ACCOUNTI

NG
Gr
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Chapter5
F
INANCI
ALSTATEMENTS
Theory

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 TABLE OF CONTENTS Page
1. Accounting cycle 3

2. The need for Financial Statements 3

3 Desirable Characteristics of Financial Statements 4

4. Factors Affecting the Financial Statements 4

5. Interested stakeholders 5

6. Operating, Financing and Investing activities 5

7. Format of an Income Statement/ Statement of Comprehensive Income 6

8. Format of the Balance Sheet and Notes to the Balance Sheet /

Statement of Financial position 8

THIS BOOKLET CONTAINS 14 PAGES

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1. ACCOUNTING CYCLE

INCOME STATEMENT
Analysis and
BALANCE SHEET Interpretation

Transactions
Financial
Statements

Source
Documents
Trial
balance

Pre-adjustment Trial
Balance
•Adjustments Journals
Post-adjustment Trial
Balance
General
•Closing Transfers Ledger
Post Closing Trial Balance

2. THE NEED FOR FINANCIAL STATEMENTS

▪ Financial Statements are needed for decision-making purposes.
▪ IFRS states: “The objective or general purpose of financial accounting is to
provide financial information about the reporting entity that is useful to existing
and potential investors, lenders and other creditors in making decisions about
providing resourcing to the entity”.
▪ Financial Statement must:
o Report the state of affairs and business of the company.
o Reflect assets, liabilities, equity, income, and expenses.
o Not be misleading or incomplete.
o State whether they have been audited by an independent auditor or subjected
to an independent review.

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3. DESIRABLE CHARACTERISTICS OF FINANCIAL STATEMENTS

• Making a difference to users

RELEVANCE
• Materiality

FAITHFUL • Unbiased and fair

REPRESENTATION • Complete and free of errors

• From one year to another

COMPARABILITY
• From one company to another

VERIFIABILITY • It must be suported by evidence

TIMELINES • There must be no unreasonable delay

UNDERSTANDIBILITY • Not confusing

4. FACTORS AFFECTING THE FINANCIAL STATEMENTS

Financial Statements will

Important information not show any transactions
must be shown like of a personal nature
interest expense – cost
of borrowing money
Business Balance
entity sheet, assets
valued at
Materiality Historical original price
Conservative. cost
Income not
anticipated
which has not GAAP Going-
yet been Concern
received. Will
provide for Prudence Financial statements prepared
losses like on the basis that the company
bad debts. will continue operating in the
Matching foreseeable future. Example,
Income and expenses recorded in stock is not valued based on
the amount of money that
the correct period. If goods are sold,
would be received if it is sold in
the cost must be recorded at the a short period
same time.

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5. INTERESTED STAKEHOLDERS
STAKEHOLDER REASON

The business is making sufficient return to justify

The partners or owners of the
their investment in the business and the risk they
business
have taken

The business has a positive trend in profits that

Potential investors or buyers in
which will continue into the future in order to
the business
justify further investments.

The business is making enough profit to pay

Financial Institutions and Banks interest, and it has enough security in order to
repay overdrafts or long-term debts.

Salaries, wages and working conditions are fair

Trade unions and employees
for the workers.

The business is regularly paying VAT and PAYE,

South African Revenue Services and the partners are paying the correct income
tax on their earnings.

The information reflects any day-to-day problems

The manager and other senior
that need to be resolved in improving the
personnel
operation of the business.

Creditors and suppliers who grant The business is able to repay the debts without
to a business. any problems, i.e., its creditworthiness.

6. OPERATING, FINANCING AND INVESTING ACTIVITIES

OPERATING ACTIVITY
• Activities in operating the business e.g. buying and selling goods, paying wages,
etc.
FINANCING ACTIVITY
• Activities in raising funds for the business either from the owner, or from lenders,
e.g. owner provides capital, borrowing funds from a lender, repays a loan, pay or
owes interest.
INVESTING ACTIVITY
• Activities in investing the funds of a business with the intention of earning a profit,
e.g. invest in a fixed deposit, transfer funds from a savings account,earning
interest. Fixed assets wil enable the business to operate and thereby earn a
profit.

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7. FORMAT OF AN INCOME STATEMENT / STATEMENT OF
COMPREHENSIVE INCOME
INCOME STATEMENT / STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED ………………………………………….
Note
Trading
activity – refer Sales 989 920
to trading Cost of sales (538 280)
account in
General Gross profit  451 640
Ledger
Income from services rendered  89 140
Fee income 85 000
Operating
activity – Commission income* 41 40
everything is Other operating income  19 980
included
except interest Bad debts recovered 16 250
income and Discount received 2 930
interest
expense. Profit on sale of fixed assets 800

Refer to the Gross operating income  560 760

Profit and loss Operating expenses  (477 939)
account in the
general ledger. Salaries & wages 380 000
BRACKETS
REQUIRED

Maintenance 25 000
NO

Depreciation 11 625
Stationery & printing 16 800
Water & electricity 44 514

Operating profit  82 821

Investing activity
Interest income 1 5 002

Profit before interest expense 87 823

Financing activity
Interest expense (19 800)

Net profit for the year 8 68 023

*Note that commission income may be shown under other operating incomes. Abide
by the guidelines of your examining body.
EXPENSES MUST BE SHOWN IN BRACKETS. MINUS IS SHOWN IN BRACKETS
MAIN PART IN THE INCOME STATEMENT

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1. GROSS PROFIT

• Debtors allowances is always closed off to sales.

• 𝑆𝑎𝑙𝑒𝑠 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 = 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡

2. GROSS OPERATING INCOME

• 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
+𝐼𝑛𝑐𝑜𝑚𝑒 𝑓𝑟𝑜𝑚 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑠 𝑟𝑒𝑛𝑑𝑒𝑟𝑒𝑑
+𝑜𝑡ℎ𝑒𝑟 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
= 𝑮𝒓𝒐𝒔𝒔 𝒐𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒊𝒏𝒄𝒐𝒎𝒆

3. OPERATING PROFIT

• 𝐺𝑟𝑜𝑠𝑠 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 − 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡

4. PROFIT BEFORE INTEREST EXPENSE

• 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 + 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = 𝑝𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒

• Total interest income is calculated in note 1: Interest income.

5. NET PROFIT FOR THE YEAR

•𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 − 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 = 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟.
• The total interst expense is calculated in note 2: Interest expense
• The net profit must be taken to note 8: current account.

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8. FORMAT OF THE BALANCE SHEET AND NOTES TO THE BALANCE
SHEET/ STATEMENT OF FINANCIAL POSITION

BALANCE SHEET / STATEMENT OF FINANCIAL POSITION ON ………

ASSET = OWNER’S EQUITY + LIABILITIES

NON-CURRENT + CURRENT
ASSETS Note

= TOTAL ASSET
Non-current assets 490 650
Tangible / Fixed assets 3 470 650
Financial assets – Fixed deposit 20 000
Current assets 321 483
Inventories 4 218 510
Trade and other receivables 5 74 011
Cash and cash equivalents 6 28 962
TOTAL ASSETS 812 133

EQUITY AND LIABILITIES

Capital and reserves/ Owners’ equity 620 563

= TOTAL EQUITY AND LIABILITIES

Capital 7 600 000

OWNER’S EQUITY + NON-

CURRENT + CURRENT
Current account 8 20 563
Non-current liabilities 127 800
Mortgage loan 127 800
Current liabilities 63 770
Trade and other payables 9 63 770
Bank overdraft (if applicable) -
Current portion of loan/ short term loan -
TOTAL EQUITY AND LIABILITIES 812 133

IMPORTANT NOTICE:

▪ Current portion of loan always subtracted from the Mortgage loan in non-current
liabilities and taken to short term liabilities.
▪ If a Fixed deposit matures, always subtract the Fixed deposit in non-current assets
and taken to your short-term assets, cash, and cash equivalents.
▪ When asked to complete the face of the Balance sheet only, then all calculations
must be shown in brackets.

8
NOTES TO THE FINANCIAL STATEMENTS
INCOME STATEMENT / STATEMENT OF COMPREHENSIVE INCOME

1. INTEREST INCOME
On fixed deposit 3 600
On overdue debtors 40
On current account 200
On savings account 1 162
5 002
The total will go to
2. INTEREST EXPENSE the Income
On mortgage loan 57 400 statement
On bank overdraft -
On overdue creditors -
57 400

BALANCE SHEET / STATEMENT OF FINANCIAL POSITION:

NON-CURRENT ASSETS

3. FIXED ASSETS Land &

Vehicles Equipment Total
buildings
Carrying value at 372 000 98 000 2 300 472 300
beginning
Cost 372 000 262 000 8 500 642 500
Accumulated
- [164 000] [6 200] [170 200]
depreciation
Movements - [9 800] 8 150 [1 650]
Additions at cost - - 11 000 11 000
Disposals at carrying
- - [1 025] [1 025]
value
Depreciation - [9 800] [1 825] [11 625]
Carrying value at 372 000 88 200 10 450 470 650
end
372 000 262 000 11 000 645 000
Cost
Accumulated - [173 800] [550] [174 350]
depreciation

The total will appear in the Balance sheet

9
1. CARRYING VALUE IN THE BEGINNING

• 𝐶𝑜𝑠𝑡 − 𝐴𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑣𝑎𝑙𝑢𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔

2. MOVEMENT

• 𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑠 𝑎𝑡 𝑐𝑜𝑠𝑡 − 𝑑𝑖𝑠𝑝𝑜𝑠𝑎𝑙 𝑎𝑡 𝒄𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝒗𝒂𝒍𝒖𝒆 − 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

= 𝑀𝑜𝑣𝑒𝑚𝑒𝑛𝑡

3. CARRYING VALUE AT THE END OF THE YEAR

• Carrying value beginning

+ Additions at cost movement
– Disposal at carrying value
– Depreciation for the year
= Carrying value end of year
• or 𝐶𝑜𝑠𝑡 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑 − 𝑎𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑
= 𝑐𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑣𝑎𝑙𝑢𝑒 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑

4. COST AT THE END OF THE YEAR

• 𝐶𝑜𝑠𝑡 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 + 𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑠 𝑎𝑡 𝑐𝑜𝑠𝑡 − 𝐶𝑜𝑠𝑡 𝑜𝑛 𝑎𝑠𝑠𝑒𝑡 𝑑𝑖𝑠𝑝𝑜𝑠𝑎𝑙

= 𝑐𝑜𝑠𝑡 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑.

5. ACCUMULATED DEPRECIATION AT THE END OF

THE YEAR
• Accumulated depreciation in the beginning
– Accumulated depreciation on asset disposed
+ Depreciation for the year (old+new+sold)
= Accumulated depreciation at the end
• or 𝐶𝑜𝑠𝑡 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑 − 𝑐𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑣𝑎𝑙𝑢𝑒 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑
= 𝑐𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑣𝑎𝑙𝑢𝑒 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑

10
 BALANCE SHEET / STATEMENT OF FINANCIAL POSITION:
CURRENT ASSETS

4. INVENTORIES
Trading stock 211 210
Consumable stores on hand 7 300
218 510

The total will appear the Balance sheet

5. TRADE AND OTHER RECEIVABLES
Net trade debtors 60 421
Trade debtors 66 021
Provision for bad debts (5 600)
Income receivable / accrued 350
Prepaid expenses 13 240
Deposit on water and electricity -
28 962

𝑇𝑟𝑎𝑑𝑒 𝑑𝑒𝑏𝑡𝑜𝑟𝑠 − 𝑝𝑟𝑜𝑣𝑖𝑠𝑖𝑜𝑛 𝑓𝑜𝑟 𝑏𝑎𝑑 𝑑𝑒𝑏𝑡𝑠 = 𝑁𝑒𝑡 𝑡𝑟𝑎𝑑𝑒 𝑑𝑒𝑏𝑡𝑜𝑟𝑠

𝑁𝑒𝑡 𝑡𝑟𝑎𝑑𝑒 𝑑𝑒𝑏𝑡𝑜𝑟𝑠
+𝐴𝑐𝑐𝑟𝑢𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒
+𝑃𝑟𝑒𝑝𝑎𝑖𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
+𝐷𝑒𝑝𝑜𝑠𝑖𝑡 𝑜𝑛 𝑤𝑎𝑡𝑒𝑟 𝑎𝑛𝑑 𝑒𝑙𝑒𝑐𝑡𝑟𝑖𝑐𝑖𝑡𝑦
= 𝑻𝑶𝑻𝑨𝑳

6. CASH AND CASH EQUIVALENTS

Fixed deposits
-
(Maturing within 12 months)
Savings account 8 162
Bank 20 000
Cash float 800
Petty cash -
28 962

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 BALANCE SHEET / STATEMENT OF FINANCIAL POSITION:
CAPITAL RESERVES / OWNERS’ EQUITY

7. CAPITIAL ACCOUNT PETER SUSAN TOTAL

Balance at the beginning of year 300 000 280 000 580 000
Contribution of capital during the year 60 000 - 60 000
Withdrawal of capital during the year (-) (40 000) (40 000)
Balance at the end of the year 360 000 240 000 600 000

The total will appear in the Balance sheet

▪ Each partner will have their own capital account.

▪ Interest on capital is calculated on the capital balance.
▪ A partner can contribute money/equipment/building/vehicles -any contribution will
be added to the capital account.
▪ A partner can withdraw their capital – do not confuse this with drawings!!!
8. CURRENT ACCOUNTS PETER SUSAN TOTAL
33 614 34 409
Profit per Income Statement 68 023
Partners’ salaries 60 000 60 000 120 000
Interest on capital 12 000 0 12 000
Partners’ bonus 28 800 19 200 48 000
Primary distribution of profits 100 800 79 200 180 000
Final distribution of profits [67 186] [44 791] [111 977]
Drawings during the year [13 000] [25 460] [38 460]
Retained income for the year 20 614 8 949 29 563
Retained income at beginning of 2 200 [11 200] [9 000]
year
22 814 [2 251] 20 563
Retained income at end of year

The total will appear in the Balance sheet

STEP 1

• Record the NET PROFIT from the Income Statements.

• A loss will be indicated in brackets.

STEP2

• Calculate the PRIMARY DISTRIBUTIONS of profits.

• Primary = Partners salary + interest on capital + partner’s bonus.

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STEP 3

• Calculate the REMAINING PROFITS.

• Net profit minus primary = remaining.
• Remaining profits must be shared between partners according to the
specific ratio.

STEP 4

• Calculate PROFIT PER INCOME STATEMENT per partner.

• Profit per Income Statement per partner
= Primary distributions of profits + final distributions of profits.

STEP 5

• Show the total DRAWINGS for the Accounting period for each partner

STEP 6

• Calculate the RETAINED INCOME for the year.

• Retained income for the year = Profit per Income Statement MINUS
Drawings

STEP 7

• RECORD the retained income in the beginning.

• Retained income in the beginning is your current account balance from
the pre-adjustment trial balance.
• A debit balance = brackets (negative).
• A credit balance = no brackets (positive).

STEP 8

• CALCULATE retained income at the end.

• Retained income at the end = retained income for the year + or –
retained income in the beginning.
• A debit balance = brackets (negative).
• A credit balance = no brackets (positive)

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 BALANCE SHEET / STATEMENT OF FINANCIAL POSITION:
CURRENT LIABILITIES

9. TRADE AND OTHER PAYABLES

Trade creditors 40 360
Accrued expenses 1 310
Income received in advance 2 100 Salaries and Wages:
Creditors for salaries and wages 3 700 ▪ Always the net
SARS: PAYE 1 250 salary or wage.
Medical aid fund - ▪ All deductions and
UIF Fund 50 contributions must
Skills and development fund - be included.
Pension fund -
*Current portion of loan/ short term loan 15 000 The total will
63 770 appear in the
Balance sheet

*Note: Can be shown as part of note 9 or can appear on the face of the Balance
sheet under current liabilities.
SUMMARY
INCOME STATEMENT/STATEMENT OF COMPREHENSIVE INCOME
•𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 = 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡

OWNER'S EQUITY
NET WORTH (Net financial position)
•𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 − 𝐷𝑟𝑎𝑤𝑖𝑛𝑔𝑠 = 𝑂𝑤𝑛𝑒𝑟 ′ 𝑠 𝑒𝑞𝑢𝑖𝑡𝑦
•If the business made a loss, will be subtracted from drawings.

BALANCE SHEET/ STATEMENT OF FINANCIAL POSITION

•𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑂𝑤𝑛𝑒𝑟 ′ 𝑠 𝑒𝑞𝑢𝑖𝑡𝑦 + 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

14