past become a
subject of interest for developing countries like Zambia. This chapter discusses the
special accounting needs of a manufacturing business. We will also look at the
special accounting treatment of organizations running multiple departments.

Learning objectives
Upon completion of this session you should be able to explain:

 The Difference between Manufacturing and merchandise businesses

 The content and meaning of entries made in the manufacturing account

 The purpose of the manufacturing account

 The trading and profit or loss account of a manufacturing business

 Prepare the financial Position of a manufacturing entity

 Prepare departmental accounts

The Financial Accountant 2019

385
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

1 Manufacturing and Merchandise Commentary

Businesses Compared Given the pristine idea of
Even though many businesses trade in finished conversion of raw materials
goods, we still have some into finished goods, it is not
entrepreneurs that buy raw materials for uncommon for
processing into finished goods. Many expert at
manufacturing concerns to
least support the idea of local value addition for
raw materials in a bid to strengthen their buy finished goods or work in
economies. The table below shows basic progress from suppliers in
differences between a merchandise business order to meet excess
and a manufacturing business. customer orders.
Merchandise Manufacturing
Business Business
 Trades in raw
 Mainly trades in materials, work in In a manufacturing concern,
finished goods progress & more emphasis is placed on
finished goods
the quality of units processed
 Does not subject
 Subjects compared to a merchandise
inventory (RM, business.
inventory to a
WIP) to a
manufacturing
manufacturing
process
process

 Does not need

 Uses production Some manufacturing
production
facilities concerns purchase work in
facilities
progress from their suppliers
 Usually holds in a bid to minimize
 Usually holds raw production costs.
one type of
materials, work in
closing inventory
progress and
in form of
finished goods
finished goods

2 Total Production Cost Total production cost is a

basis for calculating the profit
Cost accounting in a manufacturing business is
not just a key control measure on expenditure; mark up for most
through it, management will be able to plan and manufacturing entities.
decide on matters relating to cost minimization
and income maximization. Similarly, from the
Financial accountant‘s point of view, there is
need to establish the cost of production which
includes prime cost and total production
overheads. Production cost replaces purchases
of finished goods.

The Financial Accountant 2019

386
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

3 The Manufacturing Account

In order to establish the cost of production, a special account known as the manu-
facturing account is used. The mentioned account is posted with:

 Raw materials consumed in production

 Direct labour costs

 Direct expenses

 Production overheads

A format of a manufacturing account follows:

KSM Manufacturing account for the year ended 31 December 2017
K K
Raw materials opening inventory X
Purchases of raw materials X
Carriage inwards of raw materials X
Raw materials closing Inventory (X)
——-
Raw material consumed in production X
Add Direct labour X
Add Direct Expenses X
——-
Prime cost (Total variable costs) X
Overheads
Supervisors salary X
Machinery Depreciation X
Utility bill X X
——- ——-
X
Add opening work in progress X
Less closing work in progress (X)
——-
Total production cost X
——-

The Financial Accountant 2019

387
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Transfer of Production Cost at Market Value

The management of a manufacturing concern may deem it fit to transfer the
production cost at market price to the trading account in order to ensure that total
production costs are fully covered. If this need arises, the following rules are
applicable as highlighted in the table below.

Heroes Investments Co. Manufacturing Account

K000‘
Prime cost 2,000
Plus Overhead 1,000
———
Total production cost 3,000
Add Profit Mark up (Balancing Figure) 600
———
Transfer to the trading account at market value 3,600
———

In the trading account purchases will be replaced with the value of goods transferred
from the manufacturing account at market value. This price should be adjusted for
the profit mark up through passing the double entry below.

DR Production cost (Manufacturing account)

CR Trading account (Trading account)

4 The Trading Account

The trading account for a manufacturing firm is used to compute the gross profit
made in the reporting period. In the trading account, emphasis is normally placed on
the word trade which is used to refer to all entries which are used to calculate gross
profit. The format on the next page shows a basic format of the trading account.

The Financial Accountant 2019

388
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Heroes Investments Co.

trading, profit or loss account for the year ended 31 December 2016.
K K
Sales X
Sales Returns (X)
——-
X
Finished goods Opening inventory X
Total Production Cost X
Finished goods Closing inventory (X)
——-
Cost of sales (X)
——-
Gross Profit X
Selling and Distribution costs (X)
Administration Expenses (X)
——-
Net profit X/(X)
Interest paid (X)
——-
Profit or loss before tax X/(X)
Tax (X)
——-
Profit or loss after tax X(X)
——-
Manufacturing entities normally deal with three inventory classes namely:
 Raw materials
 Work in progress

 Finished goods
Remember to include the closing balances of all the types of inventory above as
current liabilities under the current asset section of the statement of financial
position.

The Financial Accountant 2019

389
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

5 Department Accounts Commentary

In a business that runs more than one product Departmental accounts can
line, departmental accounts are essentially highlight well performing and
prepared to assess the individual performance of loss making departments.
each department. The objective of departmental The above knowledge is vital
accounts therefore, is to highlight well performing for resource allocation.
and poor performing departments through
performance reports. This information is useful for
planning, control and resource allocation.

Allocation and
apportionment are techniques
Allocation and apportionment of shared
used to assign costs to
expenses
business departments.
Under this sub heading, all directly attributed
expenses such as the wages of workers should
be allocated to their respective departments.
For those departments which share expenses a
cost accounting technique known as
apportionment is used to share expenses based
on an appropriate basis of apportionment.
Examples of shared expenses include:
Loss leaders can assist a firm
 Rent and rates to free up idle capital and
improve demand for other
 Electricity
products through a popular
 Insurance marketing strategy known as
cross selling. It is obvious
 Transport
that a person who walks in a
 Telephone supermarket store for
instance just to buy bread,
 Repairs and maintenance
may decide to also buy some
 Water bills meat if they have extra cash.

Loss leaders
A loss leader is a product whose price has been
deliberately reduced in order to attract more
customers in an attempt to sale more units of
other products.

The Financial Accountant 2019

390
Study, understand and apply

Manufacturing and Departmental Accounts

Preparation Question 1
Maybin Nawa is a manufacturer. His Trial Balance as at 31 December 2017 is as
follows:
DR CR
K K
Capital 274,912
Drawings 17,120
Premises 80,000
Machinery 65,000
Office equipment 22,000
Delivery van expenses 5,000
Lighting and heating: Factory 5,718
: Office 2,220
Manufacturing wages 90,940
General expenses : Factory 7,632
: Office 11,280
Purchases of raw materials 78,108
Salesmen commission 15,720
Rent : Factory 9,600
: Office 4,400
Office salaries 12,570
Receivables and Payables 56,740 38,900
Bank 26,674
Sales revenue 273,000
Inventory at 1 January 2017
Raw Materials 17,130
Finished goods 48,500
Work in progress 10,460
—————- —————-
586,812 586,812
—————- —————-
The Financial Accountant 2019
393
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Additional information:
1. Inventory at 31 December 2017 were:
Raw materials K18,100
finished goods K49,560
Work in progress K12,840

2. Ignore depreciation of fixed assets.

Required:
From the above details, prepare the Manufacturing Account, the Income Statement
for the year ended 31 December 2017 and the statement of financial Position as at
that date.

The Financial Accountant 2019

394
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Preparation Question 2
Muchinshi Supermarket operates three sections, food, toiletries and electrical.
The Accounts Assistant has been tasked to prepare accounts for the year ended 30
September, 2013. T
Food Toiletries Electricals
K K K
Sales 80,800 70,400 32,300
Opening inventory 12,700 8,300 3,400
Purchases 35,200 29,100 7,900
Wages of sales assistants 8,500 7,900 3,600
Closing inventory 8,900 6,800 4,100
Fixtures and fittings – cost 30,000 20,000 15,000
No. of employees 6 4 2

he following information was provided:

The following expenses cannot be traced to any particular section:

K
Salary of Supervisor 18,600
Rates 3,250
Advertising 6,000
Electricity 5,200
Telephone 3,000
General office expenses 2,600
Insurance 3,600
Cleaning 2,200
Repairs and maintenance 5,800
Vehicle running costs 5,400

The Financial Accountant 2019

395
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

 Expenses are to be apportioned on the following bases:

 Floor area – rates, cleaning, depreciation of building, water & electricity, repairs
and maintenance

 Sales value – salary of supervisor, advertising

 No. of employees – telephone, general office expenses

 Cost of sales – insurance, motor vehicle depreciation and running costs

The cost of Buildings is K200,000 and Van is K45,000. The van is used mainly to
purchase goods for the supermarket. Depreciation is as follows:
Buildings 5% on cost
Fixtures and fittings 10% straight line
Motor vehicle 20% straight line

Electricity bill outstanding at the year-end was K1,800 and rates paid for six months
up to 31 December 2013 were K1,500.
Required:
Prepare Muchinshi‘s Departmental Income Statement for the year ended 30
September, 2013, showing clearly, the contribution of each department.
(18 marks)
(a) Explain what a loss leader is. (2 marks)

[Total: 20 marks]

The Financial Accountant 2019

396
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Suggested Solution
Question 1
Maybin Nawa
Manufacturing account for the year ended 31 December 2017
K K
Raw materials:

Opening inventory 17,130

Purchases 78,108
————
Total inventory available 95,238
Closing inventory (18,100)
————
Cost of raw materials consumed 77,138
Direct labour:

Wages 90,840
————
Prime cost 168,078
Add: production overheads:

Lighting and heating 5,718

General expenses 11,280
Rent 9,600 26,598
———— ————
194,676
Add: opening work in progress 10,460
Less: closing work in progress (12,840)
Production cost ————
Total production cost 192,296
————

The Financial Accountant 2019

397
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Suggested Solution
Question 1
Maybin Nawa
Statement of profit or loss for the year ended 31 December 2017
K K
Sales revenue 273,000
Opening inventory 48,500
Purchases 192,296
————
Total inventory available 240,796
(49,560)
————
Cost of raw materials consumed 191,236
————
Prime cost 81,764
Expenses

Administration expenses 5,000

Lighting and heating 2,220
General expense 7,632
Rent 4,400
Office salaries 12,570
Sales man‘s commission 15,720
Total expenses ————
47,542
————
34,222
————

The Financial Accountant 2019

398
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Suggested Solution
Question 1
Maybin Nawa
Statement of Financial position as at 31 December 2017
Cost Deprecation NBV
Assets K K K
Non-current assets
Premises 80,000 - 80,000
Machinery 65,000 - 65,000
Office equipment 22,000 - 22,000
————— ————— —————
167,000 - 167,000
————— —————
Current assets
Inventory: Raw Materials 18,100
:Work in progress 12,840
:Finished goods 49,560
Receivables 56,740
Cash at Bank 26,674 163,914
————— —————
Total assets 330,914
—————
Capital and liabilities
Capital 274,912
Add: Net profit 34,222
—————
309,134
Less Drawings (17,120)
—————
292,014
Current liabilities
Payables 38,900
—————
Total capital and liabilities 330,914

—————

The Financial Accountant 2019

399
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Muchinshi Supermarket
Departmental Income statement for the year ended 30 September, 2013
Food Toiletries Electricals
K K K
Sales 80,800 70,400 32,300
Opening inventory 12,700 8,300 3,400
Purchases 35,200 29,100 7,900
47,900 37,400 11,300
Closing inventory (8,900) (6,800) (4,100)
————- ————- ————-
Cost of goods sold: 39,000 30,600 7,200
Add: wages of sales assistants 8,500 7,900 3,600
Cost of sales 47,500 38,500 10,800
————- ————- ————-
Contribution (sale – cost of sales) 33,300 31,900 21,500
————- ————- ————-
Less shared expenses: -
Depreciation: Fixtures (10% on cost) 3,000 2,000 1,500
Salary of Supervisor 8,190 7,136 3,274
Rates 1,250 833 417
Advertising 2,642 2,302 1,056
Electricity 3,500 2,333 1,167
Telephone 1,500 1,000 500
General office expenses 1,300 867 433
Insurance 1,766 1,432 402
Cleaning 1,100 733 367
Repairs and maintenance . 2,900 1,933 967
Vehicle running costs 2,650 2,148 602
Depreciation: buildings 5,000 3,333 1,667
Depreciation: Van 4,416 3,580 1,004
————- ————- ————-
39,214 29,630 13,356
————- ————- ————-
Net profit/(loss) (5,914) 2,270 8,144
————- ————- ————-

The Financial Accountant 2019

400
Study, understand and apply

The Financial Accountant

Manufacturing and Departmental Accounts

Workings:
Shared expenses:
Basis Amount Food Toi- Elec-
letries tric
K K K K
Salary of Supervisor Sales 18,600 8,190 7,136 3,274
Rates floor area 2,500 1,250 833 417
Advertising Sales 6,000 2,642 2,302 1,056
Electricity F/area 7,000 3,500 2,333 1,167
Telephone Employees 3,000 1,500 1,000 500
General office expenses Employees 2,600 1,300 867 433
Insurance Cost of sales 3,600 1,766 1,432 402
Cleaning Floor area 2,200 1,100 733 367
Repairs and maintenance Floor area 5,800 2,900 1,933 967
Vehicle running costs Cost of sales 5,400 2,650 2,148 602
Depreciation: buildings Floor area 10,000 5,000 3,333 1,667
Depreciation: Van Cost of sales 9,000 4,416 3,580 1,004

Depreciation expense for the year:

Buildings K200,000 x 5% = K10,000 p.a.
Van: K45,000 x 20% = K 9,000 p.a.

The Financial Accountant

Public Sector Accounting

1 Objectives of Public Sector Commentary

Accounting
Public sector refers to all organizations which are
not privately owned or operated. The main The public sector refers to
objective of the public sector is to provide a state owned enterprises,
service to the community. Public sector bodies local as well as national
may engage in trading activities but this only authorities.
serves to meet their main objective.

2 Differences between Private and

Public Sectors Ideally the public and the
There are several differences between the public private sector should
and private sector and the table below lists just a compliment each other in
few. improving the warfare of
ordinary man.

Private sector Public sector

 Exist to make profit  Exist to provide a

or to provide a service to the
return to their owner members of the
(s). public.

 Ultimately
 Ultimately accountable to The major difference
Accountable to tax payers between the public and
shareholders. through their private sectors lies in their
representatives. envisioned ends and not
necessary the means to
 Charges cost  Charges low those ends.
reflective prices on prices on goods
goods and services and services to
in order to improve make them
returns and cover affordable to the
costs. community.

 Usually funded
 Usually funded by
by tax payers, fee
shareholders and
charges and
financial lenders.
donations.

The Financial Accountant 2019

404
Study, understand and apply

The Financial Accountant

Public Sector Accounting

3 Cash Versus Accruals Commentary

Accounting With all its limitations, a cash
For many years now, governments all over the accounting system remains
world have largely been using cash accounting easy, cheap and requires
rather than accruals accounting in recording and less technical knowledge to
reporting financial activities. Effectively, this set up and manage.
means that credit transactions mostly go
unaccounted for.
Cash accounting opposes in
Most authorities argue that there is little or no many ways the idea of
difference between the two modes of accounting accountability through its
particularly when one considers the benefits simple but misleading mode
against costs of switching from cash accounting of presenting the financial
to accruals accounting and hence the reluctance position and performance of
to implement accruals based accounting. the reporting institution. In
The cash accounting approach, though simple, other words under cash
may have adverse effects on the financial accounting huge errors of
decisions made by controlling officers and other omission are inevitable.
consumers of public sector accounting
information. Cash accounting only recognizes
those transactions that involve the inflow and The accruals basis of
outflow of cash. Cash accounting disregards accounting recognizes both
everything but cash. cash and credit transactions
upon occurrence and not
Attributes of a cash accounting system when cash is paid or
In a cash accounting system there are : received.

 No payables as purchases are only

recognized upon payment of cash. By nature of their size and
complexity, it is difficult if not
 No receivables as sales are only recognized impossible to state that a
upon reception of cash. particular public sector body
has no payables or
 No inventory because there is no closing and
receivables just because
opening inventory
they have adopted a cash
 No current assets as resources are accounting system.
collectively owned by the entire government.

 No current liabilities because liabilities are

collectively owed by the government.

The Financial Accountant 2019

405
Study, understand and apply

The Financial Accountant

Public Sector Accounting

Advantages of cash accounting

 Highlights how an organization has deployed funds.

 The financial reports are easy to prepare and understand.

 Encourages spending within budgetary allocation.

 Only cash transactions are recorded thereby eliminating subjectivity.

Demerits of cash accounting

 Only considers cash and this leads to understated assets and obligations.

 The true worth of the entity may not be known.

 Incomplete financial reports based solely on cash movements are highly

misleading.
Merits of the accruals accounting

 Recognition of business transactions takes place upon occurrence.

 Profit is reliably measured as credit transactions are also included in income

and expenses.
Demerits of the accruals accounting

 Requires the use of estimates, judgment and assumptions which may result in
inaccurate reporting.

 Does not take into consideration the effects of inflation on many items.

 Requires knowledge and experience to manage.

 It is open to manipulation by those who prepare financial statements.

4 Documentation under cash accounting

The cash book is a major record under cash accounting and it records receipt and
payments. Further, expenditure and receipts are analyzed into individual columns.
Column totals can be used for direct posting to the nominal ledger accounts.
Financial statements may comprise of :
i) The income and expenditure account
ii) Statement of financial position

The Financial Accountant 2019

406
Study, understand and apply

The Financial Accountant

Public Sector Accounting

5 Legislation Governing Public Commentary

Sector accounting The work of an accountant in
Like the financial statements of a private sector the public sector is affected
firm, the form and content of public sector by many rules and
financials is affected by among other things: regulations and it is generally
thought that part of the
 Local accounting standards and procedures competence required of a
public sector accountant is
 International public sector accounting the knowledge of how
standards (IPSASs) government financial system
 Legislation (Law) operate.

 Professional judgment

6 Institutional Framework for Public

Sector Accounting
The international public sector accounting
standards board is a body responsible for the
formulation of international public sector
accounting standard commonly known as IPSAS.
This body falls under the auspices of the IPSAS will definitely lead to
international federation of accountants IFAC. uniform financial reporting in
the public sector and this may
IPSAS are largely based on IFRS‘s which are help users of public sector
developed by the international accounting financial information to make
standards board and therefore are not very useful analysis of the
different from private sector accounting performance of similar public
standards. IPSAS seek to address the accounting organizations overtime.
needs of national, regional and local government
needs. IPSAS can provide a criteria
used for the evaluation of
The implementation of IPSAS can compel the government accounting
public sector to be more transparent and practices where such
accountable on how public resources have been standards are included in the
used. IPSAS can therefore enhance the role of regulatory system of a
resource stewardship in a country like Zambia. country.

The Financial Accountant 2019

407
Study, understand and apply

The Financial Accountant

Public Sector Accounting

7 Sources of Revenue for Public Commentary

Sector Bodies Most public sector bodies are
Public sector sources of revenue include: financed by tax payers contri-
 Central government funding butions.

 Fee charges
 Local taxes Perhaps one of the best ways
of encouraging tax compli-
 Rates
ance is to highlight the bene-
 Loans or debt finance fits that comes back to the
 Donor funds tax payer after they have
made their tax contribution.
Tax is used to finance public
8 Types of Government goods and services for the
Expenditure benefit of the wider citizenry.
Government expenditure is broadly grouped into
revenue and capital expenditure.
Revenue expenditure relates to day to day
expenses incurred by the government such as
petty cash expenses, salaries, utility bills etc. Huge outlay of funds
earmarked for project
Capital expenditure relates to capital projects finance, should be
such as the expenditure on roads, schools, monitored by using water
hospitals, housing projects etc. tight controls in order to avoid
Revenue expenditure is short term unlike capital loss of scarce
expenditure which is long term. Capital resources.
expenditure involves huge outlays while revenue
expenditure involves lesser amounts. Further,
capital expenditure usually involves one off type
of expenditure compared to revenue expenditure
which is frequently incurred.
In light of the above, revenue and capital
expenditure require a different approach in
accounting treatment. Revenue expenditure is
normally expensed in the income and
expenditure account and capital expenditure
should be capitalized in the statement of financial
position.

The Financial Accountant 2019

408
Study, understand and apply

The Financial Accountant

Public Sector Accounting

9 Public Sector Terms

Term Meaning
Revenues or expenses relating to normal daily activities of the a
Above the line
public sector body e.g. salaries or utility bills.

Exceptional or extraordinary items which are excluded in the

Below the line calculation of above the line profit or loss e.g. purchase of a
fleet of land and buildings.
Virement Transfer of funds from one budget to another.
Commitment Posting an expenditure before making payment.
The assignment of clear but limited roles in particular
organizational processes. No single individual should be
permitted to begin and complete an organizational process. This
promotes accountability and minimizes avoidable systemic
errors. In general, the duties below should not be under the
charge of one individual
Segregation of
duties  Record keeping
 reconciliations
 Authorization
 Custody of assets

This audit is carried out by government auditors in order to

ensure that funds were used in line with the intended purpose
and not misappropriated. Auditing work under a pre-audit may
involves the following audit procedures:

 Checking if sufficient funds were allocated to specific

expenses
 Checking if sufficient documentation were kept for
Pre-audit expenses incurred.
 Verifying that all expenses were subject to
authorization.
 Verifying that expenses were promptly and accurately
recorded.
 Ensuring budget reviews where regularly conducted at
management level.

The Financial Accountant 2019

409
Study, understand and apply

The Financial Accountant

The Financial Accountant

Public Sector Accounting

Suggested solution
Question 1
a) The public sector refers to all government ministries, agencies, and
departments. In short, public sector can be defined as all organizations which
are not privately owned or operated.
b) Differences between the public and the private sector

 The public sector primarily exists to provide a service, while the private sector‘s
main objective is to generate a return for business owners.

 The public sector is usually funded by tax payers contributions while the private
sector is largely financed by individuals or shareholders.

 Public sector management is usually accountable to elected

representatives while private sector management is usually accountable to
business owners.
c) Limitation of cash accounting includes

 Cash accounting fails to fully account for institutional assets and liabilities.

 Cash accounting also misstates the value of income and expenses which
ultimately leads to misstatement of profit.

 Cash accounting does not regard the effects of depreciation on profits.

d) Sources of funding for the public sector

Public sector sources of revenue include:
 Central government financing through the ministry of finance
 Fee charges
 Local taxes
 Rates
 Borrowings
 Donor funding

The Financial Accountant 2019

413
Study, understand and apply

The Financial Accountant

Public Sector Accounting

Term Meaning
Above the line Revenues or expenses relating to normal daily activities of a
public sector body.
Below the line Exceptional or extraordinary items which are excluded in the
calculation of above the line profit or loss.
Virement Transfer of funds from one budget to another.
Commitment Posting an expenditure before making payment.
Segregation of Officers at different levels of management hierarchy should not
duties be able to start and complete a financial transaction.
Authorization All work should be subject to supervision by senior officers.

Question 2
a) Influences on the form and content of public sector financial statements
include:

 Local accounting standards and procedures.

 International public sector accounting standards (IPSASs)

 Legislation (Law)

 Professional judgment

b) Four (4) Benefits of complying with IPSASs include:

 Promotes consistency in public sector financial reporting

 Minimizes losses resulting from fraudulent reporting by wanting controlling

officers.

 Enhanced accountability levels in the handling of public sector financial

transactions.

 Help the public sector to attract investment partners who are keen on public
governance best practice.

The Financial Accountant 2019

414
Study, understand and apply

The Financial Accountant

Public Sector Accounting

c) Internal controls
Segregation of duties
Segregation of duties involves the assignment of clear but limited roles in particular
organizational processes. No single individual should be permitted to begin and
complete an organizational process. This promotes accountability and minimizes
avoidable systemic errors. For instance officers responsible for collecting funds
from the public should not be allowed to do banking.
Fiscal discipline
All payments should be carried out in line with budgetary allocation. Bills above
budgetary limits should be subjected to further scrutiny to avoid avoidable resource
wastage.
Human resource Training and development
Skilled labor can greatly promote efficiency in the management of public resources.
Training can also be the basis of disciplinary action against all substandard output
from employees. Labor has greater influence on the other factors of production and
may require additional effort if it is to be managed successfully.
Prompt recording of financial transaction
Record keeping is a minimum legal requirement for most organizations. The prompt
recording of financial transactions prevents errors of omissions and fraudulent
reporting.
Physical controls
Third party access to cash and other valuable articles such as receipt books must
be prohibited through physical controls. This may involve the usage of strong
rooms or safes in cash custody and restricting access to the finance department.

The Financial Accountant 2019

415
Study, understand and apply

The Financial Accountant

Public Sector Accounting

d) Advantages and disadvantages of accruals accounting

 Recognition of business transactions takes place upon occurrence.

 Profit is reliably measured as credit transactions are also included in income

and expenses.
Demerits of the accruals accounting

 Requires the use of estimates, judgment and assumptions which may result in
inaccurate reporting.

 Does not take into consideration the effects of inflation on financial transactions.

The Financial Accountant 2019

416
Study, understand and apply

The Financial Accountant

Part I
Information
Technology and The
extended Trial
Balance

Session Detail Time allocation

24 Computerized accounting system 30 min
Question Practice and assignments 1 Hour
25 Extended Trial Balance 1 Hour
Question Practice and assignments 1 Hour
Mock 2 3 Hours

The Financial Accountant 2019

417
Study, understand and apply

The Financial Accountant

Session 25
Computerized Accounting
System

Focus
Information technology is here to stay. The benefits of IT to the business world are
several; including among other things, reduced operating costs, efficient processing
of transactions and ability to process millions of transactions in no time. This session
seeks to reinforce the above thoughts with particular emphasis on how IT has
positively affected the Accountant‘s office.

Learning objectives
Upon completion of this session you should be able to describe and explain:

 The importance Accounting packages

 The purpose and functions of common accounting modules

 Nature and purpose of a database

The Financial Accountant 2019

418
Study, understand and apply

The Financial Accountant

Computerised Accounting System

1 Accounting Packages Comment

Accounting packages are software programs The principles of a manual
dedicated to processing accounting tasks. accounting system and that
Computer programs are the instructions that of a computerized system are
command the electronics on how to process the same.
data. Common accounting packages are now in
use including pastel accounting, QuickBooks,
Sun system etc.
In a computerized accounting system you will
meet the popular terms software and hardware.
A monitor is a television like
Hardware is the physical part of a computer while
part of computer which
software refers to computer programs. The
displays symbols, figures,
computer hardware is made up of a central
letters etc.
processing unit (CPU), the monitor and the key
board. The central processing unit is used for
storage as well as processing of information, the
key board is used for data input, alterations and
extraction of important information and the Accounting work is mostly
monitor is used to track the operators activities done on excel spreadsheets.
on the computer system.
In the modern business world, computer
knowledge is a must have. The reader must
make every effort to get exposed to different
accounting packages. In addition, all accountants
are supposed to be savvy in the usage of general Proper usage of IT products
application software such as Microsoft excel, by Accountants may serve
word, power point, publisher etc. the organization time, effort
and the needless cost of
In the absence of the above knowledge, the human errors.
Accountant‘s ability to communicate will be
adversely affected and it will be difficult for them
to compliment the efforts of fellow colleagues in All computerized systems
the work place. Additionally, the modern finance require some degree of
department comes with all kinds time pressured human intervention.
assignments and reports. It is difficult to imagine
how an accountant can survive without IT
solutions.

The Financial Accountant 2019

419
Study, understand and apply

The Financial Accountant

Computerised Accounting System

Advantages of accounting packages

 Usable by non accounting specialists.

 Efficient and quick in processing large volumes of data.

 Improved data processing accuracy.

 Facilitates better data analysis in no time thus helpful for timely decision making.

Disadvantages of accounting packages

 Firms should be ready to incur significant system set up and training costs.

 Exposure to hacking activity, particularly where there are weak physical and
systemic controls.

 The need to develop a coding system for data checking purposes may
inconvenience those who are not familiar with the adopted codes.

 Change averse staff may not welcome and later on corporate with the idea of
implementing an automated accounting system.

 Lack of an audit trail particularly where users are not conversant with the
automated system in place may pause significant verification problems.

2 Coding
In a computerized accounting system, Accountants use codes in processing data.
Codes are simply symbols used to manipulate accounting data and information.
Codes are used to identify and manipulate information relating to customers,
suppliers, assets, liabilities, income, expenses and capital. Attributes of good codes
include the following points:

 Understandable: Not complex; easy to comprehend by users.

 Concise: short and easy to remember.

 Precise: fit for purpose or close to what is required.

 Expandable: Alterable without lose of meaning and purpose.

 Simple to use: A combination of all the above attributes.

The Financial Accountant 2019

420
Study, understand and apply

The Financial Accountant

Computerised Accounting System

Advantages of codes

 Codes minimize work duplication.

 Codes can facilitate quick report generation.

 Codes reduces users work load.

Limitation of codes

 May require additional storage capacity within a system.

 May not be suitable for specific tasks such as payroll computation etc.

 May not help in identifying the fraudsters when employees share access codes.

3 Accounting Modules
A module is a program which deals with one particular part of a business accounting
system. An accounting system may consist of one module or a collection of
modules. A collection of modules is known as a suite. Examples of accounting
modules include:

 Payable ledger

 Receivable ledger

 Nominal ledger

 Payroll

 Cash book

 Invoicing

 Inventory

Integrated software
An integrated software contains modules which are integrated with other modules.
In this type of software, updating one module results in the automatic update of a
related module. For example updating the invoicing module will automatically update
the receivable ledger module.

The Financial Accountant 2019

421
Study, understand and apply

The Financial Accountant

Computerised Accounting System

Receivable ledger system

A receivable ledger system is used to process transaction relating to credit
customers.
Inputs to a receivable ledger system include amendments and transaction data
relating to:

 Customer details

 Inclusion of new customers

 Deletion of old in-active customer accounts

Transaction data relate to :

 Credit sales

 Customers receipts

 Credit notes

Output from the receivable ledger system include:

 Day book listing which shows all transactions posted each day.

 Sales Invoices.

 Statements sent to customers.

 Aged account receivable list which shows the outstanding receivable balances
and for how long the debt has been overdue.

 Sales analysis report which analyse sales according to the sales analysis
codes.

 Reminder letters (Statements) used to make follow ups on overdue receivables

The Financial Accountant 2019

422
Study, understand and apply

The Financial Accountant

Computerised Accounting System

The payable ledger system

Input to a payable ledger system include:

 Details of purchases recorded on invoices

 Payments made to suppliers

 Correction of errors

 Adjustments

 Credit notes

Output of a payable ledger system:

 List of transactions posted

 An expenditure analysis which shows details of cash spent

 List of outstanding payable balances

 Remittance advise notes

 Aged payable analysis

Payroll
Many firms now process salaries using dedicated accounting packages which can
be a module within an integrated accounting system.
Typical output from a payroll module include:

 Summary payroll reports which show details of monthly gross earnings and
deductions.

 Pay in slips which are given to employees for their personal confirmation of
amounts earned and deductions made.

 Payroll liability report which include, salary related obligations such as pay as
you earn, national contributions, loan deductions etc.

The Financial Accountant 2019

423
Study, understand and apply

The Financial Accountant

Computerised Accounting System

The Nominal Ledger

The nominal ledger is a summary record of an entity‘s financial affairs. It contains all
ledger accounts of a business. In a computerized system, these accounts will be
coded accounts. The theory behind manual accounting is also used in a
computerized accounting system. The advantages of using a computerized system
over a manual system lies in the fact that computers minimize work duplication and
promote work productivity. In a computerized accounting system, you may omit the
day book stage when posting sales invoices for instance, thereby saving time which
can be used to do other equally important tasks.
Output of the nominal ledger include:

 The trial Balance

 Financial statements

The data base

A data base can be described as a pool of data used by different employees in their
daily work related activities.
Attributes of a data base include:

 Storage of common data for all eligible users to share.

 Minimized duplication of files.

 Provides consistent data to users thereby avoiding communications

breakdown.

Qualities of a good data base

 Data must be readily accessible by all authorized users.

 Data integrity must be preserved through relevant IT controls.

 Data must as far as possible suit the special needs of users.

 The data base should be capable of evolving and should reflect the present day
informational needs of the user.

The Financial Accountant 2019

424
Study, understand and apply

The Financial Accountant

Computerised Accounting System

Session Summary
 Many businesses now use automated accounting systems to process
business transactions.

 The advantages of a computerized accounting system over a manual

system are several. Computers are accurate, fast and efficient in data
processing compared to manual accounting systems.

 A computerised system is made up of hardware and software.

 computer programs are simply instructions that tell the electronics how
to process data.

 A module is a dedicated part of an accounting software that carries out

a specific task.

 A collection of different modules is known as a suite.

 Data base is a pool of information accessible by all authorized

members of staff.

The Financial Accountant 2019

425
Study, understand and apply

The Financial Accountant

Computerised Accounting System

Preparation Question 1
The advent of computer technology has dramatically shaped business activities in
our day. Many businesses are now using computerized accounting systems in the
place of manual accounting systems. There is no denying that information
technology to a large extent has positively affected the office of the financial
Accountant. Financial Accountants all over the world are now using bespoke
accounting packages to process information for their clients.
Required:
a) List and explain three (3) advantages and three (3) disadvantages of a
computerized accounting package (6 marks)
b) Define a data base and describe four (4) attributes of a good data base.
(5 marks)
c) List four outputs of the payables ledger and four outputs of the receivable
ledger records. (8 marks)
d) Define a module and give one example of a module (1 marks)

Preparation Question 2
Swing Song gardens is a small business specialized in providing beautiful picnic
spaces to its clients. The business idea is already attracting many families, schools
and individual clients within the neighborhood and demand is steadily increasing.
Thabo Ngandalo who is the proprietor of swing song gardens is concerned that the
current manual accounting system employed by her business will soon prove to be
inadequate. She has approached your consultancy firm and wishes to know if there
is a short term solution to her problem.
Required:
a) Explain any three advantages and disadvantages of switching from a manual
accounting system to an automated accounting system.
(6 marks)
a) List four (4) outputs from an automated payroll system (4 marks)
b) With regards to a computerized accounting system, describe the following:

The Financial Accountant 2019

426
Study, understand and apply

The Financial Accountant

Computerised Accounting System

 Computer hardware

 Computer software

 A suite

 Nominal ledger

 Integrated accounting system (10 marks)

[ Total: 20 marks]

The Financial Accountant 2019

427
Study, understand and apply

The Financial Accountant

Computerised Accounting System

Suggested solutions
Question 1
a) Advantages of accounting packages

 Usable by non accounting specialists so long as the operator receives training.

 Efficient and quick processing of enormous volumes of data.

 Improved data processing accuracy compared to a manual accounting system.

 Ability to analyze data thus helpful for decision making.

Disadvantages of accounting packages

 Firms should be ready to incur significant system set up and training costs.

 Exposure to hacking activity, particularly where there are weak systemic

controls.

 There is need to develop a coding system for system control purposes.

 Change averse staff may not welcome and later on corporate with the idea of
implementing an automated system.

A data base can be described as a structured set of data held on a computer

accessible by employees from different departments.
Attributes of a good data base include:

 Data must be readily accessible by all authorized users.

 Data integrity must be preserved through relevant IT related controls.

 Data must as far as possible suit the special needs of users.

 The data base should be capable of evolving and should reflect the current
informational needs of the users.

The Financial Accountant 2019

428
Study, understand and apply

The Financial Accountant

Computerised Accounting System

c) Payable and receivable ledger output

Payable ledger

 List of transactions posted during each day.

 Supplier invoices

 An expenditure analysis which shows details cash

 List of outstanding payable balances

 Remittance advise notes

 Aged payable analysis

Receivable ledger

 Day book listing which shows all transactions posted each day

 Sales Invoices

 Aged account receivable list which shows the outstanding receivable balances
and for how long the debt has been overdue.

 Sales analysis report which analyze sales according to the sales analysis
codes.

 Reminder letters used to make follow ups on overdue receivables

d) Define a module and give one example of a module

A part of a computerized system dedicated to the performance of specific tasks. An
example of module in a computerized system is the receivable module which is
dedicated to processing transactions relating to credit customers. A collection of
modules is known as a suite.

The Financial Accountant 2019

429
Study, understand and apply

The Financial Accountant

Computerised Accounting System

Question 2
a) Advantage and demerits of switching from a manual to a computerized system.
Advantages

 Although the cost of implementing a computerized accounting system may be

expensive in the short term, electronic systems are cheap in the long term.

 A computerized accounting system can process data with a greater degree of

accuracy compared to a manual accounting system.

 Computerized accounting system can process huge volumes of transactions in

no time. This is beneficial for decision makers who may need information
urgently.

 A computerized accounting system can reduce room for fraud if control checks
are embedded in the system.
Disadvantages

 A computerized accounting system is expensive to implement for many

businesses. Implementation cost are largely made up of license and training
costs.

 A computerized accounting system creates additional risks for the company

such as exposure of confidential information to system installers.

 Most accounting systems are not fool proof. This means all erroneous input if
not corrected will result in erroneous output. Without the necessary human
interventions, computerized accounting systems will produce incorrect
information.

 Perhaps a major weakness of a computerized accounting system is the

difficulty of establishing an audit trail. That is why most businesses still maintain
a parallel manual system.

The Financial Accountant 2019

430
Study, understand and apply

The Financial Accountant

Computerised Accounting System

b) four (4) outputs from an automated payroll system

 Summary payroll report which shows details of monthly gross earnings and
deductions.

 Pay slips which are given to employees for their personal verifications.

 Payroll liability report which include salary related obligations such as pay as
you earn, national contributions, loan deductions etc.

 The total cost of payroll to date for an accounting period.

c) Description of terms:

 Computer hardware: a collection of the physical parts of a computer including

the computer case, monitor, key board and mouse.

 Computer software: a set of instructions that tells the computer what to do or

how to perform a task. Computer software includes application and operating
systems.

 A suite: This is a collection of different modules.

 Nominal ledger: A summary record of the financial affairs of an entity.

 Integrated accounting system: A software application that standardizes the

procedures for recording transactions and sharing financial information. An
integrated accounting system minimizes redundancies thereby reducing system
administration costs and processing time.

The Financial Accountant 2019

431
Study, understand and apply

The Financial Accountant

Session 26
Extended Trial Balance

Focus
Discussions around the extended trial balance are not very different from those
relating to the traditional trial balance, which is simply a list of ledger account
balances. Armed with sound double entry knowledge, one only needs basic skills in
excel to start and complete his work of preparing financial statements using the
extended trial balance.

Learning objectives
Upon completion of this session you should be able to :

 Cast draft ledger account balances in the extended trial balance

 Pass journal entries in the extended trial balance

 Make post year end adjustments in the extended trial balance

 Prepare the primary financial statements using the extended trial

balance

The Financial Accountant 2019

432
Study, understand and apply

The Financial Accountant

Extended Trial Balance

1 Basics of the Extended Trial Commentary

Balances
An extended trial balance is a standard trial
balance which has added columns extending to The extended trial balance
the right and in which are listed the following builds on the traditional trial
categories of information : balance ideas.

 Initial balances as per general ledger

 Prior period end journal entries

You will find it easy to
 Post year end journal entries navigate in the extended trial
balance if you know your
 Statement of profit or loss closing balances basic double entry for period
end adjustments.
 Statement of financial position closing
balances

 In some cases, comparative financial

statements

2 Reason for the Extended Trial

Balance
Perhaps the usefulness of an extended trial The extended trial balance
balance lies in its ability to clearly show a gives you a full view of the
complete picture of the relationship between the relationship between the trial
trial balance and the two primary financial balance and the primary
statements; namely the statement of profit or loss financial statements
and the statement of financial position. As we
shall see, the above competence only requires
basic double entry knowledge as well as basic As you work through the
excel skills. The traditional reasons for extracting extended trial balance,
a trial balance still apply here. ensure that every entry you
On the pages that follow we concern ourselves pass leaves the total final row
with steps required in extracting a trial balance with equal debit and credit
through the use of an example. It is better to use totals.
excel in your follow through work.

The Financial Accountant 2019

433
Study, understand and apply

The Financial Accountant

Extended Trial Balance

Activity 25.1
Mr. Zulu pulled out the following list of ledger account balances from his general
ledger for the year ended 31 December, 2017.

Km‘
Rent 60
Electricity 5
Stationary 15
Sales 150
Irrecoverable debts 6
Allowances for receivables- 1st January 2017 2
Office equipment at cost 120
Accumulated depreciation-1st January 2017 40
Trade Receivables 55
Trade payables 53
Capital 110
Salaries and Wages 70
Purchases 65
Inventory-1st January, 2017 7
Interest Charge 8
Cash at Bank 8
The following adjustments are required:
i) Closing inventory is to be valued at K5m
ii) Rent amounting to K2m has been prepaid
iii) There is an accrual for electricity for K3m
iv) Depreciation on office equipment is to be provided at 20% per annum.
v) The allowance for receivables is to be increase by K3m
vi) Credit purchases of K1m were omitted from the books.

The Financial Accountant 2019

434
Study, understand and apply

The Financial Accountant

Extended Trial Balance

Required:
Using the information above, prepare the extended trial balance for the year ended
31 December, 2017.

Solution
Step by step approach
i) Extract the trial balance using the provided balances
ii) Pass the relevant journal entries
iii) Make the necessary year end adjustments
iv) Complete the statement of profit or loss
v) Complete the statement of financial position.

Check for the solution on the next page.

The Financial Accountant 2019

435
Study, understand and apply

The Financial Accountant

Extended Trial Balance

Extended trial balance

Post TB Statement Statement of
Journal
Trial Balance adjust- of profit or financial
entries
ments loss position
DR CR DR CR DR CR DR CR DR CR
Account
Km' Km' Km' Km' Km' Km' Km' Km' Km' Km'

Loan 65 65

Rent 60 2 58

Electricity 5 3 8
Stationary 15 15

Sales 150 150

Irrecoverable Debt 6 3 9

allowance for receivables 2 3 5

office Equipment 120 120

Accumulated Depreciation 40 24 64

Trade Receivables 55 55

Trade payables 53 1 54

Capital 110 110

Salaries and Wages 70 70

Purchases 65 1 66
Inventory 01.01.17 7 7
Interest 8 8
Bank 9 9

Depreciation Expense for the yr. 24 24

Inventory 31.12.17 (SOFP) 5 5

Inventory 31.12.17 (I/S) 5 5

Accruals 3 3

Prepayments 2 2

Profit or loss for the year 110 110

420 420 1 1 37 37 265 265 301 301

The Financial Accountant 2019

436
Study, understand and apply

The Financial Accountant

Extended Trial Balance

Tutor’s Guidance
In order to successfully navigate around the extended trial balance, the scholar
needs basic excel spreadsheets skills. The basic extended trial balance above was
given in order to demonstrate the thinking behind each entry made in the
spreadsheet. If you noticed:

 Every adjustment made took the form of double entry.

 In addition, the adjustments or correction of errors left the total columns in equal
balance.

 The amount of profit in the two statements was the same. Identification of profit
or loss is very important under this session.
If you look at the illustration above for instance Mr. Zulu made a loss because his
expenditure exceeded his income. Similarly, the same loss is confirmed in the
statement of financial position because the liabilities exceeded the assets. We can
summarize the above thought using the following tables.

Scenario 1 Statement of profit or Statement of Financial

loss Position
DR CR DR CR
K K K K
Total 10,000 12,000 24,000 22,000
Profit 2000 2,000
12,000 12,000 24,000 24,000

Scenario 2 Statement of profit or Statement of Financial

loss Position
DR CR DR CR
K K K K
Totals 12,000 10,000 22,000 24,000
Loss 2,000 2,000
12,000 12,000 24,000 24,000

The Financial Accountant 2019

437
Study, understand and apply

The Financial Accountant

Extended Trial Balance

Session Summary
 The extended trial balance is used by many Accountants to prepare
the financial statements for their clients.

 An extended trial balance is a standard trial balance to which added

columns extending to the right and in which are listed account balance
and journal adjustment.

 The excess of income over expenditure will result in a profit.

 The excess of expenditure over incomes or liabilities over assets will

result in a loss.

 The excess of assets over liabilities will result in a profit.

The Financial Accountant 2019

438
Study, understand and apply

The Financial Accountant

Bibliography
1. ACCA F3 study text 2017
2. London School of Business and Finance Class notes 2015
3. CIMA BA3 study text 2017
4. ZiCA CA 1.1 First Edition November 2016
5. ZiCA D1 First Edition November 2016
6. Frank Wood 1 twelfth Edition.
7. Accounting Standards 8th Edition.
8. IFRS Explained 1 Edition.

The Financial Accountant 2019

439
The Study,
Financial Accountant 2019 Edition.
understand and apply

The Financial Accountant

About the author
Joseph Ngandalo is a business trainer and tutor at Zambian accountancy and
business tuition Centre. His specialty lies in the subjects financial
accounting, financial reporting and auditing. He is currently the course
manager for ZiCA programs at ZABTUC. Joseph has vast experience in
internal audit, external audit, compliance, financial reporting and lecturing
work. He has more than eight years of lecturing experience in the
aforementioned courses.

What this book will do for the student

This book will enable the student to understand the key principles of
financial accounting which include the whole cycle of financial accounting
starting from the nature and purpose of financial accounting to the
compilation of basic financial statements.
The above will be accomplished through:

 Clear explanations of the purpose of the each topical session aimed at guiding the learning process
(Focus)

 Clear and concise explanations of the detailed part of the topical session based on logic, principle and
professional judgment (body)

 A clear summary of each topical session aimed at helping the learner to remember key concepts
discussed. (summary)

 Exam focused activities aimed at supporting theory knowledge

 Carefully selected past examination preparatory questions with associated model suggested solutions.

The Financial Accountant 2019

440

F.A. III - RK As at March 2007
100% (1)
F.A. III - RK As at March 2007
467 pages
Financial Accounting 1 by Harold
No ratings yet
Financial Accounting 1 by Harold
392 pages
CFAB - Accounting 1 - Lecture Notes
No ratings yet
CFAB - Accounting 1 - Lecture Notes
121 pages
Cima F2
No ratings yet
Cima F2
1 page
UOL 2091 Financial Reporting Lecture Notes
No ratings yet
UOL 2091 Financial Reporting Lecture Notes
97 pages
CA Zambia Syllabus Overview 2017
100% (4)
CA Zambia Syllabus Overview 2017
75 pages
Cost Accounting Final Edition - July 8
100% (1)
Cost Accounting Final Edition - July 8
204 pages
Diploma in Accountancy Examination June 2019 Q A
100% (1)
Diploma in Accountancy Examination June 2019 Q A
229 pages
Financial Accounting 1 by Harold
No ratings yet
Financial Accounting 1 by Harold
450 pages
1.B.Com.
No ratings yet
1.B.Com.
49 pages
Acc 1101 Introduction To Financial Accounting - Recording Transactions and Double Entries
No ratings yet
Acc 1101 Introduction To Financial Accounting - Recording Transactions and Double Entries
27 pages
ACCA Financial Reporting CBE Guide 2020
No ratings yet
ACCA Financial Reporting CBE Guide 2020
12 pages
Financial Accounting Exam Overview
No ratings yet
Financial Accounting Exam Overview
11 pages
Core Course Financial Accounting
100% (2)
Core Course Financial Accounting
135 pages
Determinants of GRI-based Sustainability Reporting: Evidence From An Emerging Economy
No ratings yet
Determinants of GRI-based Sustainability Reporting: Evidence From An Emerging Economy
25 pages
Bookkeeping Mock Exam: 40 Questions
No ratings yet
Bookkeeping Mock Exam: 40 Questions
10 pages
Sri Lanka Accounting Standard
No ratings yet
Sri Lanka Accounting Standard
6 pages
LUMS Resume Format
No ratings yet
LUMS Resume Format
1 page
Financial Statement Preparation Guide
No ratings yet
Financial Statement Preparation Guide
11 pages
SBR & Ethics - Updated With S&D 20 Exams
No ratings yet
SBR & Ethics - Updated With S&D 20 Exams
49 pages
Chapter 5 (1) - Accruals and Prepayments
No ratings yet
Chapter 5 (1) - Accruals and Prepayments
39 pages
ACCA Question
100% (1)
ACCA Question
9 pages
Financial Risk Management: Liquidity & Equity
100% (1)
Financial Risk Management: Liquidity & Equity
0 pages
Accounting Information For Business Decisions: Mcgraw-Hill/Irwin
No ratings yet
Accounting Information For Business Decisions: Mcgraw-Hill/Irwin
32 pages
Fa 1 Chapter 2 Assets, Liabilities and The Accounting Equation
No ratings yet
Fa 1 Chapter 2 Assets, Liabilities and The Accounting Equation
8 pages
Financial Management
100% (1)
Financial Management
302 pages
Ganesh Metal Industry Trial Balance, December 31, 2008 Account Debit (RS) Credit (RS)
No ratings yet
Ganesh Metal Industry Trial Balance, December 31, 2008 Account Debit (RS) Credit (RS)
11 pages
Advanced Management Accounting 2015 April 2025
No ratings yet
Advanced Management Accounting 2015 April 2025
107 pages
MA2 Study Text
No ratings yet
MA2 Study Text
145 pages
Fundamentals of Financial Accounting, 5th Edition Mohammadali-Haji Unlocked Content
No ratings yet
Fundamentals of Financial Accounting, 5th Edition Mohammadali-Haji Unlocked Content
111 pages
1.2 Introduction To Accounting Theory
100% (2)
1.2 Introduction To Accounting Theory
41 pages
ACCA Advanced Audit Procedures Exam 2006
No ratings yet
ACCA Advanced Audit Procedures Exam 2006
4 pages
FR15. Provision, Contingent Liab & Assets (PracticeANS)
No ratings yet
FR15. Provision, Contingent Liab & Assets (PracticeANS)
7 pages
ACCA-Certificate in International Financial Reporting IFRS
No ratings yet
ACCA-Certificate in International Financial Reporting IFRS
7 pages
Financial Accounting Full Notes
No ratings yet
Financial Accounting Full Notes
125 pages
ACCA F2L9 Relevant Costing
67% (3)
ACCA F2L9 Relevant Costing
22 pages
CPA Financial Accounting Syllabus
No ratings yet
CPA Financial Accounting Syllabus
11 pages
Lecture 1 - Regulatory Framework Financial Reporting - 2023
No ratings yet
Lecture 1 - Regulatory Framework Financial Reporting - 2023
44 pages
Bank Reconciliation Statement Guide
No ratings yet
Bank Reconciliation Statement Guide
49 pages
Essentials of Financial Accounting
No ratings yet
Essentials of Financial Accounting
28 pages
CAT T1 Recording Financial Transactions Course Slides
100% (5)
CAT T1 Recording Financial Transactions Course Slides
162 pages
MA Notes
No ratings yet
MA Notes
192 pages
Advanced Accounting & Financial Reporting
No ratings yet
Advanced Accounting & Financial Reporting
558 pages
Principles of Accounting Sample
No ratings yet
Principles of Accounting Sample
98 pages
FM BY SK As @3 April 2006
No ratings yet
FM BY SK As @3 April 2006
299 pages
IFRS List With Notes (22 Nov 24) .XLSB
No ratings yet
IFRS List With Notes (22 Nov 24) .XLSB
79 pages
AAT Level 4 Credit Management Guide
No ratings yet
AAT Level 4 Credit Management Guide
36 pages
Understanding Information Security Measures
No ratings yet
Understanding Information Security Measures
255 pages
Accounting for Decision Making Guide
No ratings yet
Accounting for Decision Making Guide
1 page
Advanced Accounting Syllabus ACCL15B
No ratings yet
Advanced Accounting Syllabus ACCL15B
7 pages
Approaches to Accounting Theories Explained
No ratings yet
Approaches to Accounting Theories Explained
15 pages
PAPER: Financial Accounting (FA) : Certified College of Accountancy's Mock Exam
No ratings yet
PAPER: Financial Accounting (FA) : Certified College of Accountancy's Mock Exam
8 pages
The Financial Accountant Draft 2022
No ratings yet
The Financial Accountant Draft 2022
466 pages
Financial Accounting II
No ratings yet
Financial Accounting II
273 pages
Financial Accounting II
No ratings yet
Financial Accounting II
8 pages
Financial Accounting Overview and Objectives
No ratings yet
Financial Accounting Overview and Objectives
125 pages
Understanding Financial Accounting Basics
No ratings yet
Understanding Financial Accounting Basics
8 pages
Financial Accounting ATD II - W
No ratings yet
Financial Accounting ATD II - W
253 pages
Executive Finance Program Guide
No ratings yet
Executive Finance Program Guide
61 pages
Constitution and By-Laws11
No ratings yet
Constitution and By-Laws11
14 pages
Principles of Management in Insurance
No ratings yet
Principles of Management in Insurance
8 pages
Corporate Governance HSBC
100% (1)
Corporate Governance HSBC
17 pages
Employment Offer Letter Template
No ratings yet
Employment Offer Letter Template
3 pages
Declaratory Relief Complaint Against KPMG
100% (4)
Declaratory Relief Complaint Against KPMG
15 pages
Burberry 09 A
No ratings yet
Burberry 09 A
136 pages
Mount Temple Parents' Association Rules
No ratings yet
Mount Temple Parents' Association Rules
9 pages
Westpac Corporate Governance Analysis
No ratings yet
Westpac Corporate Governance Analysis
15 pages
Parabolic Drugs Fy12 PDF
No ratings yet
Parabolic Drugs Fy12 PDF
95 pages
Arcadis Annual Integrated Report 2022 PDF
No ratings yet
Arcadis Annual Integrated Report 2022 PDF
295 pages
Scrip Code: Scrip Symbol:: content/uploads/2025/07/NTL-Notice-2025.pdf content/uploads/2025/07/NTL-Annual-Report-2025 PDF
No ratings yet
Scrip Code: Scrip Symbol:: content/uploads/2025/07/NTL-Notice-2025.pdf content/uploads/2025/07/NTL-Annual-Report-2025 PDF
202 pages
SBEB and Sweat Equity Regulation 2021
No ratings yet
SBEB and Sweat Equity Regulation 2021
15 pages
Understanding Corporation Law Essentials
No ratings yet
Understanding Corporation Law Essentials
14 pages
How To Start Up..eBook
No ratings yet
How To Start Up..eBook
44 pages
Corporation Midterm Exam 502 (2017)
No ratings yet
Corporation Midterm Exam 502 (2017)
5 pages
Incorporation
No ratings yet
Incorporation
51 pages
Al-Ghazi Tractors Annual Report 2016
No ratings yet
Al-Ghazi Tractors Annual Report 2016
144 pages
Strategic Management for Competitive Advantage
100% (1)
Strategic Management for Competitive Advantage
101 pages
Samsung Vs Sony
No ratings yet
Samsung Vs Sony
5 pages
Executive Assistant Resume of Darlene Hensing
No ratings yet
Executive Assistant Resume of Darlene Hensing
2 pages
Manila Prince Hotel vs GSIS Case Summary
No ratings yet
Manila Prince Hotel vs GSIS Case Summary
83 pages
Lopez Realty vs. Tanjangco: Property Dispute
No ratings yet
Lopez Realty vs. Tanjangco: Property Dispute
22 pages
Annual Report 2017
No ratings yet
Annual Report 2017
174 pages
Supreme Court Ruling on CESB Abolition
No ratings yet
Supreme Court Ruling on CESB Abolition
10 pages
India's Mandatory CSR Framework Explained
No ratings yet
India's Mandatory CSR Framework Explained
15 pages
Indonesian Company Law Guide
No ratings yet
Indonesian Company Law Guide
27 pages
Corporate Accounting Compliance Guide
No ratings yet
Corporate Accounting Compliance Guide
17 pages
A Changing of The Guards at The College of Arts and Sciences (1981)
No ratings yet
A Changing of The Guards at The College of Arts and Sciences (1981)
151 pages
HCL Technologies: Corporate Governance & CSR
No ratings yet
HCL Technologies: Corporate Governance & CSR
8 pages