FINANCIAL

ACCOUNTING
Some notes for learning F3
EFFECTIVE LEARNING
Learning outcomes

Active reading Scan Ask Read Recall Review

Take notes Mind map/diagrams

Practice exam standard Your own word

Revision
questions key points, headings
Technical
articles
Further reading

IFRS box
 Some notes for learning F3
F3 Detailed Syllabus

A. The context and purpose of

financial reporting
B. The qualitative characteristics of
financial information
C. The use of double-entry and
accounting systems
D. Recording transactions and events
E. Preparing a trial balance
F. Preparing basic financial
statements
G. Preparing simple consolidated
financial statements
H. Interpretation of financial
statements
 Some notes for learning F3
OVERVIEW

Chapter 6 &
Chapter 4 Chapter 5 Chapter 17-22
14-16

SOURCE BOOKS OF LEDGER FINANCIAL

TRIAL BALANCE
DOCUMENTS PRIME ENTRY ACCOUNTS STATEMENTS

BUSINESS CONSOLIDATED
TRANSACTIONS FINANCIAL INFORMATION FINANCIAL
Chapter 3 STATEMENTS

Chapter 7-13 Chapter 23-25

THE REGULATORY FRAMEWORK

Chapter 2
Some notes for learning F3
LEARNING OBJECTIVES

► Explain the context and purpose of

financial reporting.
► Define the qualitative characteristics of
financial information.
► Demonstrate the use of double entry and
accounting systems.
► Record transactions and events.
► Prepare a trial balance (including
identifying and correcting errors).
► Prepare basic financial statements for
incorporated and unincorporated
entities.
► Prepare simple consolidated financial
statements
► Interpretation of financial statements
INTRODUCTION TO
ACCOUNTING
Overview and learning outcomes
OVERVIEW LEARNING OUTCOMES

1. The purpose of financial reporting

2. Types of business entity
3. Stakeholders
4. Introduction to financial statements
5. Those charged with governance
Introduction to financial statements
STATEMENT OF FINALCIAL POSITION (SOFP) Income statement (IS)

LIABILITIES
 Non-current liabilities
ASSETS
 Long-term borrowings  Revenue
 Non-current assets
 Long-term provisions  Cost of sales
 Properties, plant and
 Gross profit
equipment (PPE)
 Current liabilities  Other income
 Long-term investment
 Trade and other payables  Expenses
 Other NCA
 Short-term borrowings  Selling expenses
 Bank overdraft  Operations and administrative exp
 Current assets
 Taxation  Other expenses
 Cash and cash equivalents
 Other CL  Finance cost
 Inventories
 Profit before tax (PBT)
 Trade receivables EQUITY  Income tax expenses
 Short-term investment  Share capital/premium  Profit for the year (net profit after
 Other CA  Retained Earnings (RE) tax)
 Reserves
Format of Income Statement
An income statement summarizes the income
and expenditure of the company over a period
of time. If income exceeds expenditure, the
business gets a profit, if vice versa, a loss occurs

Income: Increases in economic benefits during

the accounting period In the form of
- inflows or enhancements of assets; or
- decreases of liabilities
that result in increase in equity, other than
those relating to contributions to equity
participants

Expenses: Decrease in economic benefits

during the accounting period in the form of
- outflows or depletions of assets;
- incurrences of liabilities
that result in decreases in equity, other than
those relating to distributions to equity
participants
Format of Statement of Financial Position
The Statement of Financial
Position is a statement of assets
owned, liabilities owed and equity
of a business at a particular date.

An asset is a resource controlled by

an entity as a result of past events
and from which future economic
benefits are expected to flow to the
entity.

A liability is a present obligation of

the entity arising from past events,
the settlement of which is
expected to result in an outflow
from the entity of resources
embodying economic benefits
The Statement of Financial Position is a statement of assets owned,
liabilities owed and equity of a business at a particular date.

An asset is a resource controlled by an entity as a result of past

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

A liability is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of
resources embodying economic benefits
Format for the Statement of Cash Flow
A cash flow statement summarizes the cash inflows
(receipts) and cash outflows (payments) for a given period.
The cash flow statement provides historical information
about cash and cash Equivalents.
SOURCES, RECORDS AND BOOKS
OF PRIME ENTRY
Learning outcomes and overview
LEARNING OUTCOMES

1. Business transactions Chapter 4 Chapter 5

2. Sources of documents
3. Books of prime entry
► Sales/Sales returns day book SOURCE BOOKS OF LEDGER
► Purchase/Purchase returns DOCUMENTS PRIME ENTRY ACCOUNTS
day book
► Cash/Petty cash book
BUSINESS FINANCIAL
FINANCIAL
► Journal TRANSACTIONS INFORMATION
STATEMENTS
Chapter 3
Business transactions

Cash Credit
transactions transactions Discounts
Sources of documents
Documents Content Purpose
Quotation Quantity/description/details of goods required. To establish price from various suppliers and cross refer to
purchase requisition
Purchase order Details of supplier, e.g. name, address. Sent to supplier as request for supply. To check to the
Quantity/description/details of goods quotation and delivery note.
required and price. Terms and conditions of
delivery, payment, etc.
Sales order Quantity/description/details Cross checked with the order placed by customer.
of goods required and price. Sent to the stores/warehouse department for
processing of the order.
Receipt Details of payment received. Issued by the selling company indicating the
payment received.
Goods Details of supplier, e.g. name and address. Provided by supplier. Checked with goods
despatched Quantity and description of goods received and purchase order.
note – GDN
Goods received Quantity and description of Produced by company receiving the goods as proof of
note (GRN) goods. receipt. Matched with delivery note and purchase order.
Invoice Name and address of supplier and customer; Issued by supplier of goods as a request for payment. For
details of goods, e.g. quantity, price, value, sales the supplier selling the
tax, terms of credit, etc. goods/services this will be treated as a sales invoice. For
the customer this will be treated as a purchase invoice.
Sources of documents
Documents Content Purpose
Statement Details of supplier, name and address. Issued by the supplier. Checked with other
Date, invoice numbers and values, documents to ensure that the amount owing is
payments made, refunds, amount owing. correct.
Credit note Details of supplier, name and address. Issued by the supplier. Checked with documents
Contains details of goods returned, quantity, regarding goods returned.
price, value, sales tax, terms of
Credit.
Debit note Details of the supplier. Contains details of Issued by the company receiving the goods. Cross
goods returned, e.g. quantity, price, value, referred to the credit note issued by the supplier.
sales tax, terms of credit, etc.
Remittance Method of payment, invoice number, Sent to supplier with, or as notification of, payment.
advice account number, date, etc.
Books of prime entry
Books of prime entry Transaction type
Sales day book Credit sales
Purchases day book Credit purchases
Sales returns day book Returns of goods sold on credit
Purchases returns day Returns of goods bought on credit
book
Cash book All bank transactions
Petty cash book All small cash transactions
The journal All transactions not recorded elsewhere

All transactions are initially recorded in a book of prime entry. This is a simple note of the transaction, the
relevant customer/supplier and the amount of the transaction. It is, in essence, a long list of daily transactions.
 Books of prime entry

Sales day book Purchase day book

 The sales day book is the book of prime entry for  A business also keeps a record in the purchase day
credit sales. The sales day book is used to keep a list book of all the invoices it receives. The purchase day
of all invoices sent out to customers each day. book is the book of prime entry for credit purchases.

Sales returns day book Purchase returns day book

 When customers return goods for some reason, a  The purchase returns day book records credit notes
credit note is raised. All credit notes are recorded in received in respect of goods which the business sends
the sales returns day book. back to its suppliers.
 The sales returns day book is the book of prime  The purchase returns day book is the book of prime
entry for credit notes raised. entry for credit notes received from suppliers.
 Where a business has very few sales returns, it may  A business with very few purchase returns may record
record a credit note as a negative entry in the sales a credit note received as a negative entry in the
day book. purchase day book
 Books of prime entry

Cash book

 The cash book may be a manual record or a Petty cash book

computer file. It records all transactions that go
through the bank account.  Most businesses keep petty cash on the premises,
 The cash book deals with money paid into and out of which is topped up from the main bank account. Under
the business bank account. the imprest system, the petty cash is kept at an
 The cash book is the book of prime entry for cash agreed sum, so that each topping up is equal to the
receipts and payments. amount paid out in the period.
 A small amount of cash on the premises to make
Bank statements occasional small payments in cash, eg staff
refreshments, postage stamps, to pay the office
 Weekly or monthly, a business will receive a bank cleaner, taxi fares, etc. This is often called the cash
statement. Bank statements should be used to check float or petty cash account.
that the amount shown as a balance in the cash book  A petty cash book is a cash book for small payments.
agrees with the amount on the bank statement, and
that no cash has 'gone missing'.
LEDGER ACCOUNTS AND DOUBLE
ENTRIES
Learning outcomes and overview
LEARNING OUTCOMES

1. Financial accounting process

2. Ledger accounts
3. The accounting/business equation
4. Double entry bookkeeping
5. The receivables and payables ledger

Chapter 4 Chapter 5

SOURCE BOOKS OF LEDGER

DOCUMENTS PRIME ENTRY ACCOUNTS

BUSINESS FINANCIAL INFORMATION FINANCIAL

TRANSACTIONS Chapter 3 STATEMENTS
The Accounting Equation
Concepts Description
Stocks/Inventories Unsold goods
Account receivables (AR) Amounts owed to the business by its customers
Account payables (AP) Amount owed by the business to its suppliers
Retained earnings (RE) Profit generated from operation by a business but not yet
distributed to its owners
Drawings Amounts of money or assets taken out of a business by its
owners
Return inwards Goods returned to the business
Return outwards Goods returned by the business
Gross profit Gross profit = Sales – Cost of goods sold (COGS)
Net profit Net profit = Gross profit – Expenses
 Ledger Account
► Nominal ledger (General ledger/GL) is an accounting record which contains the principle accounts and
which summarizes the financial affairs of a business
► The method used to summarise these records: ledger accounting and double entry.
► Format of a nominal ledger

Account Name

Dr Cr
Ledger Account

Debits and Credits

 An account shows the effect of transactions on a given
asset, liability, equity, revenue, or expense account.

 Double-entry accounting system (two-sided effect).

 Recording done by debiting at least one account and

crediting another.

 DEBITS must equal CREDITS.

LO 1
 Debits and Credits

 An arrangement that shows the

Account
effect of transactions on an
account.
 Debit = “Left”
 Credit = “Right”

An Account can be Account Name

illustrated in a T-
Debit / Dr. Credit / Cr.
Account form.

LO 1
 Debits and Credits

If the sum of Debit entries are greater than the sum of

Credit entries, the account will have a debit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000

LO 1
 Debits and Credits

If the sum of Debit entries are less than the sum of

Credit entries, the account will have a credit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance

LO 1
Debits and Credits Summary
Liabilities
Debit / Dr. Credit / Cr.
Normal Normal
Balance Balance
Debit Credit Normal Balance

Chapter
3-24

Assets Equity
Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.

Normal Balance Normal Balance

Chapter Chapter
3-23

Expense
3-25
Revenue
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Normal Balance
Normal Balance

Chapter
Chapter 3-26
3-27

LO 1
 Debits and Credits Summary
Statement of Financial
Position Income Statement

Asset = Liability + Equity Revenue - Expense

Debit

Credit

LO 1
The Accounting Equation

Relationship among the assets, liabilities and equity of a

business:

The equation must be in balance after every transaction. For

every Debit there must be a Credit.
The Accounting Equation

Relationship among the assets, liabilities and equity of a

business:

The equation must be in balance after every transaction. For

every Debit there must be a Credit.
 Financial
Statements
and Ownership
Structure

Investments by shareholders
Net income retained in the
business
FROM TRIAL BALANCE TO
FINANCIAL STATEMENTS
CASE STUDY
DISCUSSION PANNEL
Learning outcomes and overview
LEARNING OUTCOMES

1. The Trial balance (TB)

2. The Statement of Profit or Loss (PL)
3. The Statement of Financial position (SFP)
4. Balancing off/Closing off ledger accounts and preparing the FSs.

Chapter 6 &
Chapter 4 Chapter 5
14-16

SOURCE BOOKS OF LEDGER

TRIAL BALANCE
DOCUMENTS PRIME ENTRY ACCOUNTS
 The Trial Balance (TB)
At suitable intervals, the entries in each ledger account are totaled and a balance is struck. Balances are usually collected
in a trial balance which is then used as a basis for preparing a statement of profit or loss and a statement of financial
position.
A trial balance is a list of ledger balances shown in debit and credit columns.
Steps to prepare the Trial Balance (TB):
► Step 1: Collect of ledger accounts
► Step 2: Balance ledger accounts
► Step 3: Collect the balances
► Step 4: Check and reconcile
Financial Statements
STATEMENT OF PROFIT AND LOSS

A profit or loss ledger account is opened up to gather all items relating to income and expenses. When rearranged,
these items make up the statement of profit or loss.

STATEMENT OF FINANCIAL POSITION

The balances on all remaining ledger accounts (including the profit or loss account) can be listed and rearranged to
form the statement of financial position.
These remaining accounts must also be balanced and ruled off, but since they represent assets and liabilities of the
business (not income and expenses) their balances are not transferred to the P/L account. Instead they are carried
down in the books of the business. This means that they become opening balances for the next accounting period
and indicate the value of the assets and liabilities at the end of one period and the beginning of the next.
Balancing off/Closing off ledger accounts
BALANCING OFF A LEDGER ACCOUNT

Step 1 Step 2 Step 3 Step 4

Total both sides Put the larger Insert a balancing
Carry the
of the T-account total in the total figure to the side
balance down
and find the box on the debit which does not
diagonally and
larger total and credit side. currently add up to
call it ‘balance
the amount in the
b/f’ (brought
total box. Call this
forward) or
balancing figure
‘balance b/d’
‘balance c/f’ (carried
(brought down).
forward) or ‘balance
c/d’ (carried down).
Balancing off/Closing off ledger accounts
BALANCING OFF A LEDGER ACCOUNT

Balance sheet ledger accounts Profit or Loss ledger accounts

Assets/liabilities at the end of a period = Assets/liabilities ► At the end of a period any amounts that relate to that
at start of the next period. period are transferred out of the income and
Balancing the account will result in: expenditure accounts into another ledger account
► A balance c/f (being the asset/liability at the end of called profit or loss.
the accounting period) ► Do not show a balance c/f or balance b/f but instead
► A balance b/f (being the asset/liability at the start of put the balancing figure on the smallest side and label
the next accounting period). it ‘profit or loss'.
Adjusted
Trial
Balance
Shows the
balance of all
accounts, after
adjusting entries,
at the end of the
accounting period.
Proves the
equality of the
total debit and
credit balances
 Closing Journal Entries
Closing Entries
Service Revenue 106,000
Profit or Loss 106,000

Profit or Loss 73,000

Salaries & Wages Expense 46,000
Supplies Expense 15,000
Rent Expense 9,000
Insurance Expense 500
Interest Expense 500
Depreciation Expense 400
Bad Debt Expense 1,600

Profit or Loss 33,000

Retained Earnings 33,000

Retained Earnings 5,000

Dividends 5,000
 CORRECTION OF ERRORS

ERRORS OF ERRORS OF ERRORS OF ERRORS OF COMPENSATING

TRANPOSITION OMISSIONS PRINCIPLE COMMISSION ERRORS
 ERRORS OF TRANSPOSITION

An error of transposition is when two digits in a figure are accidentally recorded the wrong way round.

For example, suppose that a sale is recorded in the sales account as $6,843, but it has been incorrectly
recorded in the total receivables account as $6,483. The error is the transposition of the 4 and the 8. The
consequence is that total debits will not be equal to total credits. You can often detect a transposition error by
checking whether the difference between debits and credits can be divided exactly by 9. For example, $6,843 –
$6,483 = $360; $360/9 = 40.
 ERRORS OF OMISSIONS

An error of omission means failing to record a transaction at all, or making a debit or credit entry, but not the
corresponding double entry.

(a) If a business receives an invoice from a supplier for $250, the transaction might be omitted from the books
entirely. As a result, both the total debits and the total credits of the business will be incorrect by $250.

(b) If a business receives an invoice from a supplier for $300, the payables control account might be credited, but
the debit entry in the purchases account might be omitted. In this case, the total credits would not equal total
debits (because total debits are $300 less than they ought to be).
 ERRORS OF PRINCIPLE

An error of principle involves making a double entry in the belief that the transaction is being entered in the
correct accounts, but subsequently finding out that the accounting entry breaks the 'rules' of an accounting
principle or concept.

(a) For example, repairs to a machine costing $150 should be treated as revenue expenditure, and debited to a
repairs account. If, instead, the repair costs are added to the cost of the non-current asset (capital
expenditure) an error of principle would have occurred. As a result, although total debits still equal total
credits, the repairs account is $150 less than it should be and the cost of the non-current asset is $150
greater than it should be.

(b) Similarly, suppose that the proprietor of the business sometimes takes cash out of the till for their personal
use and during a certain year these withdrawals on account of profit amount to $280. The bookkeeper states that
they have reduced cash sales by $280 so that the cash book could be made to balance. This would be an error
of principle, and the result of it would be that the withdrawal account is understated by $280, and so is the total
value of sales in the sales account.
 ERRORS OF COMMISSION

Errors of commission are where the bookkeeper makes a mistake in carrying out their task of recording
transactions in the accounts.

(a) Putting a debit entry or a credit entry in the wrong account. For example, if telephone expenses of $540
are debited to the electricity expenses account, an error of commission would have occurred. The result is
that although total debits and total credits balance, telephone expenses are understated by $540 and
electricity expenses are overstated by the same amount.

(b) Errors of casting (adding up). The total daily credit sales in the sales day book should be $28,425, but are
incorrectly added up as $28,825. The total sales in the sales day book are then used to credit total sales and
debit total receivables in the ledger accounts. Although total debits and total credits are still equal, they are
incorrect by $400.
 COMPENSATING ERRORS

Compensating errors are errors which are, coincidentally, equal and opposite to one another.

For example, although unlikely, in theory two transposition errors of $540 might occur in extracting ledger
balances, one on each side of the double entry. In the administration expenses account, $2,282 might be written
instead of $2,822 while, in the sundry income account, $8,391 might be written instead of $8,931. Both the debits
and the credits would be $540 too low, and the mistake would not be apparent when the trial balance is cast.
Consequently, compensating errors hide the fact that there are errors in the trial balance.
 SUSPENSE ACCOUNT
A suspense account is a temporary account which can be opened for a number of reasons. The most common
reasons are as follows.

(a) A trial balance is drawn up which does not balance (ie total debits do not equal total credits).

(b) The bookkeeper of a business knows where to post the credit side of a transaction, but does not know where
to post the debit (or vice versa). For example, a cash payment might be made and must obviously be credited to
cash. But the bookkeeper may not know what the payment is for, and so will not know which account to debit.
SALES TAX
Definition
Sales tax is an indirect tax levied on the sale of goods and services. It is usually administered by the local tax
authorities.
Some sales tax is irrecoverable. Where sales tax is irrecoverable it must be regarded as part of the cost of the
items purchased and included in the statement of profit or loss charge or in the statement of financial position
as appropriate.

Sales tax paid on purchases Sales tax charged on sales

(input tax) (output tax)

Dr Purchases – (net cost) Dr Receivables/cash (gross selling price)

Dr Sales tax (sales tax) Cr Sales – (net selling price)
Cr Payables/cash – (gross cost) Cr Sales tax (sales tax)
INVENTORY
Learning outcomes
LEARNING OUTCOMES

1. Definition of Inventory, cost of

Inventory
sales
2. Methods of valuing inventory
3. IAS 02 – INVENTORY
Valuation Adjustment

Cost NRV Opening Closing

Cost of goods sold
The value of closing inventories is accounted for in the nominal ledger by debiting an inventory account and
crediting the profit or loss account at the end of an accounting period. Inventory will therefore have a debit
balance at the end of a period, and this balance will be shown in the statement of financial position as a current
asset.

Cost of good sold (COGS) = Opening inventory + purchases – closing inventory

Format:
Opening inventory value X
+ Add cost of purchases (or, in the case of a manufacturing company, the cost of X
production)
X
- Less closing inventory value (X)
Cost of goods sold X
 CARRIAGE INWARDS & OUTWARDS

Cost of carriage inwards Usually added to COST of PURCHASE

Cost of carriage
Selling & distribution expense in SOPL
outwards
 VALUING INVENTORY

Purchase Purchase Import Other directly Trade

cost price duties attributable cost discounts

Cost of Costs
Costs directly
directly related
related to
to Fixed and variable
Cost
conversion the
the units
units of
of production
production production overheads

Inventory Other cost bringing the

measurement inventories to their present
location and condition

Net realisable value

(Fair value – cost to sell)
Methods of valuing inventory
The standard lists types of cost which would not be included in cost of inventories. Instead, they should be
recognised as an expense in the period they are incurred.
► Abnormal amounts of wasted materials, labour or other production costs
► Storage costs (except costs which are necessary in the production process before a further production stage)
► Administrative overheads not incurred to bring inventories to their present location and conditions
► Selling costs

CALCULATION COST OF INVENTORY

Method Key points Conditions

Unit cost This is the actual cost of purchasing Only used when items of inventory are
identifiable units of inventory. individually distinguishable and of high value

FIFO – first For costing purposes, the first items of The cost of closing inventory is the cost of the
in first out inventory received are assumed to be the most recent purchases of inventory.
first ones sold.
AVCO – The cost of an item of inventory is calculated The average cost can be calculated periodically
Average by or continuously.
cost taking the average of all inventory held.
TANGIBLE NON-CURRENT
ASSETS
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Capital expenditure and

revenue expenditure
2. Capital income and revenue
income
3. Depreciation accounting
4. NCA – Revaluation
5. NCA – Disposal
CAPEX AND OPEX
Capital expenditure Revenue expenditure

► Acquisition of non-current assets ► Trade of the business

► Improvements to existing non-current assets ► Maintain the existing earning capacity of non-current
► Recognition of a non-current asset in the statement of assets
financial position ► Expense in the Income statement

Revenue Income

Capital Income Income derived from the following sources.

► (a) The sale of trading assets, such as goods held in
The proceeds from the sale of non-trading assets inventory
(including long-term investments). ► (b) The provision of services
► (c) Interest and dividends received from investments
held by the business
IAS 16 - Properties, plant and equipment
No. Concepts Definition
1 Property, plant and Tangible assets that:
equipment ► Are held by an entity for use in the production or supply of goods or
services, for rental to others, or for administrative purposes
► Are expected to be used during more than one period

2 Cost the amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire an asset at the time of its acquisition or
construction
3 Fair value the price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date
4 Carrying amount the amount at which an asset is recognised after deducting any accumulated
depreciation and impairment losses
Measurement & Recognition
Recognition
► Probable that future economic benefits associated with the asset
► Cost of the asset to the entity can be measured reliably
► Period over 12 months

Initial
measurement
Purchase price excluding any trade discount
cost of site preparation
and sales tax

costs of dismantling and removing, Costs of testing after deducting the

COST
restoring the site net proceeds from selling samples

Directly attributable costs of bringing the Professional fees (lawyers,

asset to working condition architects, engineers)

Installation and assembly costs

Initial delivery and handling costs

Measurement & Recognition
COST model Cost – accumulated depreciation

Subsequent
measurement

REVALUATION Revaluation – Acc depreciation –

model Impairment loss

Modification

Subsequent
IMPROVEMENT Upgrade
expenditure

New production process

Depreciation Accounting
The cost of a non-current asset, less its estimated residual value, is allocated fairly between accounting periods
by means of depreciation. Depreciation is both of the following:
► Charged against profit (PL);
► Deducted from the value of the non-current asset in the statement of financial position.
Two methods of depreciation are specified in your syllabus.
► The straight line method
► The reducing balance method

Straight-line method Depreciation charge = (Cost – Residual value)/Useful life

Reducing balance
Depreciation charge = X % × carrying amount
method

Dr Depreciation expense
Double entry
Cr Accumulated depreciation
Depreciation Accounting
USEFUL LIFE

The period over which a depreciable asset is expected to be used by the enterprise; or the number of production
or similar units expected to be obtained from the asset by the enterprise.
The following factors should be considered when estimating the useful life of a depreciable asset.
► Expected physical wear and tear
► Obsolescence
► Legal or other limits on the use of the assets

RESIDUAL VALUE

The net amount which the entity expects to obtain for an asset at the end of its useful life after deducting the
expected costs of disposal
CHANGE PROSPECTIVELY

► Expected useful life

► method of depreciation
► residual value
Revaluation of Non-current Assets
When a non-current asset is revalued, depreciation is charged on the revalued amount.
The gain on revaluation is recognised in the statement of profit or loss and other comprehensive income, as
other comprehensive income. From here, the 'gain' is transferred to a revaluation surplus (sometimes called a
revaluation reserve), part of capital in the statement of financial position.
If Non-current assets were to be subsequently sold for the revalued amount, the profit would be realized and
could be taken to the statement of profit or loss.
The accounting entries to record the depreciation charge each year would therefore be as follows:
► To record the new annual depreciation charge
DEBIT Depreciation expense (statement of profit or loss)
CREDIT Accumulated depreciation account (statement of financial position)

► To record the transfer of the excess depreciation

DEBIT Revaluation surplus (statement of financial position)
CREDIT Retained earnings (statement of financial position)

► To record revaluation downwards

DEBIT Revaluation surplus
DEBIT NCA - Accumulated depreciation account
CREDIT NCA - Cost
Non-current assets disposal
When a non-current asset is sold, there is likely to be a profit or loss on disposal. This is the difference
between the net sale price of the asset and its carrying amount at the time of disposal.

Profit/loss on disposal is charged directly to PL in that period.

The ledger accounting entries are as follows:

► with the cost of the asset disposed of.

DEBIT Disposal of non-current asset account
CREDIT Non-current asset account

► with the accumulated depreciation on the asset as at the date of sale.

DEBIT Accumulated depreciation account
CREDIT Disposal of non-current asset account

► with the income from disposal

DEBIT Receivable account or cash book
CREDIT Disposal of non-current asset account
Non-current assets disposal
A business purchased a non-current asset on 1 January 20X1 for $25,000. It had an estimated life of 6 years and an
estimated residual value of $7,000. The asset was eventually sold after 3 years on 1 January 20X4 to another trader
who paid $17,500 for it.

What was the profit or loss on disposal, assuming that the business uses the straight line method for depreciation?
INTANGIBLE NON-CURRENT
ASSETS
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Definition
2. Research and development
costs
3. Accounting treatment
Definition
Intangible assets are non-current assets with no physical substance.

Intangible Non-current Assets

Tangible Non-current Assets
► Do not normally have physical substance, e.g
copyright
► Normally have physical substance, e.g land and
buildings ► Can be purchased or may be created within a
business without any expenditure being incurred,
► Normally involve expenditure being incurred
i.e internally generated, e.g brands.
► Cost of the tangible non-current asset is
► Purchased intangible non-current assets are
capitalized
capitalized. Generally, internally generated assets
► Depreciation is a reflection of the wearing out of may not be capitalized.
the asset
► Amortization is a reflection of a wearing out of the
(capitalized) assets
Research and Development costs
Research Development

the application of research findings or other knowledge to

original and planned investigation undertaken with the a plan or design for the production of new or substantially
prospect of gaining new scientific or technical knowledge improved materials, devices, products, processes,
and understanding systems or services prior to the commencement of
commercial production or use

R&D Costs

IAS
All costs that are directly attributable to R&D activities, or that 38
can be allocated on a reasonable basis ( Salaries, wages,
costs of materials and services, depreciation, overhead costs
and other costs)

be recognised as an be recognised as an
expense in the period in intangible asset (deferred
which they are incurred development expenditure)
Accounting treatment
PIRATE ► Once capitalised as an asset, development costs must be
amortised and recognised as an expense to match the costs
with the related revenue or cost savings. The amortisation
Probable future will begin when the asset is available for use.
economic
benefits ► Amortisation must be done on a systematic basis to reflect
the pattern in which the related economic benefits are
recognised.
measure Intention to ► Impairment (fall in value of an asset) is a possibility, but is
reliably the complete the perhaps more likely with development costs, when the asset
Expenditure intangible asset is linked with success of the development. The development
costs should be written down.
► If the useful life of an intangible asset is finite, the
Recognition capitalized development costs must be amortised once
criteria commercial exploitation begins.
(Capitalized as IA) ► An intangible asset with an indefinite useful life should not be
adequate amortised. Instead, it should be subject to an annual
technical, impairment review.
financial and
Technical other Disclosure in financial statements
feasibility Resources to ► IAS 38 requires both numerical and narrative disclosures for
complete the
intangible assets.
development
► The financial statements should show a reconciliation of the
Ability to use carrying amount of intangible assets at the beginning and at
or sell the the end of the period. The reconciliation should show the
intangible asset movement on intangible assets, including: Additions,
disposal, reductions in carrying amount, amortization, any
other movements).
ACCRUALS AND PREPAYMENTS
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Definition
2. Accounting treatment
Accruals concept

Expenditure Income

Accrued Prepaid
Definition
Prepayments
Accruals
► Prepaid expenses (prepayments) are expenses
► Accrued expenses (accruals) are expenses
which have already been paid but relate to a
relate to an accounting period but have not been
future accounting period. They are shown in the
paid for. They are shown in the statement of
statement of financial position as an asset.
financial position as a liability.
► Prepayments are included in receivables in
► Accruals are included in payables in current
current assets in the statement of financial
liabilities, as they represent liabilities which have
position. They are assets, as they represent
been incurred but for which no invoice has yet
money that has been paid out in advance of the
been received
expense being incurred.
► Enter any accruals
► Enter any prepayments
DR Expenses
DR Assets
CR Accruals
CR Expenses
IRRECOVERABLE AND
ALLOWANCE
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Irrecoverable debts
2. Allowances for AR Trade receivables
► Doubtful debts
► Accounting treatment
3. Presentation
Irrecoverable debts Allowances
 Irrecoverable debts
► Irrecoverable debts are specific debts owed to a business which it decides are never going to be paid. They
are written off as an expense in the statement of profit or loss.

► An irrecoverable (or 'bad') debt is a debt which is definitely not expected to be paid. An irrecoverable debt
could occur when, for example, a customer has gone bankrupt.

► According to the Conceptual Framework an asset is a resource controlled by an entity from which future
economic benefits are expected to flow. If the customer can't pay, then no economic benefits are expected to
flow from the trade receivable. So the trade receivable no longer meets the definition of an asset and it must
be removed from the statement of financial position and is charged as an expense in the statement of profit or
loss.

Writing off irrecoverable debts

DEBIT Irrecoverable debts expense (statement of profit or loss)
CREDIT Trade receivables (statement of financial position)

Subsequently paid
DEBIT Cash account (statement of financial position)
CREDIT Irrecoverable debts expense (statement of profit or loss)
Allowances for receivables
Doubtful debts
Irrecoverable debts
► A doubtful debt is a debt which is possibly
irrecoverable.
Irrecoverable debts are specific debts which are
definitely not expected to be paid. ► Doubtful debts may occur, for example, when an
invoice is in dispute, or when a customer is in
financial difficulty.

► There is doubt over whether the debt will be paid, an allowance for receivables is made against the doubtful debt. Allowance
for receivables. An impairment amount in relation to receivables that reduces the receivables asset to its recoverable
amount in the statement of financial position. It is offset against trade receivables, which are shown at the net amount.
► The allowance against the trade receivables balance is made after writing off any irrecoverable debts.

Accounting treatment
► When an allowance is first made
DEBIT Irrecoverable debts expenses (SPL)
CREDIT Allowances for receivables (SFP)
► When an allowance already exists, the increase in allowance is charged as an expense, decrease in allowance is credited
back to the statement of profit or loss for the period in which the reduction in allowance is made.
PROVISIONS AND
CONTIGENCIES
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Provisions
2. Contingencies
Provisions
DEFINITION RECOGNITION ACCOUNTING TREATMENT

DEBIT Expenses (PL)

Uncertain CREDIT Provisions (BS)
timing incurred a
present
obligation
SUBSEQUENT MEASUREMENT

Liability In subsequent years, adjustments may

probable that be needed to the amount of the
a transfer of provision. The procedure to be
economic followed then is as follows.
benefits
(a) Calculate the new provision
Uncertain required.
amount (b) Compare it with the existing
balance on the provision account (ie
a reliable the balance b/f from the previous
estimate accounting period).
(c) Calculate increase or decrease
required.
 Contingencies
Contingent liabilities
Contingent assets
A possible obligation that arises from past events and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not
A possible asset that arises from past wholly within the entity's control; or
events and whose existence will be
confirmed by the occurrence of one or A present obligation that arises from past events but is not recognised because:
or more uncertain future events not ► It is not probable that a transfer of economic benefits will be required to settle the
wholly within the enterprise's control. obligation; or
► The amount of the obligation cannot be measured with sufficient reliability.

must not be recognized, but

should be disclosed Probability of Outflow Inflow
occurence
Virtually certain > 95% Virtually certain Provide Recognise
Probable 51% – 95%
Possible 5% – 50% Probable Provide Disclosure note
Remote < 5%
Possible Disclosure note Ignore
Remote Ignore Ignore
Contingencies - Disclosure
Contingent liabilities
Contingent assets
Unless remote, disclose for each contingent liability:
Where an inflow of economic benefits is probable, an
an entity should disclose: A brief description of its nature, and where practicable;

A brief description of its nature, and where An estimate of the financial effect;
practicable;
An indication of the uncertainties relating to the amount or
timing of any outflow;
An estimate of the financial effect
The possibility of any reimbursement
Revision and Chapter summary
CONTROL ACCOUNTS
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Control accounts
2. Contra entry Memorandum accounts/
Control accounts
3. Refund lists of balance
4. Reconciliation of AR and AP

Control account
reconciliations
Control Accounts
A control account keeps a total record of a number of individual items. It is an impersonal account which is part of the double
entry system.
A control account is an account in the nominal ledger in which a record is kept of the total value of a number of similar but
individual items. Control accounts are used chiefly for trade receivables and payables.
► (a) A receivables control account is an account in which records are kept of transactions involving all receivables in total.
The balance on the receivables control account at any time will be the total amount due to the business at that time from
its receivables.

► (b) A payables control account is an account in which records are kept of transactions involving all payables in total. The
balance on this account at any time will be the total amount owed by the business at that time to its payables.

A control account is an (impersonal) ledger account which will appear in the nominal ledger

Total credit sales from Total cash received from Total credit purchases Total cash paid to debtors
sales day book debtors and discounts from purchase day book and discounts received

Receivables control
Payables control accounts
accounts
Control Accounts & Personal Accounts
The personal accounts of individual customers of the business are kept in the receivables ledger, and the amount owed by
each receivable will be a balance on the receivable's personal account. The amount owed by all the receivables together (ie all
the trade receivables) will be a balance on the receivables control account.

At any time the balance on the receivables control account should be equal to the sum of the individual balances on the
personal accounts in the receivables ledger.
DISCOUNTS
Trade discount Trade discount
is a reduction in the list price of an 1. A customer is quoted a price of $1 per unit for a particular item, but a lower
article, given by a wholesaler or price of 95 cents per unit if the item is bought in quantities of 100 units or
manufacturer to a retailer. It is often more at a time.
given in return for bulk purchase 2. An important customer or a regular customer is offered a discount on all
orders. the goods the customer buys, regardless of the size of each individual order,
because the total volume of the customer's purchases over time is so large.

Cash (Settlement) discount Cash (Settlement) discount

is a reduction in the amount payable A supplier charges $1,000 for goods, but offers a discount of 5% if the goods
in return for payment in cash, or are paid for immediately in cash. Alternatively, a supplier charges $2,000 to a
within an agreed period. credit customer for goods purchased, but offers a discount of 10% for
payment within so many days of the invoice date
 ACCOUNTING FOR DISCOUNTS
TRADE DISCOUNTS Trade discount received:
Company A purchases inventory on credit from Supplier B at a gross cost of $100, and receives a
RECEIVED ALLOWED trade discount of 5% from the supplier. The double entry for the purchase is as follows:
Dr Inventory / Cr Payables: $ 95
Trade discount allowed:
deducted
deducted Company B sells inventory on credit to Customer A at a gross sale price of $100 and offers a trade
from the cost discount of 10% to the customer. The double entry for the sale is as follows:
from sales
of purchases
Dr Income / Cr Trade receivables: $90

CASH DISCOUNTS
RECEIVED ALLOWED
included
as 'other expenses in
income' of the period
the period
ENTRIES IN CONTROL ACCOUNT
ENTRIES IN CONTROL ACCOUNT
Contra/debts off-setting
The situation may arise where a customer is also a supplier. Instead of both owing each other money, it may be
agreed that the balances are contra’d, i.e. cancelled.

The double entry for this type of contra is:

Dr Payables ledger control account
Cr Receivables ledger control account

The individual receivable and payable memorandum accounts must also be updated to reflect this.
Reconciliation process
Tick off the items
which appear in both
the statement and the
payables ledger

Agree the opening

Identify differences balance on the
supplier's statement

Allocate payments to
invoices after allowing
for any credit notes
BANK RECONCILIATION
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Definition
2. Differences analysis
Cash book Bank statement
3. Bank reconciliation process
4. Presentation

Reconciliation
 Definition and Process
In theory, the entries appearing on a Cash Bank
business's bank statement should be book statement
exactly the same as those in the Bank
business cash book. The balance charges
shown by the bank statement should or Bank Differences
be the same as the cash book balance Errors interest ► Errors – usually in the cash book
on the same date. ► Omissions – such as bank charges not
A bank reconciliation is a Timing posted in the cash book
comparison of a bank statement (sent differen ► Timing differences – such as
monthly, weekly or even daily by the ces unpresented cheques
bank) with the cash book. Differences
between the balance on the bank
statement and the balance in the cash A bank
book will be errors or timing reconciliation
differences, and they should be
identified and satisfactorily explained. Corrections and Items reconciling the
Common explanations
adjustments to the cash corrected cash book balance
book to the bank statement
BANK RECONCILIATION
Corrections and adjustments to the cash book:

(i) Payments made into the bank account or from the bank account by way of standing order or
direct debit, which have not yet been entered in the cash book

(ii) Dividends received (on investments held by the business), paid direct into the bank account
but not yet entered in the cash book

(iii) Bank interest and bank charges, not yet entered in the cash book

(iv) Errors in the cash book that need to be corrected

The corrected cash book balance is the balance that is shown in the statement of financial
position.
BANK RECONCILIATION
Items reconciling the corrected cash book balance to the bank statement

(i) Cheques drawn (ie paid) by the business and credited in the cash book, which have not yet
been presented to the bank, or 'cleared', and so do not yet appear on the bank statement. These
are commonly known as unpresented cheques or outstanding cheques.

(ii) Cheques received by the business, paid into the bank and debited in the cash book, but which
have not yet been cleared and entered in the account by the bank, and so do not yet appear on
the bank statement. These are commonly known as outstanding lodgements or deposits
credited after date.

(iii) Electronic payments that have not yet been cleared.

At 30 September 20X6, the balance in the cash book of Wordsworth Co was $805.15 debit. A
bank statement on 30 September 20X6 showed Wordsworth Co to be in credit by $1,112.30.
On investigation of the difference between the two sums, it was established that:
(a) The cash book had been undercast by $90.00 on the debit side*
(b) Cheques paid in not yet credited by the bank amounted to $208.20, called outstanding
lodgements
(c) Cheques drawn not yet presented to the bank amounted to $425.35 called unpresented
cheques
* Note. 'Casting' is an accountant's term for adding up.
Required
(a) Show the correction to the cash book.
(b) Prepare a statement reconciling the balance per bank statement to the balance per cash
book.
On 31 January 20X8 a company's cash book showed a credit balance of $150 on its current account which did
not agree with the bank statement balance. In performing the reconciliation the following points came to light.
$
Not recorded in the cash book:
Bank charges 36
Transfer from deposit account to current account 500
Not recorded on the bank statement:
Unpresented cheques 116
Outstanding lodgements 630
It was also discovered that the bank had debited the company's account with a cheque for $400 in error.

What was the original balance on the bank statement?

INCOMPLETE RECORDS
Incomplete records questions may test your ability to prepare accounts in the following situations.
• A trader does not maintain a ledger and therefore has no continuous double entry record of
transactions.
• Accounting records are destroyed by accident, such as fire.
• Some essential figure is unknown and must be calculated as a balancing figure. This may occur as a
result of inventory being damaged or destroyed, or because of misappropriation of assets.

The task of preparing the final accounts involves the following.

(a) Establishing the cost of purchases and other expenses
(b) Establishing the total amount of sales
(c) Establishing the amount of accounts payable, accruals, accounts receivable and
prepayments at the end of the year
The accounting equation: assets = capital + liabilities

The business equation:

closing net assets = opening

net assets + capital introduced
+ profit – drawings
Credit sales and trade receivables
Purchases and trade payables
Establish COGS
 The cost of the goods lost is the
difference between (a) and (b).

Stolen goods
or goods (a) The cost of goods sold

destroyed
(b) Opening inventory of the goods
(at cost) plus purchases less closing
inventory of the goods (at cost)
 Example: cost of goods destroyed

Orlean Flames is a shop which sells fashion clothes. On 1 January 20X5, it had trade inventory which
cost $7,345. During the nine months to 30 September 20X5, the business purchased goods from
suppliers costing $106,420. Sales during the same period were $154,000. The shop makes a gross
profit of 40% on cost for everything it sells. On 30 September 20X5, there was a fire in the shop which
destroyed most of the inventory in it. Only a small amount of inventory, known to have cost $350, was
undamaged and still fit for sale.

How much of the inventory was lost in the fire?

Accounting for inventory destroyed, stolen or otherwise
lost

If the lost goods were not

DR EXPENSE (Eg: Admin
insured, the business must
expense)
bear the loss, and the loss is
CR COGS
shown PL

Lost goods were insured, the

business will not suffer a loss, DR INSURANCE CLAIM
because the insurance will pay (RECEIVABLE)
back the cost of the lost goods CR COGS
ACCRUAL & PREPAYMENT
PREPARATION OF
FINANCIAL STATEMENTS FOR SOLE TRADERS
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Preparation of financial
accounts
Preparation of final accounts
You should now be able to prepare a set of final accounts for a sole trader from a trial balance after
incorporating period-end adjustments for depreciation, inventory, prepayments, accruals, irrecoverable
debts, and allowances for receivables

Adjustments to accounts
Draft Trial balance Final Trial balance

Financial statements
IFRS 15- Revenue from contracts with customer
IFRS 15 governs the recognition of revenue arising from contracts with customers.
Revenue is income arising in the ordinary course of an entity's activities, such as sales and fees.

(1) Identify the contract(s) with a customer

(2) Identify the performance obligations in the contract
(3) Determine the transaction price
(4) Allocate the transaction price to the performance obligations in the contract
(5) Recognise revenue when (or as) the entity satisfies a performance obligation
Revenue is income arising in the course of an entity’s ordinary activities.

Income is increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in an increase in equity, other than
those relating to contributions from equity participants.

A contract is an agreement between two or more parties that creates enforceable rights and
obligations.

A customer is a party that has contracted with an entity to obtain goods or services that are an
output of the entity’s ordinary activities in exchange for consideration.

A performance obligation is a promise in a contract with a customer to transfer to the

customer either: a good or service (or a bundle of goods or services) that is distinct; or a series
of distinct goods or services that are substantially the same and that have the same pattern of
transfer to the customer.

Transaction price is the amount of consideration to which an entity expects to be entitled in

exchange for transferring promised goods or services to a customer, excluding amounts
collected on behalf of third parties.
Cash/settlement discounts allowed

If a customer is expected to take up a cash/settlement discount allowed, the discount is deducted

from the invoiced amount when recording the revenue. If the customer subsequently does not take
up the discount, the discount is then recorded as revenue.

If the customer is not expected to take up the discount, the full invoiced amount is recognised as
revenue when recording the sale. If the customer subsequently does take up the discount, revenue
is then reduced by the discount.
TDF is a company that manufactures office furniture. A customer placed an order on 22 December
20X4 for an office desk at a price of $300 plus sales tax at 20% of $60. The desk was delivered to the
customer on 25 January 20X5, who accepted the goods as satisfactory by signing a delivery note. TDF
then invoiced the customer for the goods on 1 February 20X5. The customer paid $360 to TDF on 1
March 20X5.

Required
How should TDF account for revenue?
Applying the five step model:

(1) Identify the contract(s) with a customer:

A customer placed an order for a desk. This represents a contract to supply the desk.

(2) Identify the performance obligations in the contract:

There is one performance obligation, the delivery of a satisfactory desk.

(3) Determine the transaction price:

This is the price agreed as per the order, ie $300. Note that sales tax is not included since transaction price as
defined by IFRS 15 does not include amounts collected on behalf of third parties.

(4) Allocate the transaction price to the performance obligations in the contract:
There is one performance obligation, therefore the full transaction price is allocated to the performance of the
obligation of the delivery of the desk.

(5) Recognise revenue when (or as) the entity satisfies a performance obligation:
Since the customer has signed a delivery note to confirm acceptance of the goods as satisfactory, this is
evidence that TDF has fulfilled its performance obligation and can therefore recognise $300 in January 20X5.
INTRODUCTION TO
COMPANY ACCOUNTING
CASE STUDY
DISCUSSION PANNEL
 Preference shares
Preference shares carry the right to a final dividend which is expressed as a percentage of their par value.
Eg: 6% $1 preference share carries a right to an annual dividend of 6c. Preference dividends have priority over ordinary
dividend

Rights of Preference shares:

1. Preference shareholders have a priority right to a return of their capital over ordinary shareholders if the company goes
into liquidation.
2. Preference shares do not carry a right to vote.
3. If the preference shares are cumulative, it means that before a company can pay an ordinary dividend it must not only pay
the current year's preference dividend but must also make good any arrears of preference dividends unpaid in previous
years
 Preference shares
Classification Definition Examples Treatment
• Treated like loans and are included
as non-current liabilities in the
statement of financial position;
Redeemable 5% $1 preference shares
the company will • Reclassify them as current
20X9' means that the company will pay
Redeemable redeem (repay) the liabilities if the redemption is due
these shareholders $1 for every share
preference nominal value of within 12 months;
they hold on a certain date in 20X9. The
shares those shares at a • Dividends paid on redeemable
shares will then be cancelled and no
later date. preference shares are treated like
further dividends paid.
interest paid on loans and are
included in financial costs in the
statement of profit or loss.
Irredeemable
preference treated just like other shares. They form part of equity and their dividends are treated as appropriations
shares of profit.
 Ordinary shares
Ordinary shares are shares which are not preferred with regard to dividend payments. Thus a holder only receives a
dividend after fixed dividends have been paid to preference shareholders.

Example:

Garden Gloves Co has issued 50,000 ordinary shares of 50 cents each and 20,000 7% preference shares of $1 each. Its
profits after taxation for the year to 30 September 20X5 were $8,400. The management board has decided to pay an
ordinary dividend (ie a dividend on ordinary shares) which is 50% of profits after tax and preference dividend.

Required
Show the amount in total of dividends and of retained profits, and calculate the dividend per share on ordinary
shares
 Loan stock or bonds
• Limited liability companies may issue loan stock or bonds.
• These are long-term liabilities. In some countries they are described as loan capital because they are a means of raising
finance, in the same way as issuing share capital raises finance

SHARE CAPITAL LOAN STOCK

Shareholders are members of a company Providers of loan capital are creditor

Holders of loan capital are entitled to a fixed rate of

Shareholders receive dividends (appropriations of profit)
interest (an expense charged against revenue)

Loan capital holders can take legal action against a

Shareholders cannot enforce the payment of dividends.
company if their interest is not paid when due

Not secured on company assets Loan stock is often secured on company assets
Reserves
Shareholder’s equity

Ordinary share capital

Other equity (reserves) (Irredeemable
preference share)

Revaluation
Share premium Retained earnings Others
surplus

Non statutory reserves/

Statutory reserves
Revenue reserves

reserves which a company is required to set reserves consisting of profits which are
up by law, and which are not available for distributable as dividends, if the company so
the distribution of dividends. wishes.
Reserves
Shareholder’s
equity

Par value of issued

capital (minus any Other equity:
amount not yet called • Capital paid-up in excess
up on issued shares) of par value (share
premium)
• Revaluation surplus
• Reserves
• Retained earnings
 Share premium account
'premium' means the difference between the issue price of the share and its par value. The account is sometimes called
'capital paid-up in excess of par value.

The difference between cash received by the company and the par value of the new shares issued is transferred to the share
premium account.

Share premium account cannot be distributed as a dividend under any circumstances.

Eg: if X Co issues 1,000 $1 ordinary shares at $2.60 each. What would be the accounting entries?

Debit Cash $ 2,600

Credit Ordinary shares $ 1,000
Share premium
Credit $ 1,600
account
 Bonus and Right Issues
Bonus issues Right issues

Advantages Disadvantages Advantages Disadvantages

► Increases capital without

diluting current ► Does not raise any cash ► Raises cash for the
shareholders' holdings ► Dilutes shareholders'
► Could jeopardise company
holdings if they do not
► Capitalise reserves, so payment of future ► Keeps reserves available take up rights issue
they cannot be paid as dividends if profits fall for future dividends
dividends

Objectives Objectives

Increase the share capital

Raise additional financing
Increase marketability
Statement of Changes in Equity
EVENTS AFTER THE REPORTING
PERIOD
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Definition
Events after the reporting period
2. Types of events
3. Disclosures

Adjusting Non-adjusting
Definition
► Events after the reporting period which provide additional evidence of conditions existing at the reporting date will
cause adjustments to be made to the assets and liabilities in the financial statements.
► IAS 10 Events after the reporting period requires the provision of additional information in order to facilitate such an
understanding. IAS 10 deals with events after the reporting date which may affect the position at the reporting date.
► Events after the reporting period: An event which could be favourable or unfavourable, that occurs between the
reporting period and the date that the financial statements are authorised for issue. (IAS 10)
► Adjusting event: An event after the reporting period that provides further evidence of conditions that existed at the
reporting period.

Adjusting events Non-adjusting events

Events that provide further evidence Events which do not affect the situation
of conditions that existed at the at the reporting date should not be
reporting date should be adjusted for adjusted for, but should be disclosed in
in the financial statements. the financial statements.
Adjusting Events and Non Adjusting Events
ADJUSTING EVENTS
IAS 10 An entity shall adjust the amounts recognised in its financial statements to reflect adjusting events after the reporting period.
► Evidence of a permanent diminution in property value prior to the year end
► Sale of inventory after the end of the reporting period for less than its carrying value at the year end
► Insolvency of a customer with a balance owing at the year end
► Amounts received or paid in respect of legal or insurance claims which were in negotiation at the year end
► Determination after the year end of the sale or purchase price of assets sold or purchased before the year end
► Evidence of a permanent diminution in the value of a long-term investment prior to the year end
► Discovery of fraud or errors that show that the financial statements are incorrect

NON ADJUSTING EVENTS

IAS 10 An entity shall not adjust the amounts recognised in its financial statements to reflect non-adjusting events after the reporting
period.
► Acquisition, or disposal, of a subsidiary after the year end
► Announcement of a plan to discontinue an operation
► Major purchases and disposals of assets
► Destruction of a production plant by fire after the end of the reporting period
► Announcement or commencing implementation of a major restructuring
► Share transactions after the end of the reporting period
► Litigation commenced after the end of the reporting period.
► Dividends proposed or declared after the end of the reporting period are not recognised as a liability in the accounts at the reporting date,
but are disclosed in the notes to the accounts
Adjusting Events and Non Adjusting Events
DIVIDENDS
Dividends proposed or declared after the end of the reporting period are not recognised as a liability in the
accounts at the reporting date, but are disclosed in the notes to the accounts.

DISCLOSURES
The following disclosure requirements are given for material events which occur after the reporting period which do
not require adjustment. If disclosure of events occurring after the reporting period is required by this standard, the
following information should be provided.
(a) The nature of the event
(b) An estimate of the financial effect, or a statement that such an estimate cannot be made
STATEMENT OF CASH FLOW
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Preparing Statement of cash

flows The need for a cash flow statement
2. Classification of activities in
cash flows
3. Cash flows accounting
Format of a cash flow statement

Preparation of cash flow statement

Interpretation using a cash flow

statement
Preparing Statement of Cash flows
Statements of cash flows are a useful addition to the financial statements of a company because accounting
profit is not the only indicator of performance. They concentrate on the sources and uses of cash and are a
useful indicator of a company's liquidity and solvency.

IAS 7

Objectives Scope

Provide information for users of financial statements A statement of cash flows should be presented as an
about an entity's ability to generate cash and cash integral part of an entity's financial statements. All
equivalents, as well as indicating the cash needs of types of entity can provide useful information about
the entity. The statement of cash flows provides cash flows, as the need for cash is universal,
historical information about cash and cash whatever the nature of their revenue-producing
equivalents, classifying cash flows between activities. Therefore all entities are required by the
operating, investing and financing activities. standard to produce a statement of cash flows.
Classification of activities in cash flows

The standard gives the following definitions, the most important of which
are cash and cash equivalents.
Operating
► Cash comprises cash on hand and demand deposits. activities
► 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.
► Cash flows are inflows and outflows of cash and cash equivalents. Investing
► Operating activities are the principal revenue-producing activities of activities
the enterprise and other activities that are not investing or financing
activities.
► Investing activities are the acquisition and disposal of non-current
assets and other investments not included in cash equivalents.
Financing
► Financing activities are activities that result in changes in the size activities
and composition of the equity capital and borrowings of the entity.
 Operating activities
Most of the components of cash flows from operating activities will be those items which determine the net profit or loss of
the enterprise, ie they relate to the main revenue-producing activities of the enterprise.

The standard gives the following as examples of cash flows from operating activities:
(a) Cash receipts from the sale of goods and the rendering of services
(b) Cash receipts from royalties, fees, commissions and other revenue
(c) Cash payments to suppliers for goods and services
(d) Cash payments to and on behalf of employees

Certain items may be included in the net profit or loss for the period which do not relate to operational cash flows; for
example, the profit or loss on the sale of a piece of plant will be included in net profit or loss, but the cash flows will be
classed as investing.
 Investing activities
The cash flows classified under this heading show the extent of new investment in assets which will generate future profit
and cash flows. The standard gives the following examples of cash flows arising from investing activities.

(a) Cash payments to acquire property, plant and equipment, intangibles and other non-current assets, including those
relating to capitalised development costs and self-constructed property, plant and equipment
(b) Cash receipts from sales of property, plant and equipment, intangibles and other non-current assets
(c) Cash payments to acquire shares or debentures of other enterprises
(d) Cash receipts from sales of shares or debentures of other enterprises
(e) Cash advances and loans made to other parties
(f) Cash receipts from the repayment of advances and loans made to other parties
 Financing activities
The standard gives the following examples of cash flows which might arise under these headings.
(a) Cash proceeds from issuing shares
(b) Cash payments to owners to acquire or redeem the enterprise's shares
(c) Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short- or long term borrowings
(d) Cash repayments of amounts borrowed
Methods
2 ways of
Direct method creating a cash Indirect method
flow statement

net profit or loss is adjusted for the

effects of transactions of a non-
cash nature, any deferrals or
disclose major classes of gross cash accruals of past or future operating
receipts and gross cash payments cash receipts or payments, and
items of income or expense
associated with investing or
financing cash flows
 Direct method example
Boggis Co had the following transactions during the year.
(a) Purchases from suppliers were $19,500, of which $2,550 was unpaid at the year end. Brought forward payables were $1,000.
(b) Wages and salaries amounted to $10,500, of which $750 was unpaid at the year end. The accounts for the previous year showed an accrual for
wages and salaries of $1,500.
(c) Interest of $2,100 on a long-term loan was paid in the year.
(d) Sales revenue was $33,400, including $900 receivables at the year end. Brought forward receivables were $400.
(e) Interest on cash deposits at the bank amounted to $75.
Indirect method
The net profit or loss for the period is adjusted for the following:
(a) Changes during the period in inventories, operating receivables and payables
(b) Non-cash items, eg depreciation, provisions, profits/losses on the sales of assets
(c) Other items, the cash flows from which should be classified under investing or financing activities
Indirect method
(a) Depreciation is not a cash expense, but is deducted in arriving at the profit figure in the statement of profit or
loss. It makes sense, therefore, to eliminate it by adding it back.

(b) By the same logic, a loss on a disposal of a non-current asset (arising through underprovision of depreciation)
needs to be added back and a profit deducted.

(c) An increase in inventories means less cash – you have spent cash on buying inventory.

(d) An increase in receivables means the company's receivables have not paid as much, and therefore there is less
cash.

(e) If we pay off payables, causing the figure to decrease, again we have less cash
 Interest & Dividends
Cash flows from interest and dividends received and paid should each be disclosed separately. Each should be classified in a
consistent manner from period to period.

(a) Interest paid should be classified as an operating cash flow or a financing cash flow.

(b) Interest received and dividends received should be classified as operating cash flows or, more usually, as investing cash
flows.

(c) Dividends paid by the enterprise should be classified as an operating cash flow, so that users can assess the enterprise's
ability to pay dividends out of operating cash flows or, more usually, as a financing cash flow, showing the cost of obtaining
financial resources.
Indirect method
Principles
The treatment is logical if you think in terms of cash:
(a) Increase in inventory is treated as negative (in brackets). This is because it represents a cash
outflow; cash is being spent on inventory.
(b) An increase in receivables would be treated as negative for the same reasons; more receivables
means less cash.
(c) By contrast, an increase in payables is positive because cash is being retained and not used to settle
accounts payable. There is therefore more of it.

Step 3
Step 2 Calculate the Step 5
Begin with the cash flow figures Step 4
Step 1 Be able to
reconciliation of for dividends Open up a
Set out the complete the
profit before tax paid, purchase working for the
proforma statement by
to net cash from or sale of NCA, trading, income
statement of slotting in the
operating issue of shares and expense
cash flows figures given or
activities as far and repayment account
calculated
as possible of loans if these
are not already
Cash Flows Accounting
ability to
generate cash

satisfies the more

needs of all comprehensive
users

Advantages

a better means
easier to
of comparing the
prepare
results

Creditors are
more interested
INTRODUCTION TO GROUP AND
CONSOLIDATED ACOUNTS
Learning outcomes and overview
LEARNING OUTCOMES

1. Group and consolidation

2. Subsidiaries
3. Associates and trade investments
4. Consolidated Financial statements

OVERVIEW
Group
account/consolidation

IAS 27 IAS 28 IFRS 3 IFRS 10 IFRS 11 IFRS 12

Separate financial Investment in Business Consolidated Joint Disclosure of interest
statements associates combinations financial statements arrangements in other entities

Business Controls
present its
Accounting for combinations Consolidated
investments in the Joint venture
associates Recognition financial statements Disclosures
separate financial Joint operations
Equity method Measurement Procedures
statements
(GW, NCI) Investment entities
Introduction to Group Account
Types of Investment

Subsidiaries Associates Joint arrangements Other investments

Acquisition accounted for as

method and Joint ventures using a financial
Accounting
apply full Equity method equity method instrument in line
method
consolidation Joint operations with IAS
procedures 39 or IFRS 9

Significant
Criteria Control Joint Control Other
influence

Share 162 ≥50% 20% to <50% Equal Other

Introduction to Group Account
No Concepts Definition
1 Control An investor controls an investee when the investor is exposed, or has rights, to
variable returns from its involvement with the investee and has the ability to
affect those returns through power over the investee
2 Power Existing rights that give the current ability to direct the relevant activities of the
investee
3 Subsidiary An entity that is controlled by another entity
4 Parent An entity that controls one or more subsidiaries
5 Group A parent and all its subsidiaries
6 Associate An entity over which an investor has significant influence and which is neither a
subsidiary nor an interest in a joint venture
7 Significant The power to participate in the financial and operating policy decisions of an
influence investee but it is not control or joint control over those policies
Basic Principles of Consolidation
► Consolidation means adding together (uncancelled items).
► Consolidation means cancellation of like items internal to the group.
► Consolidate as if you owned everything then show the extent to which you do not.
Keep these basic principles in mind as you work through the detailed techniques of consolidated financial statements.
Basic Principles of Consolidation
owns more than half (ie over 50%) of the voting power of an
entity unless it can be clearly shown that such ownership does
not constitute control (these situations will be very rare)

over more than 50% of the voting rights by virtue of agreement

with other investors

govern the financial and operating policies of the entity by

IFRS 10 Control
statute or under an agreement.

power to appoint or remove a majority of members of the board of

Business entity concepts
directors (or equivalent governing body)

Ignore the legal boundaries power to cast a majority of votes at meetings of the board of
directors
Basic Principles of Consolidation
Representation on the board of directors (or equivalent)
of the investee

Participation in the policy making process

Significant
Associates Material transactions between investor and investee
influence

Interchange of management personnel

Equity
method

Provision of essential technical information

Consolidated Financial Statements

Objectives of IFRS 10

Accounting Investment
Consolidated FS Control
requirements entities

Exemption from
preparing group
accounts

a wholly-owned not in the

ultimate or
subsidiary or it is not publicly process of
intermediate
a partially owned traded issuing
parent
subsidiary securities
Consolidated Financial Statements
Non-controlling interest
NCI

be presented in the consolidated statement

The equity in a subsidiary not attributable,
of financial position within equity, separately
directly or indirectly, to a parent
from the parent shareholders’ equity

Group structure

Direct interest Indirect holdings

P P

S 60%
S1 S2 S3

55% 60% SS 70%

80%
Consolidated Financial Statements
Non-controlling interest
NCI

be presented in the consolidated statement

The equity in a subsidiary not attributable,
of financial position within equity, separately
directly or indirectly, to a parent
from the parent shareholders’ equity

Group structure

Direct interest Indirect holdings

P P

S 60%
S1 S2 S3

55% 60% SS 70%

80%
Consolidated statement of financial position
Consolidated statement of financial position
The financial statements of a parent and its subsidiaries are combined on a line-by-line basis by
Basic procedures
adding together like items of assets, liabilities, equity, income and expenses.

Parent Subsidiary Group Action

Investment in subsidiary Portion of equity Eliminated

Intra-group trading Intra-group trading Eliminated

Internal balances Internal balances Eliminated

Dividend received from Dividend paid to parent Eliminated

subsidiary
NCI of net income Adjusted to net income attributed to
owners of parent
NCI of net asset Presented separately in the
consolidated SOFP
Goodwill (GW) IFRS 3
171
Consolidated statement of financial position

Calculated NCI

Proportionate share Full (fair) value

NCI value = fair value of NCI's holding at acquisition

NCI value = NCI % × S’s net assets at acquisition
(number of shares NCI own × subsidiary share price)

Fair value of NCI in subsidiary just before acquisition

Goodwill attributable to NCI

Goodwill
Consideration transferred
INVESTMENT
VALUE
NCI value at acquisition
CARRYING VALUE
OF NET ASSETS Ordinary shares

Subsidiary’s net assets Reserves on acquisition

FAIR VALUE OF
NET ASSETS Fair value of net assets Retained earnings (RE)

Fair value adjustment

GOODWILL GOODWILL
Goodwill
Cash paid

Contingent consideration Fair value

Consideration Unwinding discount (PV x cost of capital) is

Deferred consideration discounted
transferred charged to finance cost

Share exchange @ published prices at acquisition date

Lawyers, audit fees, accounting fees are

Expense and issue cost
written off as incurred

Issue costs are deducted from the proceeds

Goodwill impairment Goodwill arising on consolidation is subjected to an annual impairment review and impairment may be
expressed as an amount or as a percentage.

DEBIT Impairment expenses (PL) (Group retained earnings-BS)/ CREDIT Goodwill (BS)

When NCI is valued at fair value the goodwill in the statement of financial position includes goodwill
attributable to the NCI.

DEBIT Impairment expenses (PL) (Group retained earnings-BS)/ DEBIT NCI/ CREDIT Goodwill (BS)
Intra Group Transactions

Parent (P) Subsidiary (S) Group Adjustments

P sells at mark-up S buys at mark-up but not Unrealised profit (URP) at P DR Group RE
sells out to customers Closing inventory at S CR Group Inventory (URP)
P buys at mark-up but not S sells at mark-up Unrealised profit at S DR Group RE
sells out to customers Closing inventory at P DR NCI
CR Group Inventory (URP)
P sells Non-current assets at S buys Non-current assets Unrealised profit (URP) at P DR Group RE (URP)
mark-up from P at mark-up NCA at S and unreal CR NCA
additional depreciation at S CR Depreciation
P buys Non-current assets S sells Non-current assets at Unrealised profit (URP) at S DR Group RE (URP)
from S at mark-up mark-up NCA at P and unreal DR NCI
additional depreciation at P CR NCA
CR Depreciation
Consolidated Procedures
Working Procedures
Working 1 Group structure

PS

Working 2 Net assets of subsidiary At the date of At the reporting Post-acquisition

acquisition date

Share capital (SC) XXX XXX -

Share premium (SP) XXX XXX -

Reserves (RS) XXX XXX XXX

Retained Earnings (RE) XXX XXX XXX

XXX XXX XXX

Fair value adjustment XXX XXX

Fair value of net assets XXX XXX

 Consolidated Procedures
Working Procedures

Working 3 Goodwill

Investment value (IV) XXX

Fair value of net assets (FV) – (W2) (XXX)

Goodwill XXX

Impairment of GW (LOS 3) (XXX)

XXX

Working 4 Non-controlling interest

NCI value at acquisition (LOS 3) XXX

NCI share of post-acquisition reserves (W2) XXX

NCI share of impairment (fair value method only) (XXX)

XXX
Consolidated Procedures

Working Procedures

Working 5 Group Retained Earnings (RE)

P's retained earnings (100%) XXX

P's % of sub's post-acquisition retained earnings (W2) XXX

Less: Parent share of impairment (W3) (XXX)

XXX

Working 6 Eliminate Intra-group transactions

Working 7 Aggregate assets and liabilities

Working 8 Share capital

Only P’s accounts

 Cancellation entries
No. Contents Notes

W1 Recording fair value of consideration given

DR Investment in S

CR Payable to S Record contingent or deferred consideration

DR RE – P (interest expense)

CR Payable to S Record interest expense on unwinding the discount

W2 Cancellation of carrying value of S’s net assets

DR OS/SP/Reserve – S

DR RE – S @ acq

CR Investment in S

CR NCI
 Cancellation entries

No. Contents Notes

W3 Recording Goodwill and fair value adjustment

DR Goodwill

DR Assets

CR Investment in S

CR NCI

CR Liabilities

DR RE – P Adjusted accumulated depreciation expenses for

depreciable assets
DR NCI

CR Assets
 Cancellation entries
Inter-co sales of Non-current assets

Downstream transaction (P sells to S)

1 DR RE – P (gain) Eliminate gain on sales of assets

CR Assets

2 DR Assets Adjust accumulated depreciation expenses

CR RE - P

Upstream transaction (S sells to P)

1 DR RE – P (gain) Eliminate gain on sales of assets

DR NCI

CR Assets

2 DR Assets Adjust accumulated depreciation expenses

CR RE - P

CR NCI
Cancellation entries

No. Contents Notes

Inter-co dividend Not affect the SFP

Inter-co payable/receivables

DR Payables

CR Receivables

Payment in transit

1 DR Cash Eliminate payment in transit

CR Receivables

2 DR Payables Eliminate AR/AP

CR Receivables
 Cancellation entries

No. Contents Notes

Inter-co dividend Not affect the SFP

Inter-co payable/receivables

DR Payables

CR Receivables

Payment in transit

1 DR Cash Eliminate payment in transit

CR Receivables

2 DR Payables Eliminate AR/AP

CR Receivables
CONSOLIDATED STATEMENT OF PROFIT
AND LOSS AND OTHER COMPREHENSIVE
INCOME
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. The consolidated statement of

profit or loss (and other
comprehensive income)
2. Disposals
Consolidated SOCI
No. Contents Notes

Step 1 Aggregate revenue and expenses (100% P + 100% S)

Step 2 Eliminate intra-group items from both revenue and costs of sales
Goods sold by P. Increase cost of sales by unrealised profit

Goods sold by S. Increase cost of sales by full amount of unrealised profit

and decrease non-controlling interest by their share of unrealised profit

Step 3 Fair value adjustment

If the value of S’s NCA have been subjected to FV uplift then any additional
depreciation must be charged to PL. NCI will need to be adjusted for their
share.
Impairment of Goodwill

Eliminate dividend paid by subsidiary DR Dividend income (PL)

DR NCI
CR Retained Earnings (RE)
Consolidated SOCI
No. Contents Notes

Step 4 Calculate NCI

S’s profit after tax as per statement of P/L XXX

LESS Unrealized profit (*) (XXX)

Profit on disposal of NCA (*) (XXX)

Additional depreciation due to FV adjustments (XXX)

ADD Additional depreciation due to disposal of NCA (*) XXX

XXX

NCI (%) XXX

Step 5 Present profit attributable to owners of P and NCI separately

Notes (*) ALL sales of goods and non-current assets made by subsidiary

Only the post-acquisition profits of the subsidiary are brought into the
Consolidated PL
INTERPRETATION OF
FINANCIAL STATEMENTS FOR COMPANIES
Learning outcomes and overview
LEARNING OUTCOMES OVERVIEW

1. Financial analysis
2. Limitations of ratios analysis Interpretation of financial statements
3. Ratios

Review the raw data Ratio analysis

Profitability Liquidity Efficiency Position

Financial Analysis

Comparison
s across
companies

Trend
analysis

Financial
analysis
 Trend Analysis
Different
Changes in degrees of
the nature of diversification
the business

Different
Different effects
production and
of government
Unrealistic purchasing
incentives Comparability
Changes in Trend depreciation policies
accounting rates under between
policies analysis historical cost
accounting
companies

The
changing Different Different
value of the
currency accounting financing
unit being policies policies
reported
The Broad Categories of Ratios
RATIO
ANALYSIS

Long-term solvency Short-term solvency Efficiency (turnover Shareholders'

Profitability and return
and stability and liquidity ratios) investment ratios

► Return on
capital ► Gearing
employed ► Receivables ratio/leverage
► Net profit as a collection period ► EPS
► Debt ratios
percentage of ► Payables ► Dividend cover
► Gearing ► Current ratio
sales payment period ► Dividend per
ratio/leverage ► Quick ratio
► Asset turnover ► Inventory share
ratio ► Interest cover turnover period ► Price earning
► Gross profit as a ratios
percentage of
sales
 ROCE

Profit Asset
margin turnover

PBIT/ SALES SALES / CAPITAL EMPLOYED

A warning about comments on profit margin and asset turnover

(a) A high profit margin means a high profit per $1 of sales but, if this also means that sales prices are
high, there is a strong possibility that sales turnover will be depressed, and so asset turnover lower.

(b) A high asset turnover means that the company is generating a lot of sales, but to do this it might
have to keep its prices down and so accept a low profit margin per $1 of sales.
Debt ratio

(a) Assets consist of non-current assets at their statement of financial position value, plus current assets.
(b) Debts consist of all payables, whether they are due within one year or after more than one year.

There is no absolute guide to the maximum safe debt ratio but, as a very general guide, you might regard 50% as
a safe limit to debt. In practice, many companies operate successfully with a higher debt ratio than this, but 50% is
nonetheless a helpful benchmark
Gearing/leverage

Gearing or leverage is concerned with a company's long-term capital structure. We can think of a
company as consisting of non-current assets and net current assets (ie working capital, which is current
assets minus current liabilities). These assets must be financed by long-term capital of the company, which is
either:
(a) Shareholders' equity
(b) Long-term debt

There is no absolute limit to what a gearing ratio

ought to be. A company with a gearing ratio of
more than 50% is said to be highly geared,
whereas low gearing means a gearing ratio of less
than 50%
Leverage is the term used to describe the converse of gearing, ie the proportion of total assets financed by
equity, and which may be called the equity to assets ratio. It is calculated as follows
Interest cover

The interest cover ratio shows whether a company is earning enough PBIT to pay its interest costs comfortably,
or whether its interest costs are high in relation to the size of its profits, so that a fall in PBIT would then have a
significant effect on profits available for ordinary shareholders
Short-term solvency and liquidity

Liquidity is the amount of cash a company can put its hands on quickly to settle its debts (and possibly to
meet other unforeseen demands for cash payments too).

Liquid funds consist of:

(a) Cash
(b) Short-term investments for which there is a ready market
(c) Fixed-term deposits with a bank or other financial institution, for example, a six month high-interest deposit with
a bank
(d) Trade receivables (because they will pay what they owe within a reasonably short period of time)
The Cash Cycle
Cash goes out to pay for supplies, wages and salaries and other expenses, although payments can be
delayed by taking some credit. A business might hold inventory for a while and then sell it. Cash will come
back into the business from the sales, although customers might delay payment by themselves taking some
credit.
The main points about the cash cycle are as follows:
► Cash flows out can be postponed by taking credit. Cash flows in can be delayed by having receivables
► The time between making a purchase and making a sale also affects cash flows
► Holding inventories and having payables can therefore be seen as two reasons why cash receipts are
delayed.
► Similarly, taking credit from creditors can be seen as a reason why cash payments are delayed.
The liquidity ratios and working capital turnover ratios are used to test a company's liquidity, length of
cash cycle and investment in working capital.
Liquidity ratios: current ratio and quick ratio

A current ratio in excess of 1 should be expected.

The quick ratio should ideally be at least 1 for companies with a slow inventory
turnover. For companies with a fast inventory turnover, a quick ratio can be
comfortably less than 1 without suggesting that the company should be in cash
flow trouble
Efficiency ratios: control of receivables and inventories and payables