FINANCIAL ACCOUNTING

Mr. Kibet Barkerot (CPA, Bcom, MBM)

Core areas of the syllabus
 The context and purpose of financial reporting
 The qualitative characteristics of financial information
 The use of double entry and accounting systems
 Recording transactions and events
 Preparing a trial balance
 Preparing basic financial statements
 Preparing simple consolidated statements
 Interpretation of financial statements
• This is assessed in the form of a computer-based
exam
• Time allowed – 2 hours
• Format: All questions are compulsory
 Section A: 35 OT questions – 2 marks each
 Section B: 2 multi-task questions – 15 marks each

- Final accounts preparation question (either sole trader

or limited company)
- Statement of cash flow and ratio analysis
- Consolidation question
Introduction to financial reporting
What is financial reporting?
Financial reporting is a way of recording,
analysing and summarising financial data.

• Financial accounting and management accounting

Financial accounting is
mainly a method of Management (or cost)
reporting the financial accounting is a
performance and financial management information
position of a business. system which analyses
data to provide
information as a basis for
managerial action.
What is a business?
Businesses of whatever size or nature exist to make a
profit.
• Types of business entity
- Sole trader
- Partnership
- Limited liability company
QUIZ

Which of the following users do you think

require the most detailed financial information
to be made available to them?
o Competitors
o Management of the business
o Trade unions
o Investors
Which of the following are true of sole traders?
(1) A sole trader's financial statements are private; a company's
financial statements are sent to shareholders and may be publicly
filed
(2) Only companies, and not sole traders, have capital invested into
the business
(3) A sole trader is fully and personally liable for any losses that the
business might make; a company's shareholders are not
personally liable for any losses that the company might make
o 1 and 2 only
o 2 and 3 only
o 1 and 3 only
o 1, 2 and 3
Which TWO of the following are advantages of trading as a
partnership?
(1) Additional capital can be raised because more people are
investing in the business
(2) A partnership has a separate legal identity from the individual
partners
(3) Partners have limited liability and are not personally liable for
the debts of the partnership
(4) A partnership is not required to make its financial accounts
publicly available
o 1 and 2
o 1 and 4
o 2 and 4
o 2 and 3
Which TWO of the following are disadvantages of trading as a
limited liability company?
(1) The shareholders of the company have limited liability for the
debts of the company
(2) A company must publish annual financial statements
(3) Raising finance is easier as a company, as more shares can be
issued
(4) The financial statements of larger limited liability companies
must be audited
o 1 and 2
o 1 and 4
o 2 and 3
o 2 and 4
What should be the main aim for a director of a company?
o To manage the affairs of the company in order to earn a good
bonus
o To manage the affairs of the company in order to create wealth
for the shareholders
o To manage the affairs of the company in order to generate the
largest profits in the shortest time
o To manage the affairs of the company in order to contribute to
the general wellbeing of society
The elements of the financial
statements:
Assets – An asset is a
resource controlled by the
entity as a result of past
events from which future
economic benefits are
expected to flow to the entity.

For example, a building that is owned and controlled

by a business and that is being used to house
operations and generate revenues would be classed
as an asset.
Liabilities – A liability is an
obligation to transfer economic
benefit as a result of past
transactions or events.

For example, an unpaid tax

obligation is a liability.
Equity – This is the 'residual
interest' in a business and
represents what is left when
the business is wound up, all
the assets sold and all the
outstanding liabilities paid.

It is effectively what is paid back to the

owners (shareholders) when the business
ceases to trade.
Income – This is the recognition
of the inflow of economic benefit
to the entity in the reporting
period.

This can be achieved, for example, by earning

sales revenue or through the increase in value
of an asset.
Expenses – This is
the recognition of
the outflow of
economic benefit
from an entity in the
reporting period.

This can be achieved, for example, by purchasing

goods or services off another entity or through
the reduction in value of an asset.
CORPORATE GOVERNANCE

What is ‘corporate governance’?

The Cadbury Report 1992 provides a useful
definition: 'the system by which companies are
directed and controlled‘ in the interests of
shareholders and in relation to those stakeholders
beyond the company boundaries'

If directors of a company have a responsibility to these

groups then they must also be held accountable to
them.
The basic elements of sound corporate
governance include:
• effective management
• effective systems of internal control
• oversight of management by non-executive directors
• fair appraisal of director performance
• fair remuneration of directors
• fair financial reporting, and
• constructive relationships with shareholders.
Responsibility for the financial statements
Directors are responsible for the preparation of the
financial statements of the company. Specifically,
directors are responsible for:
 The preparation of the financial statements of the
company in accordance with the applicable
financial reporting framework (eg IFRSs)
 The internal controls necessary to enable the
preparation of financial statements that are free
from material misstatement, whether due to error
or fraud
 The prevention and detection of fraud
QUIZ
1.
Which one of the following is the main aim of
accounting?
o To maintain ledger accounts for every asset and
liability
o To provide financial information to users of such
information
o To produce a trial balance
o To record every financial transaction individually
 2.
Classify the following items into current and
non-current assets and liabilities:
 
• land and buildings
 
• receivables
 
• cash
 
• loan repayable in two years’ time
 
• payables
 
• delivery van.
 3.
Who is responsible for the preparation of the
financial statements of a company?
(1)The finance department
(2)The board of directors
(3)The external auditors
o 1 only
o 1 and 2 only
o 2 only
o 1, 2 and 3
 4.
Which TWO of the following criteria need to be
satisfied in order for an item to be recognised
in the financial statements?
o It meets the definition of an element of the
financial statements
o It is probable that future economic benefits will
flow to or from the enterprise
o It is certain that future economic benefits will
flow to or from the enterprise
o The entity has paid for the item
 5.
Which of the following is most useful for
managers?
o Financial statements for the last financial year
o Tax records for the past five years
o Budgets for the coming financial year
o Bank statements for the past year
THE REGULATORY FRAMEWORK
Why a regulatory framework is necessary?
 To ensure that the needs of the users of financial
statements are met with at least a basic minimum of
information.
 To ensure that all the information provided in the
relevant economic arena is both comparable and
consistent. Given the growth in multinational
companies and global investment this arena is an
increasing international one.
 To increase users’ confidence in the financial
reporting process.
 To regulate the behaviour of companies and
directors towards their investors.
The following factors that have shaped financial
accounting can be identified.
 National/local legislation
 Accounting concepts and individual judgement
 Accounting standards
 Other international influences
 Generally accepted accounting principles (GAAP)
 Fair presentation
The standard setting process
International Financial Reporting Standards (IFRS)
Foundation
The IFRS Foundation:
 Is the supervisory body for the IASB
 Is responsible for governance issues and ensuring
each body is properly funded.
The objectives of the IFRS Foundation include:
 Develop a set of global accounting standards of
high quality which are understandable and
enforceable
 Promote using and applying these standards
 Bring about the convergence of national and
international accounting standards.
International Accounting Standards Board
(IASB)
The IASB: is solely responsible for issuing
International Financial Reporting Standards (IFRSs)
The IASB and national standard setters
The intentions of the IASB are:
 To develop a single set of understandable and
enforceable high quality worldwide accounting
standards, however
 The IASB cannot enforce compliance with its
standards, therefore
 It needs the cooperation of national standard
setters.
FRS Interpretations Committee (IFRS IC)
 issues rapid guidance on accounting matters where
divergent interpretations of IFRSs have arisen
 these must be approved by the IASB
The IFRIC addresses issues of reasonably
widespread importance, not issues that are of concern
to only a small minority of entities. The interpretations
cover both:
 newly identified financial reporting issues not
specifically dealt with in IFRSs; or
 issues where unsatisfactory or conflicting
interpretations have developed, or seem likely to
develop in the absence of authoritative guidance,
with a view to reaching a consensus on the
appropriate treatment.
The IFRS Advisory Council (IFRS IC)
The IFRS Advisory Council provides a forum for the
IASB to consult a wide range of interested parties
affected by the IASB's work, with the objective of:
 advising the Board on agenda decisions and
priorities in the Board's work,
 informing the Board of the views of the
organisations and individuals on the Council on
major standardsetting projects, and
 giving other advice to the Board or to the Trustees.
Development of an IFRS- Due process
The procedure for the development of an IFRS is as
follows:
1) The IASB identifies a subject and appoints an advisory
committee to advise on the issues.
2) The IASB may issue a discussion paper to encourage
comment.
3) The IASB publishes an exposure draft for public
comment, being a draft version of the intended
standard.
4) Following the consideration of comments received on
the draft, the IASB publishes the final text of the IFRS.
The publication of an IFRS, exposure draft or IFRIC
interpretation requires the votes of at least eight of the 15
IASB members.
 1.
Under the current structure of regulatory
bodies, which of the bodies listed below acts as
the overall supervisory body?
o IFRS Interpretations Committee
o International Accounting Standards Board
o IFRS Advisory Council
o IFRS Foundation
 2.
Which of the bodies listed below is responsible
for issuing International Accounting Standards
and guidance on their application?
o IFRS Interpretations Committee
o International Accounting Standards Board
o IFRS Advisory Council
o IFRS Foundation
 3.
Which of the bodies listed below is responsible
for issuing International Financial Reporting
Standards?
o IFRS Interpretations Committee
o International Accounting Standards Board
o IFRS Advisory Council
o IFRS Foundation
 4.
Which of the bodies listed below is responsible
for the approval of Draft Interpretations?
o IFRS Interpretations Committee
o International Accounting Standards Board
o IFRS Advisory Council
o IFRS Foundation
 5.
Which of the following best describes the role
of the IFRS Advisory Council?
o To prepare interpretations of International
Accounting Standards
o To provide the IASB with the views of its’
members on standard setting projects
o To promote the use of International Accounting
Standards amongst its members
o To select the members of the IASB
The IASB's Conceptual Framework
This is a set of principles which underpin the
foundations of financial accounting. It is the basis on
which IFRSs are formulated.
Underlying assumption
The Conceptual Framework sets out one important
underlying assumption for financial statements, the
going concern concept.
Going concern- It is the assumption that the entity will
continue in operation for the foreseeable future. Hence,
it is assumed that the entity has neither the intention
nor the need to liquidate or curtail materially the scale
of its operations.
Going concern-
A retailer commences business on 1 January and
buys inventory of 20 washing machines, each
costing $100. During the year they sell 17
machines at $150 each.

How should the remaining machines be valued at

31 December in the following circumstances?
A. They are forced to close down their business at the
end of the year and the remaining machines will
realise only $60 each in a forced sale
B. They intend to continue their business into the next
year
The Conceptual Framework makes it clear that financial
statements should be prepared on an accruals basis.

Accruals basis
The effects of transactions and other events are
recognised when they occur (and not as cash or its
equivalent is received or paid) and they are recorded
in the accounting records and reported in the financial
statements of the periods to which they relate.
Accruals basis
Emma purchases 20 T-shirts in her first month of trading (May)
at a cost of $5 each. She then sells all of them for $10 each.
Emma has therefore made a profit of $100, by matching the
revenue ($200) earned against the cost ($100) of acquiring
them.

If, however, Emma only sells 18 T-shirts, it is incorrect to

charge her statement of profit or loss with the cost of 20 T-
shirts, as she still has two T-shirts in inventory. Therefore, only
the purchase cost of 18 T-shirts (18 × $5 = $90) should be
matched with her sales revenue (18 × $10 = $180), leaving her
with a profit of $90.
Discuss how will the T-shirts be accounted for in
the following TWO situations:

a) If Emma had decided to give up selling T-shirts.

b) If the two unsold T-shirts are unlikely to be sold at
more than their cost of $5 each (say, because of
damage or a fall in demand).
Qualitative characteristics
Introduction
Qualitative characteristics are the attributes that make
information provided in financial statements useful to others.
Relevance
Information is relevant if:
 it has the ability to influence the economic decisions
of users, and
 is provided in time to influence those decisions

Materiality has a direct impact on the relevance of

information.
Information is material if omitting it or misstating it
could influence decisions that users make on the basis
of financial information about a specific reporting entity.

Information that is relevant has predictive, or

confirmatory, value.
Faithful representation
If information is to represent faithfully the transactions
and other events that it purports to represent, they
must be accounted for and presented in accordance
with their substance and economic reality and not
merely their legal form.
To be a perfectly faithful representation, financial
information would possess the following
characteristics:
 Completeness- All the necessary descriptions and
explanations.
 Neutrality- Free from bias
 Free from error- With no material error or an
omission
Enhancing qualitative characteristics
Comparability- is the qualitative characteristic that
enables users to identify and understand similarities in,
and differences among, items. Information about a
reporting entity is more useful if it can be compared
with similar information about other entities and with
similar information about the same entity for another
period or date.
Verifiability- helps assure users that information
faithfully represents the economic
phenomena it purports to represent. It means that
different knowledgeable and independent observers
could reach consensus that a particular depiction is a
faithful representation.
Timeliness- means having information available to
decision-makers in time to be capable of influencing
their decisions. Generally, the older information is the
less useful it is.

Understandability- Classifying, characterising and

presenting information clearly and concisely makes it
understandable.
Other accounting concepts:
Fair presentation
Financial statements are required to give a fair
presentation or present fairly in all material respects
the financial results of the entity.
Compliance with IFRSs is key although departure from
the IFRS may be required to achieve a fair presentation.

IAS 1 states what is required for a fair presentation.

a) Selection and application of accounting policies
b) Presentation of information in a manner which
provides relevant, reliable, comparable and
understandable information
c) Additional disclosures where required
Consistency
To maintain consistency, the presentation and
classification of items in the financial statements
should stay the same from one period to the next,
except as follows.
a) There is a significant change in the nature of the
operations or a review of the financial statements
indicates a more appropriate presentation
b) A change in presentation is required by an IFRS
 1.
According to the Conceptual Framework for
Financial Reporting, which of the following is the
underlying assumption of a set of financial
statements?
o Going Concern
o Prudence
o Accruals
o Comparability
 2.
Which concept is applied when a business
records the cost of a non-current asset even
though it does not legally own it?
o Substance over form
o Prudence
o Accruals
o Going concern
 3.
Link the terms below to whether they relate to
the principle of relevance or faithful
representation
 4.
Which one of the following only contains qualitative
characteristics of useful information contained in the
Framework?
o prudence, consistency, understandability, faithful
representation, substance over form
o accruals basis, going concern concept, consistency,
prudence, true and fair view
o faithful representation, neutrality, substance over
form, completeness, consistency, faithful and free
from material error
o relevance, faithful representation, timeliness,
comparability, verifiability.
 5.
Under the Conceptual Framework for Financial
Reporting, which of the following is the
‘threshold quality’ of useful information?
o Relevance
o Reliability
o Materiality
o Understandability
DOUBLE ENTRY BOOKKEEPING
Source documents
Quotation. A document sent to a customer by a
company stating the fixed price that would be charged
to produce or deliver goods or services.
Purchase order. A document of the company that
details goods or services which the company wishes to
purchase from another company.
Sales order. A document of the company that details
an order placed by a customer for goods or services.
Goods received note. A document of the company
that lists the goods that a business has received from
a supplier.
Goods despatched note. A document of the company
that lists the goods that the company has sent out to a
customer.
Statement. A document sent out by a supplier to a
customer listing the transactions on the customer's
account, including all invoices and credit notes issued
and all payments received from the customer.
Credit note. A document sent by a supplier to a
customer in respect of goods returned or overpayments
made by the customer. It is a 'negative' invoice.
Debit note. A document sent by a customer to a
supplier in respect of goods returned or an
overpayment made. It is a formal request for the
supplier to issue a credit note.
Remittance advice. A document sent to a supplier with
a payment, detailing which invoices are being paid and
which credit notes offset. A remittance advice allows
the supplier to update the customer's records to show
which invoices have been paid and which are still
outstanding.
Receipt. A document confirming confirmation that a
payment has been received. This is usually in respect
of cash sales, eg a till receipt from a cash register.
An invoice relates to a sales order or a purchase
order.
 When a business sells goods or services on credit
to a customer, it sends out an invoice. The details
on the invoice should match the details on the sales
order. The invoice is a request for the customer to
pay what they owe.
 When a business buys goods or services on credit
it receives an invoice from the supplier. The details
on the invoice should match the details on the
purchase order.
Books of prime entry
The main books of prime entry are as follows.
(a) Sales day book
(b) Purchase day book
(c) Sales returns day book
(d) Purchase returns day book
(e) Journal (described in the next chapter)
(f) Cash book
(g) Petty cash book
The sales day book
The sales day book is the book of prime entry for
credit sales.
The purchase day book
A business also keeps a record in the purchase day book of
all the invoices it receives.
The purchase day book is the book of prime entry for credit
purchases.
The sales returns day book
When customers return goods for some reason, a
credit note is raised. All credit notes are recorded in the
sales returns day book. An extract from the sales
returns day book follows.

The sales returns day book is the book of prime entry

for credit notes raised.
The purchase returns day book
Not surprisingly, the purchase returns day book
records credit notes received in respect of goods which
the business sends back to its suppliers.

The purchase returns day book is the book of prime

entry for credit notes received from suppliers.
Mr Kipper-Ling runs a business providing equipment for
bakeries. He always makes a note of sales and
purchases on credit and associated returns, but he is
not sure how they should be recorded for the purposes
of his accounts.
Write up the following credit transactions arising in
the first two weeks of August 20X6 into the relevant
day books.
1 August Mrs Bakewell purchases cake tins at a
cost of $500.
1 August Mr Kipper-Ling purchases equipment at a
cost of $2,000 from wholesalers TinPot Ltd.
2 August Mr Kipper-Ling returns goods costing $150
to another supplier, I Cook.
3 August Jack Flap buys equipment which cost
$1,200.
3 August Mrs Bakewell returns $100 of the goods
supplied to her.
4 August Victoria Sand-Witch buys a new oven for
$4,000.
5 August Mr Kipper-Ling purchases baking trays for
$500 rom regular supplier TinTin Ltd.
8 August Mr Kipper-Ling purchases ovens costing
$10,000 from Hot Stuff Ltd.
8 August Mr Kipper-Ling returns equipment costing
$300 to TinPot Ltd.
9 August Pavel Ova purchases goods costing
$2,200.
11 August Mrs Bakewell buys some oven-proof
dishes costing $600.
The cash book
The cash book is the book of prime entry for cash receipts
and payments.

• All transactions involving cash

at bank are recorded in the
cash book.
• Many businesses have two
distinct cash books – a cash
payments book and a cash
receipts book.

• A note of cash discounts received is also recorded in the

cash book. This is to facilitate the recording of discounts
in both the general and accounts payable ledgers.
Example: cash book

At the beginning of 1 September, Robin Plenty had $900

in the bank. During 1 September 20X7, Robin Plenty had
the following receipts and payments.
 Cash sale: receipt of $80
 Payment from credit customer Hay $400 less discount
allowed $20
 Payment from credit customer Been $720
 Payment from credit customer Seed $150 less discount
allowed $10
 Cheque received from Len Dinger $1,800 to provide a
short-term loan
 Second cash sale: receipt of $150
 Cash received for sale of machine $200
 Payment to supplier Kew $120
 Payment to supplier Hare $310
 Payment of telephone bill $400
 Payment of gas bill $280
 $100 in cash withdrawn from bank for petty cash
 Payment of $1,500 to Hess for new plant and
machinery
If you look through these transactions, you will see that
seven of them are receipts and six of them are
payments.
The cash received in the day amounted to $3,470. Added to
the $900 b/d, this comes to $4,370. This is not the amount to
be carried forward to the next day, because first we have to
subtract all the payments made during 1 September.
The cash received in the day amounted to $3,470. Added to
the $900 b/d, this comes to $4,370. This is not the amount to
be carried forward to the next day, because first we have to
subtract all the payments made during 1 September.
Bank statements should be used to check that the amount
shown as a balance in the cash book agrees with the amount
on the bank statement
Petty cash book
A petty cash book is a cash book for small payments.

Controls over petty cash

• The petty cash must be kept in a petty cash box.
• The petty cash box must be secured in a safe.
• The person responsible for petty cash must be
reliable and competent.
• All petty cash must be supported by invoices.
• Petty cash vouchers must be signed by the claimant
and the person responsible for running the petty
cash.
• Regular spot checks must be carried out to ensure
that the petty cash is accurate.
Imprest system
Under the imprest system, the amount of money in petty
cash is kept at an agreed sum or 'float' (say, $250). This is
called the imprest amount. Expense items are recorded on
vouchers as they occur.
$
Cash still held in petty cash 195
Plus voucher payments (25+5+10+15) 55
Must equal the imprest amount 250

The total float is replenished regularly to the imprest amount

by means of a cash payment from the bank account . The
amount of the 'top-up' into petty cash will be the total of the
voucher payments since the previous top-up.
petty cash and the imprest system
DEF operates an imprest system for petty cash. During
February 20X9, the following petty cash transactions
took place.
$
2.2.X9 Stamps 12.00
3.2.X9 Milk 25.00
8.2.X9 Taxi fare 15.00
17.2.X9 Stamps 5.00
18.2.X9 Received from
staff for photocopying 8.00
28.2.X9 Stationery 7.50
The amount remaining in petty cash at the end of the
month was $93.50. What is the imprest amount?
A $166.00 B $150.00 C $72.50 D $56.50
The journal
The journal is a book of prime entry which records
transactions which are not routine (and not recorded in
any other book of prime entry), for example:
• year-end adjustments
 depreciation charge for the year
 irrecoverable debt write-off
 record the movement in the allowance for receivables
 accruals and prepayments
 closing inventory
acquisitions and disposals of non-current assets
• opening balances for statement of financial position
items
• correction of errors.
Presentation of a journal
To record the purchase of non-current asset on credit.
Dr Non-current asset X
Cr Payables X
A brief narrative should be given to explain the entry.
Example:
LEDGER ACCOUNT
 ledger accounts are where the double entry records of
all transactions and events are made.
 Ledger accounts summarise all the individual
transactions listed in the books of prime entry.
 A company's financial statements are generated from
summary totals in the ledgers.
The nominal ledger
The nominal ledger is an accounting record which
summarises the financial affairs of a business.
The nominal ledger contains details of all accounts
including assets, liabilities, capital, income and
expenditure, and so profit and loss.
The accounting equation

Business entity concept. Regardless of how a business

is legally set up, for accounting purposes, a business is
always treated separately from its owner(s).
Illustration

The transactions of a new business in its first five days

are as follows:
Use the accounting equation to illustrate the position of
the business at the end of each day. (Ignore inventory
for this example).
Day 1 Avon commenced business introducing $1,000
cash.
Day 2 Bought a motor car for $400 cash.
Day 3 Obtained a $1,000 loan.
Day 4 Purchased goods for $300 cash.
Day 5 Sold all of the goods purchased on day 4 for
$400 on credit.
Day 1: Avon commenced business introducing
$1,000 cash

Day 2: Bought a motor car for $400 cash

Day 3: Obtained a $1,000 loan

Day 4: Purchased goods for $300 cash

Day 5: Sold goods for $400 on credit
 Liza Doolittle starts a business. The business
begins by owning the cash that Liza has put into it,
$2,500.
 Liza Doolittle purchases a market stall from Len
Turnip, who is retiring from his fruit and vegetables
business. The cost of the stall is $1,800.
 She also purchases some flowers and potted plants
from a trader in the wholesale market, at a cost of
$650.
 On 3 July Liza has a very successful day. She sells
all of her flowers and plants for $900 cash.
 Liza decides to pay herself $180 in 'wages'.
The next market day is on 10 July and Liza purchases
more flowers and plants for cash, at a cost of $740. She
is not feeling well because of a heavy cold, and so she
decides to accept help for the day from her cousin Ethel.
Ethel is to be paid a wage of $40 at the end of the day.
Trading on 10 July was again very brisk, and Liza and
Ethel sold all their goods for $1,100 cash. Liza paid Ethel
her wage of $40 and drew out $200 for herself.
Required
a) State the accounting equation before trading began on
10 July.
b) State the accounting equation at the end of 10 July,
after paying Ethel:
(i) But before drawings are made
(ii) After drawings have been made
Payables and receivables
Trade accounts payable are liabilities. Trade
accounts receivable are assets.

A trade payable is a person or organisation to whom a

business owes money for debts incurred in the
course of trading operations. In the accounts of a
business, debts still outstanding which arise from the
purchase of materials, components or goods for resale
are called trade accounts payable, sometimes
abbreviated to 'accounts payable' or 'payables'. In
some businesses, you may see trade accounts
payable referred to as trade creditors.
The example of Liza Doolittle's market stall is
continued, by looking at the consequences credit
transactions
a) Liza Doolittle realises that she is going to need more
money in the business and so she makes the
following arrangements.
i. She immediately invests a further $250 of her
own capital.
ii. She persuades her Uncle Henry to lend her
$500 immediately. Uncle Henry tells her that she
can repay the loan whenever she likes but, in the
meantime, she must pay him interest of $5 each
week at the end of the market day. They agree that
it will probably be quite a long time before the loan
is eventually repaid.
(b) She decides to buy a secondhand van to pick up flowers and plants from
her supplier and bring
them to her stall in the market. She finds a car dealer, Laurie Loader, who
agrees to sell her a
van on credit for $700. Liza agrees to pay for the van after 30 days' trial use.
The trial balance
A trial balance is a list of ledger balances shown in
debit and credit columns.
At suitable intervals, the entries in each ledger account
are totalled 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 can be used to test the accuracy of the

double entry accounting records. It works by
listing the balances on ledger accounts, some of which
are debits and some credits. Total debits should
equal total credits.
1 -Trial balance:
Your business has the following balances on its ledger.
Accounts Balance $ Capital Balance
Accounts 13,000 $
Bank loan 12,000 Local taxes14,600
Sales 1,880
Cash at bank 11,700 Sundry payables 1,620
TA receivable 12,000
Bank loan interest 1,400
TA payable 11,200 Other expenses 11,020
Purchases 12,400 Vehicles 2,020
During 31.3.20X7, the business made the following
transactions.
a) Bought materials for $1,000, half for cash and half on credit
b) Made $1,040 sales, $800 of which was for credit
c) Paid wages to shop assistants of $260 in cash
d) Brought a personal machine of $ 2,800 to business
You are required to draw up a trial balance as at 31.3.20X7.
2. The following transactions took place in the first week
of Alfie’s trading. Use the to prepare Alfie’s Trial Balance:
1) Alfie transfers $10,000 of his savings into a business
bank account and a car $ 2,000 to start business.
2) He then buys goods from Isabel, a supplier, for
$1,000 and pays $800 by cheque the rest on credit.
3) A sale is made for $400 – the customer pays half by
cheque and the rest was to be paid in future .
4) Alfie makes a sale for $600 and the customer
promises to pay in the future.
5) Alfie then buys goods from his supplier, Kamen, for
$500 and a machine $ 1,500 on credit.
6) Alfie pays a telephone bill of $150 by cheque. This is
out of a bill of $ 200 received during the week.
7) The credit customer pays the balance on her account.
The following transactions took place in the second
week of Alfie’s trading.
Prepare the ledger accounts and update his trial
Balance.
1) Alfie pays Kamen $340.
2) Bank interest of $30 is received.
3) A cash customer returned $20 goods to Alfie for a
refund.
4) Alfie sent goods of $100 back to Kamen.
3. Collin has extracted the following balances from the
ledger accounts for his business:
  $ $
Plant and 95,000 Drawings 32,000
machinery Sales 362,000
Property 135,000 Purchases 156,000
Inventory 6,400 Purchase returns 2,200
Payables 3,600 Discounts allowed ?
Receivables 2,850 Discounts received 3,500
Bank overdraft 970 Sundry expenses 82,500
Loan 45,000
Capital 100,000
He has forgotten to extract the balance from the
discounts allowed account. What is the value of the
missing balance? A $4,020 B $7,520 C$5,580 D$3,120
Inventory IAS 2

Inventories are assets:

 Held for sale in the ordinary course of business
 In the process of production for such sale
 In the form of materials or supplies to be consumed in
the production process or in the rendering of services
Inventory is recorded in the ledger accounts at the end of
the accounting period.
Cost of goods sold
The cost of goods sold is calculated as:
Opening inventory + purchases – closing inventory.
Formula:
Opening inventory value X
Add cost of purchases (or, in the case of a
manufacturing company, the
cost of production) X Less closing
inventory value (X)
Cost of goods sold X
The cost of carriage inwards is usually added to the
cost of purchases.
The cost of carriage outwards is a selling and
distribution expense in the statement of profit or loss.
The carrying forward of unused inventory is the
application of the matching concept. This is an extension
of the accruals concept. Inventory costs are matched to
the revenues they help generate.
Illustration:
On 1 July 20X5, Clickety Clocks had clocks in
inventory valued at $17,000. During the year to 30
June 20X6 he purchased more clocks at a cost of
$75,000. Carriage inwards amounted to $2,000. Sales
for the year were $162,100. Other expenses of the
business amounted to $56,000 excluding carriage
outwards which cost $2,500. The value of the goods in
inventory at the year end was $15,400.
Required
Prepare the statement of profit or loss of Clickety
Clocks for the year ended 30 June 20X6.
Peter buys and sells washing machines. He has been
trading for many years. On 1 January 20X7, his
opening inventory is 30 washing machines which cost
$9,500. He purchased 65 machines in the year
amounting to $150,000 and on 31 December 20X7 he
has 25 washing machines left in inventory with a cost
of $7,500. Peter has sold 70 machines with a sales
value of $215,000 in the year.
Calculate the gross profit for the year ended 31
December 20X7.
Goods written off or written down
Reasons for drop or loss in inventory value
a) Goods might be lost or stolen.
b) Goods might be damaged, become worthless and
so be thrown away.
c) Goods might become obsolete or out of fashion.
These might be thrown away, or sold off at a very
low price in a clearance sale.
The value of the inventories should be written down to:
 Nothing, if they are worthless
 Their net realisable value, if this is less than their
original cost
Inventory count
At cost - Realisable value = Amount written down
Illustration:
At 1 April 20X5 Lucas had goods in inventory valued at
$8,800. During the year to 31 March 20X6, he
purchased goods costing $48,000. Fashion goods
which cost $2,100 were still held in inventory at 31
March 20X6, and Lucas believes that these could only
now be sold at a sale price of $400. The goods still
held in inventory at 31 March 20X6 (including the
fashion goods) had an original purchase cost of
$7,600. Sales for the year were $81,400.
Required
Calculate the gross profit for the year ended 31
March 20X6.
At 1 June 2017 June had goods in inventory valued at
$18,000. During the year to 31 May 2018, she
purchased goods costing $65,000. Batch X which cost
$8,400 were still held in inventory at 31 May 2018, and
June believes that these could only now be sold at a
sale price of $2,400. Batch Y which had costed $ 5,000
where spoiled beyond repair and there have since been
dumped. The goods still held in inventory at 31 May
2018 (including Batch X and Y ) had an original
purchase cost of $18,500. Sales for the year were
$135,600.
Required
Calculate the gross profit for the year ended 31 May
2018.
At 1 June 2017 Jay had shoe in inventory valued at
$180,000. During the year to 31 May 2018, she
purchased goods costing $650,000. Safari boots which
cost $80,400 were still held in inventory at 31 May
2018, and Jay believes that these could only now be
sold at a sale price of $70,400. Office shoes which had
costed $ 50,000 where spoiled beyond repair and some
have since been donated to poor people. The
remainder can be sold at only $10,000. The goods still
held in inventory at 31 May 2018 (including Safari boots
and Office shoes ) had an original purchase cost of
$180,000. Sales for the year were $1,300,600.
Required
Calculate the gross profit for the year ended 31 May
2018.
Accounting for opening and closing
inventories
Opening inventories b/f in the inventory account are
transferred to the profit or loss account, and so at the
end of the accounting year the balance on the inventory
account ceases to be the opening inventory value b/f
and becomes instead the closing inventory value c/f.
When a inventory count is made:
Dr- Inventory account (closing inventory value) $X
Cr- Profit or loss account $X
Closing inventory (opening inventory next period)
Dr- Profit or loss account $X
Cr- Inventory account (value of opening inventory) $X
Counting and Valuation inventories:
The quantity of inventories held at the year end is
established by means of a physical count of
inventory in an annual counting exercise, or by a
'continuous' inventory count.
Valuation of inventory
Inventory consists of:
• goods purchased for resale
• consumable stores (such as oil)
• raw materials and components (used in the
production process)
• partly-finished goods (usually called work in progress
– WIP)
• finished goods (which have been manufactured by the
business).
IAS 2
Cost of inventory
The cost of inventories will consist of all the following
costs.
1. Purchase
2. Costs of conversion
3. Other costs incurred in bringing the inventories to their
present location and condition (IAS 2, para 10).
The standard lists the following as comprising the costs of
purchase of inventories.
a) Purchase price
b) Import duties and other taxes
c) Transport, handling and any other cost directly
attributable to the acquisition of finished goods, services
and materials
d) Less any trade discounts, rebates and similar amounts
Costs of conversion
Costs of conversion of inventories consist of two parts.
a) Costs directly related to the units of production, eg
direct materials, direct labour
b) Fixed and variable production overheads that are
incurred in converting materials into finished goods,
allocated on a systematic basis
The following costs should not be included:
• 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)
• Administrative overheads not incurred to bring
inventories to their present location and conditions
• Selling costs
Net realisable value (also referred to as 'fair
value less further costs to sell')
Net realisable value is the net amount that would be
realised after incurring any further costs required to
make the sale.

principal situations in which NRV is likely to be less

than cost.
a) An increase in costs or a fall in selling price
b) A physical deterioration in the condition of
inventory
c) Obsolescence of products
d) A decision as part of the company's marketing
strategy to manufacture and sell products at a loss
e) Errors in production or purchasing
Suppose a company has four items of inventory on
hand at the end of its accounting period. Their cost
and NRVs are as follows.

Inventory item Cost NRV Lower of cost/NRV

$ $ $
1. 27 32 27
2. 14 8 8
3. 43 55 43
4. 29 40 29
113 135 107

The Lower of cost and NRV is therefore 107

1. According to IAS 2 Inventories, the items that may be
included in computing the value of an inventory of finished
goods manufactured by a business are clearly specified.
Which one of the following consists only of items
which may be included in the statement of financial
position value of such inventories according to IAS 2?
o Foreman’s wages, carriage inwards, carriage outwards,
raw materials.
o Raw materials, carriage inwards, costs of storage of
finished goods, plant and machinery costs.
o Plant and machinery costs, carriage inwards, raw
materials, foreman’s wages.
o Carriage outwards, raw materials, foreman’s wages,
plant and machinery costs.
2. The following figures relate to inventory held at the
year end.
A B C
$ $ $
Cost 20 9 12
Selling price 30 12 22
Modification cost to enable sale – 2 8
Marketing costs 7 2 2
Units held 200 150 300
Required
Calculate the value of inventory held.
3. Storm, had 500 units of product X at 30 June 20X5.
The product had been purchased at a cost of $18 per
unit and normally sells for $24 per unit. Recently,
product X started to deteriorate but can still be sold for
$24 per unit, provided that some rectification work is
undertaken at a cost of $3 per unit.
What was the value of closing inventory at 30 June
20X5?
4. Hurricane, had 1,500 units of product Y at 30 June
20X8. The product had been purchased at a cost of $30
per unit and normally sells for $40 per unit. Recently,
product Y started to deteriorate and can now be sold for
only $38 per unit, provided that some rectification work is
undertaken at a cost of $10 per unit.
What was the value of inventory at 30 June 20X8?
Determining the purchase cost:
IAS 2 Permits the use of FIFO or AVCO .
IAS 2 Inventories does not permit the use of LIFO.
Cost- all costs incurred in bringing items to their
location and condition.
FIFO (first in, first out). Using this technique, we
assume that components are used in the order
in which they are received from suppliers. The cost
of closing inventory is the cost of the most recent
purchases of inventory.
AVCO (average cost). As purchase prices change with
each new consignment, the average price of
components held is constantly changed. The average
cost can be calculated periodically or continuously.
TRANSACTIONS DURING MAY 20X7-
Quantity cost Total Mv
Units $ $ $
Opening balance 1 May 100 2.00 200
Receipts 3 May 400 2.10 840 2.11
Issues 4 May 200 2.11
Receipts 9 May 300 2.12 636 2.15
Issues 11 May 400 2.20
Receipts 18 May 100 2.40 240 2.35
Issues 20 May 100 2.35
Closing balance 31 May 200 2.38
1,916
How would issues and closing inventory be valued
using FIFO and AVCO?
FIFO
AVCO
Inventory valuations and profit

Each method of valuation produced different costs both

of closing inventories and also of material issues.
Since raw material costs affect the cost of production,
and the cost of production works through eventually
into the cost of sales, it follows that different methods of
inventory valuation will provide different profit figures.

Different inventory valuations will produced different

cost of sales figures, and therefore different profits.
Invicta has closing inventory of 5 units at a cost of $3.50 per
unit at 31 December 20X5. During the first week of January
20X6, Invicta entered into the following transactions:
Purchases
• 2nd January – 5 units at $4.00 per unit
• 4th January – 5 units at $5.00 per unit
• 6th January – 5 units at $5.50 per unit
Invicta sold 7 units for $10.00 per unit on 5th January.
Required:
a) Calculate the value of the closing inventory
at the end of the first week of trading using
FIFO and weighted average cost
b) Prepare the statement of profit or loss
using each method of inventory valuation.
FIFO
3 units × $4.00 = $12.00
5 units × $5.00 = $25.00
5 units × $5.50 = $27.50 Closing inventory cost $64.50
AVCO
A business commenced on 1 January and purchases
are made as follows:
Month No of Unit
units price Value
$ $
Jan 380 2.00 760
Feb 400 2.50 1,000
Mar 350 2.50 875
Apr 420 2.75 1,155
May 430 3.00 1,290
Jun 440 3.25 1,430
2,420 6,510
In June, 1,420 articles were sold for $7,000.
What is the cost of closing inventory and gross
profit for the period using the FIFO and AVCO:
A firm has the following transactions with its product R.
Year 1 Year 2
Opening inventory: nil Buys 10 units at $200 per unit
Buys 10 units at $300 per unit Sells 5 units at $400 per unit
Buys 12 units at $250 per unit Buys 12 units at $150 per unit
Sells 8 units at $400 per unit Sells 25 units at $400 per unit
Buys 6 units at $200 per unit
Sells 12 units at $400 per unit

Required
Using FIFO and AVCO, calculate the following:
(i) The closing inventory
(ii) The sales
(iii) The cost of sales
(iv) The gross profit
Non-current and current assets
Non-current assets are assets which are bought by
the business for continuing use. Tangible
noncurrent assets are those with physical form.
Capital and revenue expenditure
Which of the following should be classified as 'capital'
a) The purchase of a property (eg an office building)
b) The annual depreciation of such a property
c) Solicitors' fees for the purchase of property
d) The costs of adding extra storage capacity to a computer
used by the business
e) Computer repairs and maintenance costs
f) Profit on the sale of an office building
g) Revenue from sales by credit card
h) The cost of new plant
i) Customs duty on the plant when imported into the country
j) The 'carriage' costs of transporting the new plant from the
supplier's factory to the business purchasing the plant
k) The cost of installing the new plant in the premises
l) The wages of the machine operators
 IAS 16 Property, plant and equipment

Property, plant and equipment are tangible assets that:

• 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
Recognition
The recognition of property, plant and equipment
depends on two criteria.
a) It is probable that future economic benefits
associated with the asset will flow to the entity.
b) The cost of the asset to the entity can be measured
reliably.
Initial measurement
Once an item of property, plant and equipment qualifies
for recognition as an asset, it will initially be measured at
cost.
The entries to record an acquisition of a non-current
asset are:
DR: Non-current asset – cost $X
CR: Cash (or payable, if a credit transaction) $X
Components of cost (PPE)- IAS 16
 Purchase price, import duties paid, but excluding
any trade discount and sales tax paid
 Initial estimate of the costs of dismantling and
removing the item and restoring the site.
 Directly attributable costs of bringing the asset to
working condition for its intended use, eg:
 The cost of site preparation.
 Initial delivery and handling costs
 Installation and assembly costs
 Professional fees (lawyers, architects, engineers)
 Costs of testing, after deducting the net proceeds
from selling samples produced when testing.
 Staff costs arising directly from the construction or
acquisition of the asset
The following costs will not be part of PPE
 Expenses of operations that are incidental to the
construction or development of the item
 Administration and other general overhead costs
 Start-up and similar pre-production costs
 Initial operating losses before the asset reaches
planned performances
 Staff training costs
 Maintenance contracts purchased with the asset

All of these will be recognised as an expense rather

than as part of the cost of the asset.
Subsequent expenditure
Subsequent expenditure is added to the carrying
amount of the asset, but only when it is probable that
future economic benefits, in excess of the originally
assessed standard of performance of the existing
asset, will flow to the enterprise.(improvement)
The following are examples of such improvements.
a) Modification of an item of plant to extend its
useful life, including increased capacity
b) Upgrade of machine parts to improve the quality of
output
c) Adoption of a new production process leading to
large reductions in operating costs
Bilbo started a limousine taxi services on 1 January 20X5.
In the year to 31 December he incurred the following costs:
What amounts should be capitalised as ‘Land and
buildings’ and ‘Motor vehicles’? $
Office premises 250,000
Legal fees associated with purchase of office 10,000
Cost of materials and labour to paint office in
Bilbo’s favourite colour, purple 300
Mercedes E series estate cars 116,000
Number plates for cars 210
Delivery charge for cars 180
Road licence fee for cars 480
Drivers’ wages for first year of operation 60,000
Blank taxi receipts printed with Bilbo Baggins’
business name and number 450
Depreciation accounting
IAS 16 (PPE) defines depreciation as ‘the systematic
allocation of the depreciable amount of an asset
over its useful life'
The cost of a non-current asset, less its estimated
residual value, is allocated fairly between accounting
periods by means of depreciation.
Depreciation is:
 Charged against profit
 Deducted from the value of the non-current asset in
the statement of financial position

There are TWO methods of depreciation.

1. The straight line method
2. The reducing balance method
'the depreciation method applied to an asset should
reflect the pattern in which the assets future economic
benefits are expected to be consumed' (IAS 16)
Straight-line method
Depreciation charge = (Cost – Residual value)/Useful life

Alternatively it can simply be given as a simple

percentage of cost.
A non-current asset costing $20,000 with an estimated life of
10 years and no residual value would be depreciated at the
rate of:
$20,000 = $2,000 per annum
10 years
The total depreciable amount is charged in equal
instalments to each accounting period over the expected
useful life of the asset. In this way, the carrying amount of
the non-current asset declines at a steady rate, or in a
'straight line' over time.
A non-current asset costing $60,000 has an estimated life
of 5 years and a residual value of $7,000. The
depreciation charge using straight line method would be:
$(60,000 – 7,000) = $10,600 per annum
5 years
Reducing balance method
This method calculates the annual depreciation charge
as a fixed percentage of the carrying amount of the asset,
as at the end of the previous accounting period.

Depreciation charge = X % × carrying amount

CA: original cost of the non-current asset less
accumulated depreciation on the asset to date.
Illustration
A lorry bought for a business cost $17,000. It is expected
to last for 5 years and then be sold for scrap for $2,000.
Required
Work out the depreciation to be charged each year under
the straight line method and reducing balance method
(using a rate of 35%)
Under the straight line method, depreciation for each of
the 5 years is:
Annual depreciation = $(17,000 – 2,000) = $3,000
5
Under the reducing balance method, depreciation for
each of the 5 years is:
Year Depreciation
1. 35% × $17,000 = $5,950
2. 35% × ($17,000 – $5,950) = 35% × $11,050 = $3,868
3. 35% × ($11,050 – $3,868) = 35% × $7,182 = $2,514
4. 35% × ($7,182 – $2,514) = 35% × $4,668 = $1,634
5. Balance to bring book value down to
$2,000 = $4,668 – $1,634 – $2,000 = $1,034
a) Assets acquired part-way through an accounting
period
Illustration
A business which has an accounting year that runs from 1
January to 31 December purchases a new
non-current asset on 1 April 20X1, at a cost of $24,000.
The expected life of the asset is 4 years, and
its residual value is nil. What should the depreciation
charge for 20X1 be?
Solution
The annual depreciation charge will be $24,000
4 years
= $6,000 per annum
= 9 × $6,000 = $4,500
12
b) Change in method of depreciation
Jakob Co purchased an asset for $100,000 on 1.1.X1. It
had an estimated useful life of 5 years and it was
depreciated using the reducing balance method at a rate
of 40%. On 1.1.X3 it was decided to change the method
to straight line.
Show the depreciation charge for each year (to 31
December) of the asset's life.
c) Change in expected useful life or residual value
of an asset
A business purchased a non-current asset costing
$12,000 with an estimated life of four years and no
residual value. what would happen if the business
decided after two years that the useful life of the asset
has been underestimated, and it still had five more
years in use to come.
Solution
The asset would have been depreciated by $3,000 per
annum, so that its carrying amount after two years
would be $(12,000 - 6,000) = $6,000.
An annual depreciation charge for the final five years
will be: $6,000 = $1,200 per year
5 years
Alfie purchased a non-current asset for $100,000 on 1
January 20X2 and started depreciating it over five
years. Residual value was taken as $10,000.
At 1 January 20X3 a review of asset lives was
undertaken and the remaining useful life of the asset
was estimated at eight years. Residual value was
estimated to be nil.
Calculate the depreciation charge for the year
ended 31 December 20X3 and subsequent years.
Solution
Initial depreciation charge = ($100,000 – $10,000)/5
years = $18,000 pa.
At 1 Jan 20X3, Its carrying amount $100,000 – $18,000
= $82,000.
New estimation $82,000/8 years = $10,250 pa.
Alberto bought a wood-burning oven for his pizza
restaurant for $30,000 on 1 January 20X0. At that time
he believed that the oven’s useful life would be 20
years after which it would have no value.
On 1 January 20X3, Alberto revises his estimations: he
now believes that he will use the oven in the business
for another 12 years after which he will be able to sell it
second-hand for $1,500.
What is the depreciation charge for the year ended
31 December 20X3?
Solution
Initial depreciation charge = $30,000/20 years = $1,500
CA at date of change = $30,000 – ($1,500 × 3 years)
= $25,500. New depreciation charge = $25,500 –
$1,500/12 years = $2,000 pa
 1.
Karen has been running a successful nursery school
‘Little Monkeys’ since 20X1. She bought the following
assets as the nursery grew:
• a new oven for the nursery kitchen at a cost of
$2,000 (purchased 1 December 20X4).
• a minibus to take the children on trips for $18,000
(purchased 1 June 20X4).
She depreciates the oven at 10% straight line and the
minibus at 25% reducing balance. A full year’s
depreciation is charged in the year of purchase and
none in the year of disposal.
What is the total depreciation charge for the year
ended 31 October 20X6?
 2.
The following information relates to Bangers & Smash,
a car repair
business:
Machine 1 Machine 2
Cost $12,000 $8,000
Purchase date 1 August 20X5 1 October 20X6
Depreciation 20% straight line 10% reducing
Method pro rata balance pro rata

What is the total depreciation charge for the years

ended 31 December 20X6?
 1.
Oven 20X6 $
£2,000 × 10% 200
Minibus
20X4 : 25% × $18,000 = $4,500
20X5: 25% × $(18,000 – 4,500) = $3,375
20X6: 25% × $(18,000 – 7,875) = $2,531 2,531
Total depreciation charge 2,731
2.
Machine 1
20X5: 20% × $12,000 × 5/12 = 1,000
20X6: 20% × $12,000 = 2,400
Machine 2
20X6: 10% × $8,000 × 3/12 = 200
Total depreciation charge 20X6: $2,400 + $200
=2,600
Accounting for depreciation
Whichever method is used to calculate depreciation, the
accounting remains the same:
Dr Depreciation expense (P/L) X
Cr Accumulated depreciation (SFP) X

 The depreciation expense account is a profit or loss

account and therefore is not accumulated.
 The accumulated depreciation account is a statement
of financial position account and as the name
suggests is accumulated, i.e. reflects all depreciation
to date.
Illustration
Brian Box set up his own computer software business
on 1 March 20X6. He purchased a computer system on
credit from a manufacturer, at a cost of $16,000. The
system has an expected life of 3 years and a residual
value of $2,500. Depreciation rate 15% (Pro-rata)
a) Using the straight line method of depreciation,
show the non-current asset account,
accumulated depreciation account and
statement of profit or loss (extract) and
statement of financial position (extract) for each
of the next 2 years, 28 February 20X7, 20X8.
b) Proceed to 28 February 20X9 given that an
additional computer system was purchased in 1
May 20X8 for $20,000
A business purchased a machine on 1 July 20X1 at a
cost of $35,000. Another machine was bought in 1
Feb 20X3 for 40,000. The machines have an
estimated residual value of $3,000 and a life of 8
years.
The rate of depreciation for reducing balance is 18%
Show the accounts up to year end 30th June 20X4
(pro-rata basis) using both methods
Disposal of non-current asset
The ledger accounting entries are as follows.
(i) DEBIT Disposal of non-current asset account
CREDIT Non-current asset account
with the cost of the asset disposed of.
(ii) DEBIT Accumulated depreciation account
CREDIT Disposal of non-current asset account
with the accumulated depreciation on the asset
as at the date of sale.
(iii) DEBIT Receivable account or cash book
CREDIT Disposal of non-current asset account
Illustration
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.
Solution
Annual depreciation = $(25,000 - 7,000) 6 years
= $3,000 per annum
$
Cost of asset 25,000
Less accumulated depreciation (three years) 9,000
Carrying amount at date of disposal 16,000
Sale price 17,500
Profit on disposal 1,500
A business purchased a machine on 1 July 20X1 at a
cost of $35,000. The machine had an estimated residual
value of $3,000 and a life of 8 years. The machine was
sold for $18,600 on 31 December 20X4, the last day of
the accounting year of the business. To make the sale,
the business had to incur dismantling costs and costs of
transporting the machine to the buyer's premises. These
amounted to $1,200. The business uses the straight line
method of depreciation. What was the profit or loss on
disposal of the machine?
Revaluation of non-current assets
IAS 16 allows entities to choose between keeping an
asset recorded at cost or revaluing it to fair value.
IAS 16 says that 'If an asset’s carrying amount is
increased as a result of a revaluation, the increase shall
be recognised in other comprehensive income and
accumulated in equity under the heading of revaluation
surplus' (IAS 16, para 39).

Vanguard owns land which originally cost $250,000.

No depreciation has been charged on the land in
accordance with IAS 16. Vanguard wishes to revalue
the land to reflect its current market value, which it has
been advised is $350,000.
How is this reflected in the financial statements?
The land is currently held at cost of $250,000. This
needs to be increased by $100,000 to reflect the new
valuation of $350,000. Therefore the following is
required:

Statement of profit or loss and other comprehensive

income:
Other comprehensive income – item that will not be
reclassified in subsequent accounting periods:
Revaluation surplus in the year $100,000

Statement of financial position:

Dr Non-current asset – land $100,000
Cr Revaluation surplus (within equity) $100,000
Revaluation surplus = Revalued amount – Carrying amount
For a non-depreciated asset:
Dr Non-current asset revaluation
Cr Revaluation surplus revaluation With the surplus

Note that the revaluation surplus within equity is an

accumulated revaluation surplus. The amount
recognised within other comprehensive income is the
revaluation surplus accounted for in that year.

For a depreciated asset:

Dr Accumulated depreciation depreciation to date
Dr Non-current asset – cost ß
Cr Revaluation surplus revaluation gain
The revaluation gain for the year is disclosed on the
face of the statement of profit or loss and other
comprehensive income as an item of 'other
comprehensive income'. This amount is added to any
earlier revaluation from a previous accounting period to
arrive at a cumulative revaluation surplus in the
statement of changes in equity (SOCIE) and statement
of financial position.
Depreciation of a revalued asset
Dr Revaluation surplus X
Cr Retained earnings X
• When a non-current asset has been revalued, the
charge for depreciation should be based on the
revalued amount and the remaining useful life of the
asset.
Illustration
Building cost $300,000 Accumulated depreciation $100,000
The building asset account needs to be raised by $450,000
to $750,000.

Therefore the double entry required is:

Dr Non-current asset – building $450,000
Dr Accumulated depreciation $100,000
Cr Revaluation surplus $550,000
The gain of $550,000 reflects the difference between the
carrying amount pre-revaluation of $200,000 and the
revalued amount of $750,000.
Other comprehensive income:
Item that will not be reclassified in subsequent accounting
periods: Gain on property revaluation in year $550,000
 1.
Vanguard owns land which originally cost $250,000. No
depreciation has been charged on the land in accordance
with IAS 16. Vanguard wishes to revalue the land to
reflect its current market value, which it has been advised
is $350,000.
How is this reflected in the financial statements?
2.
Max owns a fish finger factory. The premises were
purchased on 1 January 20X1 for $450,000 and
depreciation charged at 2% pa on a straight- line basis.
Max now wishes to revalue the factory premises to
$800,000 on 1 January 20X7 to reflect the market value.
What is the balance on the revaluation surplus after
accounting for this transaction?
……………………….
Depreciation and disposal of a revalued asset
When a non-current asset has been revalued, the
charge for depreciation should be based on the
revalued amount and the remaining useful life of the
asset.
The excess of the new annual depreciation charge over
the old depreciation charge may be the subject of an
annual transfer from revaluation surplus to retained
earnings (within the equity section of the
statement of financial position) as follows:
Dr Revaluation surplus X
Cr Retained earnings X
Esoteric owns a retail unit in central Springfield. It
bought the property 25 years ago for $100,000,
depreciating it over 50 years on a straight-line
basis. At the start of 20X6 the company decides to
revalue the unit to $800,000. The unit has a remaining
useful life of 25 years at the date of the revaluation. It
is company policy to make the annual transfer of
excess depreciation between revaluation surplus and
retained earnings within equity.
What accounting entries should be made in the
financial statements for 20X6?
Statement of profit or loss and other comprehensive income:
Other comprehensive income: items that will not be
reclassified to profit or loss in future periods:
Revaluation surplus on property in the year $750,000
Statement of financial position:
On revaluation at start of 20X6
Dr Non-current asset – retail unit $700,000
Dr Accumulated depreciation $50,000
Cr Revaluation surplus $750,000
Depreciation for 20X6
Dr Depreciation expense ($800,000/25 yrs) $32,000
Cr Accumulated depreciation $32,000
Transfer of excess depreciation within equity for 20X6
Dr Revaluation surplus ($32,000 – $2,000) $30,000
Cr Retained earnings $30,000
Disposal of a revalued asset
IAS 16 says that 'the gain or loss arising from the
derecognition of an item of property, plant and
equipment shall be determined as the difference
between the net disposal proceeds, if any, and the
carrying amount of the item' (IAS 16, pars 71).
Additionally, IAS 16 says that 'the revaluation surplus
included in equity in respect of an item of property,
plant and equipment may be transferred directly to
retained earnings when the asset is derecognised'
(IAS16, para 41).
The double entry within equity is as follows:
Dr Revaluation surplus
Cr Retained earnings
Tiger Trees owns and runs a golf club. Some years
ago the company purchased land next to the existing
course with the intention of creating a smaller nine-
hole course. The cost of the land was $260,000. Over
time the company had the land revalued to $600,000.
It has now decided that building the new course is
uneconomical and has sold the land for $695,000.

What accounting entries are required to reflect the

disposal?
The cost of a property was $1,260,000. it is depreciated
at 12% reducing balance. After two years the company
had the property revalued to $1,600,000. It has now
decided that property is uneconomical and has sold the
property for $1,695,000.

What accounting entries are required to reflect the

disposal?
Intangible assets
Intangible assets are non-current assets with no
physical substance.
'Intangible assets' means assets that literally cannot be
touched, as opposed to tangible assets (such as plant
.
and machinery) which have a physical existence.
Intangible assets
include: goodwill,
intellectual rights (eg
patents, performing
rights and authorship
rights), and research
and development
costs.
 The key characteristics of an intangible non-current asset
are as follows:
• it is a resource controlled by the entity from which the
entity expects to derive future economic benefits,
• it lacks physical substance, and
• it is identifiable and separately distinguishable from
goodwill.
The basic principle of recognition of an intangible asset in
the financial statements is that 'the asset meets :
• the definition of an intangible asset, and
• the recognition criteria' (IAS 38, para 18).
As with any asset, it should be capable of reliable
measurement and it is probable that future economic
benefits will be received over the useful life of the asset.
Research Development
Research
is original and planned investigation undertaken with the
prospect of gaining new knowledge and understanding.
Examples of research costs
a) Activities aimed at obtaining new knowledge
b) The search for, evaluation and final selection of,
applications of research findings or other knowledge
c) The search for alternatives
d) The formulation, design evaluation and final
selection of possible alternatives

Research expenditure: write off as incurred to the

statement of profit or loss.
Development
is the application of research findings or other
knowledge to a plan or design for the production of new
or substantially improved materials, devices, products,
processes, systems or services before the start of
commercial production or use.
Examples of development costs include:
a) The design, construction and testing of pre-
production or pre-use prototypes and models
b) The design of tools, jigs, moulds and dies
c) The design, construction and operation of a pilot
plant
d) The design, construction and testing of a chosen
alternative for new or improved materials, devices,
products, processes, systems or services
Development expenditure: recognise as an intangible
asset if, and only if, an entity can demonstrate all of the
following:
1. Probable future economic benefits from the asset.
2. Intention to complete the asset and use or sell it
3. Resources available to complete the development
and to use or sell the intangible asset
4. Ability to use or sell the intangible asset
5. Technical feasibility of completing the intangible
asset so that it will be available for use or sale
6. Expenses attributable to the intangible asset during
its development can be measured.
Which of the following should be classified as
development costs?
1) Braynee Ltd has spent $300,000 investigating whether
a particular substance, flubber, is resistant to heat.
2) Cleverclogs Ltd has incurred $120,000 expenses in the
course of making a new waterproof and windproof
material with the idea that it may be used for ski-wear.
3) Ayplus Ltd has found that a chemical compound, known
as XYX, is not harmful to the human body.
4) Braynee Ltd has incurred $450,000 using flubber in
creating prototypes of a new heat-resistant suit.
A. All of them The correct answer is C.
B. 1 and 3 Both 1 and 3 involve researching
C. 2 and 4 materials, without any form of
D. 2 only commercial production in mind.
This year, Deep Blue Sea Ltd has developed a new
material from which the next generation of wetsuits will be
made. This special material will ensure that swimmers are
kept warmer than ever. The costs incurred meet the
capitalisation criteria and by the 31 December 20X5 year
end $250,000 has been capitalised.
The wetsuits are expected to generate revenue for five
years from the date that commercial production
commences on 1 January 20X6.
What amount is charged to the statement of profit or loss
in the year ended 31 December 20X6?
A nil The correct answer is D.
B $250,000 Therefore the amortisation charge for each
C $100,000 of the years ended 31 December 20X6 –
D $50,000 20Y0 will be: $250,000/5 years = $50,000
Accounting treatment
In accordance with IAS 38, intangible assets are
capitalised in the accounts and amortised (another word
for depreciation but referring specifically to intangible
assets). Amortisation is intended to write off the asset
over its useful life (under the accruals concept).
A business buys a patent for $50,000. It expects to use
the patent for the next ten years, after which it will be
valueless.
Amortisation =Cost – residual value
Estimated useful life
In this case, amortisation will be $5,000 per annum
(50,000/10).The double entry:
Dr. Amortisation account (SPL) $5,000
Cr. Accumulated amortisation account (SOFP) $5,000
Willis Ltd purchased a patent, with a useful life of ten
years for $20,000 on 1 January 20X9.
Prepare extracts of the financial statements for the
year ended 31 December 20X9?
Statement of profit or loss
Amortisation $2,000
($20,0000/10 years)

Statement of financial position extract

Intangible assets $18,000
($20,000 – $2,000)
Accruals and prepayments
Accrued expenses (accruals) are expenses which
relate to an accounting period but have not been paid
for.
 They are shown in the statement of financial
position as a liability.
Prepaid expenses (prepayments) are expenses
which have already been paid but relate to a future
accounting period.
 They are shown in the statement of financial position
as an asset.
Accruals basis of accounting- Profit for the period,
must include all the income and expenditure relating to
the period, whether or not the cash has been received or
paid or an invoice received.
Accruals vs trade accounts payables
Accruals: generally represent liabilities to pay for
goods or services received in a period, that have not
yet been invoiced for by the suppliers.
Trade accounts payables: are liabilities to pay for
goods or services received in a period that have been
invoiced for by the suppliers.
An accrual can be an estimated amount, since the
actual cost may not be known until the invoice is
received.
When the invoice is received, the expense and liability
for the invoiced amount is then recorded.
the accrual therefore must be reversed to avoid
recording twice
Illustration
A plumber quoted approximately $500.00 in December
20X4. The invoice is received from the plumber in January
20X5 for $525.00. The double entry for the accrual will be:
December 20X4
Dr. Repairs and maintenance costs $500.00
Cr. Accruals (liability) $500.00
The double entry for the invoice (ignoring sales tax) will be:
January 20X5
Dr. Repairs and maintenance costs $525.00
Cr. Accounts payable (liability) $525.00
The double entry for the accrual reversal will be:
January 20X5
Dr. Accruals (liability) $500.00
Cr. Repairs and maintenance costs $500.00
Double entry for accruals and prepayments
 Illustration
Rent paid on 1 October 20X2 for the year to 30
September 20X3 was $12,000, and rent paid on 1
October 20X3 for the year to 30 September 20X4 was
$16,000.
What figure for rent expense should be shown in the
statement of profit or loss for the year ended
31 December 20X3?

1 Oct X2 30 Sep X3 30 Sep X4

1 Jan X3 31 Dec X3

[(12,000/12)* 9] + [(16,000/12)*3] = $13,000

Illustration
John Simnel’s business has an accounting year end of
31 December 20X1. He rents factory space at a rental
cost of $5,000 per quarter, payable in arrears.
During the year to 31 December 20X1 his cash
payments of rent have been as follows:
• 31 March (for the quarter to 31 March 20X1) $5,000
• 29 June (for the quarter to 30 June 20X1) $5,000
• 2 October (for the quarter to 30 September 20X1)
$5,000
The final payment due on 31 December 20X1 for the
quarter to that date was not paid until 4 January 20X2.
Show the ledger accounts required to record the
above transactions.
Tubby Wadlow pays the rental expense on his market stall
in advance. He starts business on 1 January 20X5 and on
that date pays $1,200 in respect of the first quarter’s rent.
During his first year of trade he also pays the following
amounts:
• 3 March (in respect of the quarter ended 30 June) $1,200
• 14 June (in respect of the quarter ended 30 September)
$1,200
• 25 September (in respect of the quarter $1,400 ended 31
December)
• 13 December (in respect of the first quarter of 20X6)
$1,400
Show these transactions in the rental expense account.
On 1 January 20X5, Willy Mossop owed $2,000 in respect
of the previous year’s electricity. Willy made the following
payments during the year ended 31 December 20X5:
• 6 February $2,800
• 8 May $3,000
• 5 August $2,750
• 10 November $3,100
At 31 December 20X5, Willy calculated that he owed
$1,800 in respect of electricity for the last part of the year.
What is the electricity charge to the statement of profit
or loss?
o $1,800
o $11,450
o $11,650
o $13,450
Accrued income
Accrued income arises where income has been earned in the
accounting period but has not yet been received.
A business earns bank interest income of $300 per
month. $3,000 bank interest income has been received in
the year to 31 December 20X5.

Prepaid income
Prepaid income arises where income has been received in
the accounting period but which relates to the next
accounting period.
A business rents out a property at an income of $4,000 per
month. $64,000 has been received in the year ended 31
December 20X5.
Effect on profit and net assets
Provisions and contingencies
Provisions
A provision is a liability of uncertain timing or amount.
A liability is an obligation of an entity to transfer economic
benefits as a result of past transactions or events.
A provision should be recognised:
 When an entity has incurred a present obligation
 When it is probable that a transfer of economic
benefits will be required to settle it
 When a reliable estimate can be made of the amount
involved
IAS 37 states that a provision should be recognised
(which simply means 'included') as a liability in the
financial statements when all three of the following
conditions are met.
1) An entity has a present obligation (legal or
constructive) as a result of a past event.
2) It is probable (ie more than 50% likely) that a
transfer of economic benefits will be required to
settle the obligation.
3) A reliable estimate can be made of the obligation.
Provisions: ledger accounting entries
When a business first sets up a provision;
Dr. Expenses (statement of profit or loss)
Cr. Provisions (statement of financial position)
In subsequent years;
Calculate increase or decrease required.
a) If a higher provision is required now:
Dr. Expenses (statement of profit or loss)
Cr. Provisions (statement of financial position)
with the amount of the increase.
b) If a lower provision is needed now than before:
Dr. Provisions (statement of financial position)
Cr. Expenses (statement of profit or loss)
with the amount of the decrease.
Illustration
A business has been told by its lawyers that it is likely
to have to pay $10,000 damages for a product
that failed. The business duly set up a provision at 31
December 20X7. However, the following year, the
lawyers found that damages were more likely to be
$50,000.
Required
How is the provision treated in the accounts at:
(a) 31 December 20X7?
(b) 31 December 20X8?
Measurement of provisions
The amount recognised as a provision should be the best
estimate of the expenditure required to settle the present
obligation at the end of the reporting period as per the
judgement of the entity's management supplemented by
the experience of similar transactions.
warranty provision
Parker Co sells goods with a warranty under which
customers are covered for the cost of repairs of any
manufacturing defect that becomes apparent within the
first six months of purchase. The company's past
experience and future expectations indicate the following
pattern of likely repairs.
% of goods sold Defects Cost of repairs
$m
75 None –
20 Minor 1.0
5 Major 4.0
What should the warranty provision in Parker Co's
financial statements be?
Solution
Parker Co should provide on the basis of the expected
cost of the repairs under warranty.
The expected cost is calculated as (75% × $nil) +
(20% × $1.0m) + (5% × $4.0m) = $400,000.
Parker Co should include a provision of $400,000 in the
financial statements.
Contingent liabilities and contingent assets
IAS 37 defines a contingent liability as:
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 wholly within the entity's control; or

A present obligation that arises from past events but is

not recognised because:
 It is not probable that a transfer of economic benefits
will be required to settle the obligation; or
 The amount of the obligation cannot be measured
with sufficient reliability.
A contingent liability must not be recognised as a
liability in the financial statements. Instead it should
be disclosed in the notes to the accounts, unless the
possibility of an outflow of economic benefits is remote.
Contingent assets
IAS 37 defines a contingent asset as:
A possible asset that arises from past events and whose
existence will be confirmed by the occurrence of one or
more uncertain future events not wholly within the
enterprise's control.
A contingent asset must not be recognised as an
asset in the financial statements. Instead it should be
disclosed in the notes to the accounts if it is probable
that the economic benefits associated with the
asset will flow to the entity.
During 20X9 Smack Co gives a guarantee of certain
borrowings of Pony Co, whose financial condition at
that time is sound. During 20Y0, the financial condition of
Pony Co deteriorates and at 30 June 20Y0
Pony Co files for protection from its creditors.
What accounting treatment is required:
(a) At 31 December 20X9?
(b) At 31 December 20Y0?
After a wedding in 20X0 ten people became seriously ill,
possibly as a result of food poisoning from products sold
by Callow Co. Legal proceedings are started seeking
damages from Callow but it disputes
liability. Up to the date of approval of the financial
statements for the year to 31 December 20X0, Callow's
lawyers advise that it is probable that it will not be found
liable. However, when Callow prepares the financial
statements for the year to 31 December 20X1 its
lawyers advise that, owing to developments in the case,
it is probable that it will be found liable.
What is the required accounting treatment:
(a) At 31 December 20X0?
(b) At 31 December 20X1?
Anchor Co is being sued for compensation by one of
its employees as a result of suffering an injury whilst at
work. Legal advisers believe that there is a 30%
chance that Anchor Co will lose the claim and will have
to pay damages of $250,000.
Which of the following is the correct accounting
treatment to report this situation?
o The issue is ignored in the financial statements
o The issue and estimated damages are disclosed in
the financial statements
o A provision is required for $250,000
o A provision is required for $75,000
An oil company causes environmental contamination in
the course of its operations, but cleans up only when
required to do so under the laws of the country in which
it is operating. One country in which it has been
operating for several years has up to now had no
legislation requiring cleaning up. However, there is now
an environmental lobby in this country. At the date of the
company's year end, it is virtually certain that a draft law
requiring clean-up of contaminated land will be enacted
very shortly. The oil company will then be obliged to
deal with the contamination it has caused over the past
several years.
What accounting treatment is required at the year
end?
Irrecoverable debts and allowances
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 debt could occur when,
for example, a customer has gone bankrupt.
Recap: Cash and credit sales
If a sale is for cash: Dr. Cash
Cr. Sales revenue
If a sale on credit : Dr. Trade receivables
Cr. Sales
If the buyer pays : Dr. Cash account
Cr. Trade receivables
With irrecoverable debts, it is prudent to remove them
from the accounts and to charge the amount as an
expense to the statement of profit or loss.
The original sale remains in the accounts.
The double entry required to achieve this is:
Dr. Irrecoverable debts expense
Cr. Receivables
Araf & Co have total accounts receivable at the end of
their accounting period of $45,000. Of these it is
discovered that one, Mr Xiun who owes $790, has been
declared bankrupt, and another who gave his name as
Mr Jones has totally disappeared owing Araf & Co
$1,240.
Calculate the effect in the financial statements of
writing off these debts as irrecoverable.
Design Co has a total balance for trade receivables of
$25,000 at the year end. A review of the receivables
balances highlights that one of its customers, Mann Co,
has gone bankrupt. Design Co is owed $4,000 by Mann
Co for design work done during the year. This debt is
now considered irrecoverable.
Required
a) What is the balance for trade receivables to be
shown in the statement of financial position at the
year end?
b) What is the irrecoverable debts expense to be
shown in the statement of profit or loss at the
year end?
Irrecoverable debts written off and subsequently paid
An irrecoverable debt which has been written off might
occasionally be unexpectedly paid.
Because the debt has already been written off, it no
longer exists in the statement of financial position and so
the cash received cannot be offset against it in the usual
way. Instead, the cash received is offset against the
irrecoverable debts expense.
Dr. Cash account
Cr. Irrecoverable debts expense

When an irrecoverable debt is recovered, the credit

entry cannot be taken to receivables as the debt has
already been taken out of the receivables balance.
Celia Jones had receivables of $3,655 at 31 December
20X7. At that date she wrote off a debt from Lenny Smith of
$699. During the year to 31 December 20X8 Celia made
credit sales of $17,832 and received cash from her
customers totalling $16,936. She also received the $699
from Lenny Smith that had already been written off in 20X7.
What is the final balance on the receivables account at
31 December 20X7 and 20X8?
20X7 20X8
$ $
A. 2,956 3,852
B. 2,956 3,153
C. 3,655 4,551
D. 3,655 3,852
Allowances for receivables
In addition to irrecoverable debts, a business may make
an allowance for receivables as a prudent precaution
to account for the fact that some receivables balances
might not be collectable.
An increase in the allowance for receivables is shown
as an expense in the statement of profit or loss.
Trade receivables in the statement of financial position
are shown net of any receivables allowance.
Accounting for the allowance for receivables
When a business first sets up an allowance for
receivables, the full amount of the allowance should
be debited to irrecoverable debts expense as follows.
Dr. Irrecoverable debts expense (SP/L)
Cr. Allowance for receivables (SOFP)
In subsequent years, adjustments may be needed to
the amount of the allowance.
Calculate increase or decrease required
 If a higher allowance is required now:
Dr. Irrecoverable debts expense (SOP/L)
Cr. Allowance for receivables (SOFP)
with the amount of the increase
 If a lower allowance is needed now than before:
Dr. Allowance for receivables (SOFP)
Cr. Irrecoverable debts expense (SOP/L)
with the amount of the decrease
Irrecoverable debts are deducted from receivables
when calculating the closing amount of the
allowance for receivables, if not yet deducted
John has opening balances at 1 January 20X6 on his trade
receivables account and allowance for receivables account
of $68,000 and $3,400 respectively. During the year to 31
December 20X6 John made credit sales of $354,000 and
collected cash from his receivables of $340,000.
At 31 December 20X6 John acknowledged that he is
unlikely ever to receive debts totalling $2,000. In addition,
at that date he estimated that amounts totalling $4,000
were overdue and that an allowance for receivables was
required to cover these amounts.
What is the amount charged to John’s SP/L for
irrecoverable debt expense in the year ended 31
December 20X6?
What will the effect be of Irrecoverable debts on both
the SP/L and SOFP?
Horace makes an allowance for receivables equivalent to
2% of outstanding trade receivables at the reporting date
from 28 February 20X6. On 28 February 20X8, Horace
determines that the allowance has been overestimated
and he recalculates it to be the equivalent of 1% of
outstanding trade receivables. Outstanding receivables
balances at the various reporting dates are as follows.
28.2.20X6-15,200, 28.2.20X7-17,100, 28.2.20X8- 21,400
Required
Show extracts from the following ledger accounts for
each of the three years above.
(a) Trade receivables
(b) Allowance for receivables
(c) Extracts of SP/L and SOFP.
 Sales tax
Sales tax is an indirect tax levied on the sale of goods
and services. It is usually administered by the local tax
authorities.
Sales tax is charged and paid on purchases (input
tax) by suppliers and charged and collected on sales
(output tax).
Sales tax is a cumulative tax, collected at various
stages during the life of goods or services.
 Wholesaler purchases television 200 30 230
 Wholesaler sells television to a retailer 320 48 18 368
 Retailer purchases television 320 48 368
 Retailer sells television 480 72 24
552
Customer purchases television 480 72 552
Amounts inclusive and exclusive of tax
In business, you are likely to come across sales and
purchases figures quoted as gross or net of sales tax.
The gross amount of a sale or purchase is the amount
inclusive of sales tax. The net amount of a sale or
purchase is the amount exclusive of sales tax.
E.g. if: net amt exclusive of sales tax: = $100
Sales tax: = $100 × 15% = $15
Gross amt inclusive of sales tax: = $100 + $15 = $115
Illustration
Orlando sells the following goods:
(1) to Bruno at a tax inclusive price of $470.
(2) to Cosmo at a tax exclusive price of $700.
How much sales tax is Orlando collecting on behalf of
the tax authority if the rate of sales tax is 17.5%?
Solution:
Sales tax can be calculated using the relevant
percentage depending on whether the price is tax
inclusive or exclusive.

Sales to Bruno (sales price tax inclusive)

(17.5%/117.5%) × $470 = $70
Sales to Cosmo (sales price tax exclusive)
(17.5%/100%) × $700 = $122.50
Total sales tax collected: $70 + $122.50 = $192.50

The difference between the gross and net selling price is

tax collected on behalf of the tax authority which should
be paid to it.
Lorenzo purchases goods for $174,240 (including
sales tax) and sells goods for $230,400 (including
sales tax). The sales tax rate is 20%.
What amount of sales tax is ultimately payable to
the tax authority based upon this information?
A $9,360
B $14,926
C $4,471
D $11,232

Solution:
Sales tax (230,400 × 20/120) 38,400
Sales tax (174,240 × 20/120) 29,040
Payable to tax authorities:
Output tax – Input tax (38,400 – 29,040) 9,360
At 1 March 20X5 Lauren owed the tax authorities $27,338.
During the month of March, she recorded the following
transactions:
 Sales of $750,000 inclusive of 20% sales tax.
 Purchases of $450,000 exclusive of sales tax.
What is the balance on Lauren’s sales tax account at
the end of March?
…………………….
Balance b/d 27,338
Output tax (750,000 × 20/120) 125,000
Input tax(450,000 × 20%) 90,000
62,338
 
Irrecoverable sales tax
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.
For example, if a business pays $500 for entertaining
expenses and suffers irrecoverable input sales tax of $75
on this amount, the total of $575 paid should be charged
to the statement of profit or loss as an expense. Similarly,
if a business pays $5,000 for a motor vehicle and suffers
irrecoverable input sales tax of $400, the business
should capitalise the full amount of $5,400 as a non-
current asset in the statement of financial position.
Accounting for sales tax
Illustration
if a business is invoiced for input sales tax of $8,000
and charges sales tax of $15,000 on its credit sales and
sales tax of $2,000 on its cash sales, the sales tax
control account would be as follows.
A business in its first period of trading charges $4,000 of sales tax on its sales
and suffers $3,500 of sales tax on its purchases which includes $250
irrecoverable sales tax on business entertaining. Prepare the sales tax control
account.
If sales (including sales tax) amounted to $26,612.50,
and purchases (excluding sales tax) amounted to
$15,000, what would be the balance on the sales tax
account, assuming all items are subject to tax at 20%?
A $1,435.42
B $2,822.50
C $2,322.50
D $3,887.08
Output tax 4,435.42
(26,612.50 × 20/120)
Input tax 3,000.00
(15,000 × 20%)
Balance c/d 1,435.42
What are 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) 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.
Control accounts and 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.

Illustration
A business has three trade accounts receivable: A Arnold
owes $80, B Bagshaw owes $310 and C Cloning owes
$200. There personal accounts will be debited with these
amounts. This is not part of the double entry system.
The total of $590 is posted from the sales day book into
the receivables control account (Dr) and credited to sales.
Discounts
Discounts can be defined as follows.
 A trade discount is a reduction in the list price of an
article, given by a wholesaler or manufacturer to a
retailer. It is often given in return for bulk purchase
orders.
 A cash (or settlement) discount is a reduction in the
amount payable in return for payment in cash, or within
an agreed period.
Trade discounts received are deducted from the cost of
purchases. Cash discounts received are included
as 'other income' of the period.
Trade discounts allowed are deducted from sales and
cash discounts allowed are shown as expenses of the
period.
Illustration
Soft Supplies Co recently purchased from Hard
Imports Co 10 printers originally priced at $200 each. A
10% trade discount was negotiated together with a 5%
cash discount if payment was made within 14 days.
Calculate the following.
A The total of the trade discount
B The total of the cash discount
Solution:
A $200 ($200 × 10 × 10%)
B $90 ($200 × 10 × 90% × 5%)
cash (settlement) discounts are separately recorded
in the books;
Sales and purchases are recorded net of trade
discounts.
Illustration:
You are required to prepare the statement of profit or
loss of Seesaw Timber Merchants for the year
ended 31 March 20X6, given the following information.
$
Purchases at gross cost 120,000
Trade discounts received 4,000
Settlement discounts received 1,500
Cash sales 34,000
Credit sales at invoice price 150,000
Cash discounts allowed 8,000
Selling expenses 32,000
Administrative expenses 40,000
Drawings by proprietor, Tim Burr 22,000
SEESAW TIMBER MERCHANTS
Sp/l THE YEAR ENDED 31 MARCH 20X6
$ $
Revenue (Note 1) 184,000
Purchases (Note 2) 116,000
Gross profit 68,000
Discounts received 1,500
Selling expenses (32,000)
Administrative expenses (40,000)
Discounts allowed (8,000)
Loss for the year (transferred to SOFP) (10,500)
Notes
1 $(34,000 + 150,000)
2 $(120,000 – 4,000)
3 Drawings are not an expense,(appropriation of profit)
Entries in control accounts:
 RECEIVABLES CONTROL ACCOUNT
Opening dr bal b/d X Opening cr bal b/d (if any) X
Sales SDB X
Dishonoured bills X Cash received CB X
cheques Discounts allowed CB X
Cash paid to clear Returns inwards from
credit balances X customers X
Interest changed on Irrecoverable debts Jnl X
paid accounts Jnl X Contra X
Closing cr bal c/d X Closing dr bal c/d X
XX XX
Dr bal b/d X Cr bal b/d X
 PAYABLES CONTROL ACCOUNT
Opening dr bal b/d X Opening cr bal b/d X
Cash paid X
Discount received X Credit purchases X
Returns outwards Interest paid on overdue
to suppliers X accounts X
cash received to clear dr
bal X
Contra X
Closing cr bal c/d X Closing dr bal c/d X
XX XX
Dr bal b/d X Cr bal b/d X
on 1 October 20X8 the receivables ledger bal were $8,024 dr
and $57 cr, and the payables ledger bal on the same date
$6,235 cr and $105 dr. During the year, the following took place
$
Sales 63,728
Purchases 39,974
Cash from trade accounts receivable 55,212
Cash to trade accounts payable 37,307
Discount received 1,475
Discount allowed 2,328
Returns inwards 1,002
Returns outwards 535
Irrecoverable debts written off 326
Cash received to clear dr bal in payables ledger 105
settlement by contra 434
Allowances to customers on goods damaged 212
Jones Co prepares monthly receivables' and payables'
ledger control accounts. At 1 November 2018 the
following balances existed in the entity’s records.
Dr $ Cr $
Receivables' ledger control account 54,000 1,000
Payables' ledger control account 200 43,000
The following information was extracted in
November 2018 from the entity's records:
Credit sales 251,000
Cash sales 34,000
Credit purchases 77,000
Cash purchases 29,000
Credit sales returns 11,000
Credit purchases returns 3,000
Amounts received from credit customers 242,000
Dishonoured cheques 500
Amounts paid to credit suppliers 74,000
Cash discounts received 2,000
Irrecoverable debts written off 4,000
Increase in allowances for receivables 1,200
Interest charged to customers 1,400
Contra settlements 800
At 30 November 2018 the balances in the Receivables
and Payables ledgers, as extracted, totalled:
Dr $ Cr $
Receivables ledger balances ? 2,000
Payables ledger balances 200 ?
Prepare the receivables' and the payables‘ ledger
control accounts for Jones Co of the month of Nov
2018 to determine the closing dr and cr balances.
Reconciliation of control accounts with
receivables and payables ledgers
• An incorrect amount may be posted to the control
account because of a miscast of the total in the book
of original entry (ie adding up incorrectly the total value
of invoices or payments).
• A transposition error may occur in posting an
individual's balance from the book of prime entry to the
memorandum ledger, eg a sale to C Cloning of $250
might be posted to the account as $520.
• A transaction may be recorded in the control
account and not in the memorandum ledger, or vice
versa.
• The sum of balances extracted from the memorandum
ledger may be incorrectly extracted or miscast.
Reconciliation of individual receivables balances
with control account balance
$
Balance as extracted from list of receivables X
Adjustments for errors X/(X)
Revised total agreeing with balance c/f
on control account X
 You must decide for each error whether correction
is required in the control account, the list of
individual balances or both.
 When all errors have been corrected, the revised
balance on the control account should agree to the
revised total of the list of individual balances.
Illustration
ABC has a payables control account balance of $12,500 at
31 December 20X6. However, the extract of balances from
the payables ledger totals $12,800. Investigation finds the
following errors: purchases for week 52 of $1,200 had
been omitted from the control account; a supplier account
of $900 had been omitted from the list of balances.
What is the correct payables balance at 31 Dec 20X6?
Tonga received a statement from a supplier, Cook,
showing a balance of $14,810. Tonga’s Payables ledger
shows a balance due to Cook of $10,000. Investigation
reveals the following:
1) Cash paid to Cook of $4,080 has not been recorded by
Cook.
2) Tonga’s recorded the fact that a $40 cash discount was
not allowed by Cook, but forgot to record this in the
payables ledger.
What discrepancy remains between Tonga and Cook’s
records after allowing for these items?
A. $9,930
B. $9,850
C. $770
D. $690
D.
Cook $ Tonga $
Difference
Balance per question 14,810 10,000
Adjustment (4,080) 40
Revised balance 10,730 10,040 690
THE BANK RECONCILIATION
The objective of a bank reconciliation is to reconcile the
difference between:
 the cash book balance, i.e. the business’ record of
their bank account, and
 the bank statement balance, i.e. the bank’s record of
the bank account.
There are three common explanations of the
difference.
a) Error. Errors in calculation, or recording income
and payments, are more likely to have been made
by you than by the bank, but it is conceivable that
the bank has made a mistake too.
b) Unrecorded items. The bank might deduct
charges for interest on an overdraft or for its
services, which you are not informed about until you
receive the bank statement. Others include
dishonored cheques, direct debits and direct credits
c) Timing differences.
i. Outstanding/unpresented cheques, and
ii. Outstanding/uncleared lodgements
 CASH BOOK
20X0 20X0
Bank interest X Bank charge X Dividends paid
direct to bank X Standing order X
Dishonored
Cheques X
Illustration
At 30 September 20X6, the balance in the cash book of
Words Co was $805.15 debit. A bank statement on 30
September 20X6 showed Words 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
Show the correction to the cash book and prepare a
statement reconciling the balance per bank statement
to the balance per cash book.
The following is the cause of a difference between a cash
book and a bank statement
1) Direct debit $530.
2) Lodgements not credited $1,200.
3) Cheque paid in by the company and dishonoured $234.
4) Outstanding cheques $677.
5) Bank charges $100.
6) Error by bank $2,399 (cheque incorrectly credited to
the account).
Which of these items will require an entry in the cash
book?
A 3, 4 and 6
B 1, 3 and 5
C 1, 2 and 4
D 2, 5 and 6
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.
$
Bank charges 36
Transfer from deposit account to current account 500
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?
A company's bank statement shows $715 direct debits
and $353 investment income not recorded in the
cash book. The bank statement does not show a
customer's cheque for $875 entered in the cash book
on the last day of the accounting period.
If the cash book shows a credit balance of $610,
what balance appears on the bank statement?
A. $1,847 debit
B. $1,847 credit
C. $972 credit
D. $972 debit