Only study guide for
FAC1601
201
9

© 201
8
University of South Africa
All rights reserved
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University of South Africa
Muckleneuk, Pretoria
FAC1601/3/2019-2021
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Introduction and overview of the module....................................................................iv
.................................................................................................... 1
Introduction to the preparation of financial statements ................................ 1
.................................................................................................. 25
Financial statements of a sole proprietorship ............................................ 25
.................................................................................................. 45
Establishment and financial statements of a partnership........................... 45
.................................................................................................. 67
Changes in the ownership structure of partnerships.................................. 67
.................................................................................................. 85
The liquidation of a partnership ................................................................. 85
................................................................................................ 101
Close corporations................................................................................... 101
................................................................................................ 143
Introduction to companies ....................................................................... 143
................................................................................................ 163
Branches ................................................................................................. 163
................................................................................................ 185
Statement of cash flows .......................................................................... 185 iii

Dear Student,
We are pleased to welcome you to this module and hope that you will find the content both interesting and rewarding. We shall do our best to assist you to master this module and we recommend that you start studying immediately after enrolment. Accounting is a subject that requires continued exercise by working through many examples and you will be required to work continually throughout the semester.
First-year accounting at UNISA consists of the following modules namely FAC1502 and
FAC1601 or FAC1602. If you aim to become a chartered accountant (CA) or plan to include second and third-year Financial Accounting modules in your degree, the FAC1601 module is compulsory for the Bachelor of Accounting Sciences degree and other qualifications where second and third-year Financial Accounting is required. Completing FAC1502 and FAC1601 successfully, allow you to enrol for the second-year modules FAC2601 and FAC2602. If your focus is certain diplomas and other Bachelors of Commerce degrees where you only need first-year Financial Accounting, we recommend that you enrol for the FAC1602 module.
However, ensure that FAC2601 and FAC2602 are not included in your degree’s syllabus as only FAC1601 allows access to further studies in Financial Accounting.
FAC1601 concerns itself with the issues of accounting reporting for different entities and builds on the learning outcomes of FAC1502. You will remember that in FAC1502 the following topics were covered: iv

Basic principles of accounting
Including the nature of accounting, financial position and performance, double entry and the accounting process
Collecting and processing accounting data
Including the processing of data and adjustments, closing off procedures and preparing financial statements
Accounting for current and non-current assets
Including cash and cash equivalents, trade and other receivables, inventory, property, plant and equipment, and other non-current assets
Accounting for current and non-current liabilities
Accounting Reporting
Including the financial statements of a sole proprietor, non-profit entities and incomplete records
FAC1502 taught the basic bookkeeping functions and introduced you to the concepts, principles and procedures of accounting. It is important to realise that FAC1502 forms the foundation for all other financial accounting modules. The knowledge that you gained in
FAC1502 forms the building block of this module and cannot be repeated. If you need to refresh your memory on these concepts, please refer to your FAC1502 guide and About
Financial Accounting Volume 1 textbook.
Although the aim is not to provide an exhaustive list of concepts dealt with in FAC1502, we provide you with a summary of the most important ones to enable you to refer back with ease: x x
Value-added tax (VAT) – section 5.10 in the FAC1502 guide and section 5.4 in the textbook. Remember that the input and output VAT accounts are closed off to a VAT control account which can be either a debtor (if VAT input is greater than VAT output for the period) or a creditor (when VAT output is greater than VAT input for the period). In this module, we refer to the VAT debtor account as VAT receivable and the VAT creditor account is referred to as VAT payable.
The recording of depreciation – section 6.3 and section 11.5 – 7 in the FAC1502 guide and section 11.7 in the textbook. Familiarise yourself with the reason for depreciation, the journal entries to provide for depreciation and the different methods that can be used v

x x x x x to calculate depreciation. These methods are the diminishing balance, the straight-line and the production unit method. Remember that the useful life of an asset is an estimation that must be reviewed annually and the depreciable amount is reduced with the residual value or scrapping value of the asset.
Credit losses and allowances for credit losses – section 9.5 in the FAC1502 guide and section 9.4 – 9.6 in the textbook. Refresh your memory on the journal entries to write off credit losses as well as to create, increase or reduce an allowance for credit losses. Also refer to section 9.8 in the textbook where the VAT on credit losses is discussed and how to journalise the VAT amount when credit losses are written off. Remember that when credit losses previously written off are recovered, that a VAT output must again be accounted for.
Settlement discount granted and allowance for settlement discount granted – section
5.9 and 9.2 – 9.3 in the FAC1502 guide and section 9.3 in the textbook. Remember that settlement discount granted reduces sales in financial statements. Refresh your memory on the VAT implications that arose with settlement discount granted and how to account for VAT on settlement discounted granted in the journals of first entry.
Settlement discount received – section 5.9 in the FAC1502 guide and section13.6 in the textbook. Remember that settlement discount received reduces purchases in financial statements. The same VAT implications as for settlement discount granted is applicable and you need to refresh your memory on the treatment of settlement discount received in the journals of first entry.
Inventory systems – section 7.4 in the FAC1502 guide. Remember that an entity can either use a perpetual (continuous) inventory system or a periodic inventory system.
When a perpetual inventory system is used, the cost of sales is determined for every transaction and the inventory account reflects the purchases and sales of inventory items. Under this inventory system, a purchase journal and purchase returns journal are not used and a physical inventory count will disclose shortages or surpluses in inventory.
When a periodic inventory system is used, purchases and purchases returns journals are used. Accounts are closed off to a trading account. The trading account is used to calculate cost of sales as no cost of sales account is kept and a physical inventory count is essential to establish the closing inventory.
Inventory valuation – refer to Chapter 10 in the textbook where the measurement and the value determination for inventory are discussed. Please familiarise yourself with the calculation of the cost of inventory which includes the cost of purchases, conversion costs and other cost. The cost of purchases includes the purchase price, import duties, non-recoverable taxes, transportation costs and handling costs. The cost of purchases must be reduced by trade discounts, settlement discounts and rebates on purchases.
Conversion costs include, for example, direct labour cost, variable production overhead costs and fixed overhead cost based on production at normal capacity. Other cost could include for example designing and storage costs. Refresh your memory on the different inventory valuation methods such as first-in-first-out (FIFO) and weighted average that were covered in FAC1502. Remember that inventory is valued in the financial statements at the lower of cost or net realisable value (NRV). The NRV is the selling price less the cost to make the sale and these costs can include inventory completion costs, trade and other discounts allowed, advertising cost, sales commission, packaging costs and transport costs.
Assuming that your abovementioned knowledge is refreshed and sufficient, we can now discuss the module objective and content of FAC1601 .
vi

The main objective of this module is to teach you certain aspects of financial accounting and reporting so that you are able to do the following: x
Discuss specified aspects of the Conceptual Framework for the preparation and presentation of financial statements.
x
Understand and apply the concept of International Financial Reporting Standards (IFRS).
x
Prepare the financial statements for sole proprietors, partnerships and close corporations according to certain of the requirements of International Accounting Standards 1 (IAS 1).
x
Apply the accounting procedures to record changes in the ownership structure of partnerships on the admittance, retirement or death of partners.
x
Apply the accounting procedures to record the simultaneous and piecemeal liquidation of partnerships.
x
Record transactions pertaining to the capital structure of companies.
x
Explain how a business entity with branches operates, and record the transactions between head offices and their branches.
x
Prepare statements of cash flows for sole proprietors, partnerships and close corporations according to the requirements of International Accounting Standard 7 (IAS 7).
vii

The FAC1601 module content is illustrated in the following diagram:
Study Unit 1
Introduction to the preparation of financial statements
Study Unit 2
Financial statements of a sole proprietorship
Study Unit 3
Establishment and financial statements of a partnership
Study Unit 4
Change in the ownership structure of partnerships
Study Unit 5
The liquidation of a partnership
Study Unit 6
Close Corporations
Study Unit 7
Introduction to companies
Study Unit 8
Branches
Study Unit 9
Statement of cash flows viii

The study guide and the prescribed textbook, About Financial Accounting Volume 2, are the primary sources of learning content for this module. The prescribed textbook contains a major part of the learning content and must be used according to the directives given in the study guide. For example, the guide will indicate that certain sections in the prescribed textbook need only be read, whereas other sections must be studied thoroughly. Such references usually include action words. In this regard, the following action words should be interpreted as follows:
ACTION
Read
Study
WORD
Read to obtain broad and basic background knowledge of the subject under discussion. You must read attentively so that theory/explanations are clearly understood. You may be assessed on the theory by means of short questions in activities and also in assignments.
Learn with a view to gaining the highest level of understanding that is necessary to solve problems in exercises, assignments and in the examination. This level of knowledge will also be necessary for further studies in financial accounting and/or your career. You will, never be required to give a definition of a concept or to discuss theory in the examination. You will however, be required to apply the theory in the correct accounting format and to apply the correct steps/procedures.
For example, the layout and terminology to be used in the preparation of financial statements are prescribed by the International Accounting
Standards. You may not use any other format.
Each learning unit starts with a number of learning outcomes , which will direct your learning.
The learning outcomes indicate what are expected of you to understand, know, calculate, disclose and apply and will help you to structure your learning. In each learning unit, keywords or key concepts are provided and should give you an indication of the issues that are being dealt with in the learning content. Activities, examples and exercises will get you involved in the content of the particular learning unit. These are designed to find out if you have the necessary assumed knowledge, understand the work and can apply new knowledge gained.
Activities can be in the form of theory questions, multiple-choice questions, calculations, journal entries, true or false questions, etc. whereas examples/exercises are detailed questions dealing with the learning content. Exercises are indicative of the types of questions that can be expected in assignments and in the examinations. Activities, examples and exercises imply “doing”. They help you to cover the content of the module systematically. For you to become an active learner, you should first do the activity, example and exercise before referring to the feedback and solutions.
ix

The following icons are used in this study guide to refer to the above-mentioned concepts that you will encounter in the study guide:
ICON DESCRIPTION
Learning outcomes . This icon indicates what aspects of the particular topic you have to master and be able to show that you understand.
Key concepts. The learning content will address the following issues .
Activity.
This icon indicates activities that you must do in order to develop a deeper understanding of the learning material.
Self-assessment.
This icon indicates that you will be required to test your knowledge, understanding and application of the material you have just studied.
Feedback.
This icon indicates that you will receive feedback on your answers to the activities.
Read.
If it is suggested that you should read a certain section, you should take note of the contents because that section will contain useful background information or offer another perspective of further examples.
Study.
This icon indicates which aspects of the study material you need to study and internalise.
Timeout.
Well done – you have completed the learning unit!
x

To indicate the length, scope and format of answers to questions, action verbs are deliberately applied. An analysis of the action verbs in a question should enable you to: x plan the answer systematically; x ensure that you comply with the lecturer’s/examiner’s requirements.
A clear understanding of the meaning of certain words is required and for the purpose of this module the following interpretations are given:
Adjust
WORD
Apply
Calculate
INTERPRETATION
To adapt to new conditions/environment; to put in order; add, change
Use in a practical manner; use as relevant or suitable
Ascertain by mathematical procedure/exact reckoning
Clarify
Compare
Complete
Define
Describe
Discuss
Explain
Make clear the meaning of; explain the intention of; show by reasoning/evidence
Examine in order to observe resemblances, relationships and differences
Finish/add what is required; show the necessary detail
State precisely the meaning/scope/total character of; make clear (especially the outline of); give a concise description of the distinguishing features of
Give clearly the distinguishing details or essential characteristics of
Examine by argument, debate, hold conversation about
Set out in detail (interpret); the meaning of account for something; make something understandable
List Record/itemise names or things belonging to a class
Mention/name/state Specify by name; cite names, characteristics, items, elements of facts
Prepare Make ready/complete for a particular purpose; to put together using parts; compose, construct. Also meaning to compile or complete what is required on the basis of prior knowledge
Reconcile
Record
Show
To make or become visible, noticeable; to exhibit or present; to indicate
Put in writing; set down for reference or retention
To make compatible or consistent with each other xi

At the end of each learning unit there is an elementary self-assessment questionnaire , which you must complete in order to evaluate your knowledge of the learning content of each learning unit and to monitor your progress. These questionnaires are presented in the form of questions to which you must answer either “yes” or “no”. If you have answered “yes” to all the questions you may proceed to the next learning unit. If you have any “no” answers, you must study that particular section of the work again. Since a clear understanding of certain aspects in a learning unit may be essential for your further understanding of the course, you are advised not to go on to the next learning unit until you have resolved all your problems in the preceding one.
Before you start studying, please read the discussion section in Tutorial Letter 101. Apart from details on the prescribed textbook, this tutorial letter contains valuable guidelines on how to go about studying this module, as well as suggested time specifications pertaining to each learning unit in order to ensure that you cover the whole syllabus in time. It also provides you with the contact and communication details of your lecturers for the FAC1601 module.
It is very important that you show all your calculations in your answers to exercises and questions. In the study guide and the prescribed textbook, short calculations are disclosed in brackets after an entry in a journal, ledger account or financial statement. Note that these calculations do not form part of the actual accounting disclosures. They are disclosed as such for practical illustrative purposes only. Calculations that are more elaborate are referred to by encircled symbols, for example “ ߇ ”. Sub-calculations are referred to by shaded encircled symbols, for example “
ᬚ
”. You may follow the same or a similar approach when preparing your answers in assignments and examinations.
You should be aware that the books of first entry in respect of cash transactions are the cash receipts journal and the cash payments journal as taught in FAC1502. However, to simplify matters in this module, cash transactions where required, are disclosed in the general journal.
If there is anything discussed in the prescribed textbook or the study guide which in your opinion needs to be explained in more detail or in a different fashion, please notify us accordingly by post or e-mail. The postal and e-mail addresses of this module are provided in
Tutorial Letter 101.
We trust that you will enjoy this module and wish you all the best!
Lecturers
FAC1601: Financial Accounting and Reporting
“Aim for success, not perfection.
Never give up your right to be wrong, because then you will lose the ability to learn new things and move forward with your life. Remember that fear always lurks behind perfectionism”
David M Burns xii

1
1
Learning outcomes ..............................................................................................................2
Key concepts .......................................................................................................................3
1.1
Introduction .................................................................................................................4
1.2
Conceptual framework for financial reporting ..............................................................5
1.3
Applicable International Financial Reporting Standards ............................................11
1.4
Presentation of financial statements: IAS 1 ...............................................................11
1.5
Financial instruments ................................................................................................15
1.6
Practical applications of IAS 1 and financial instruments...........................................17
1.7
Exercises and solutions ............................................................................................18
Self-assessment ................................................................................................................22
1

After studying this learning unit, you should be able to: x explain the acronyms IFRS, IAS, APB, FRSC and SAICA, and know what they entail x describe what the concept "Conceptual Framework" entails x list the specific purposes of the Conceptual Framework regarding the preparation and presentation of financial statements x explain the main objectives of financial statements per the Conceptual Framework x explain the underlying assumption when preparing financial statements per the
Conceptual Framework x discuss the qualitative characteristics of financial statements per the Conceptual
Framework x explain what the Conceptual Framework implies when it refers to the constraints in preparing financial statements as it is referred to in the Conceptual Framework x discuss the elements of financial statements as explained in the Conceptual Framework and indicate which elements pertain to the statement of financial position and which to the statement of profit or loss and other comprehensive income x discuss the concepts of recognition and disclosure of the elements incorporated in financial statements, as explained in the Conceptual Framework x explain what is meant by the measurement of the elements of financial statements by referring to the measurement methods discussed in the Conceptual Framework x explain what type of business ownership must comply with IFRS x define each of the following terms per IAS 1: fair presentation going concern accrual basis of accounting materiality and aggregation offsetting frequency of reporting comparative information consistency of presentation x list the individual statements that, per IAS 1, together form the complete set of financial statements of a reporting entity x explain what is meant by the identification of financial statements x explain what is meant by reporting period x explain which items comprise current assets and current liabilities per IAS 1 x list the items that must be presented on the face of the Statement of Financial Position and the Statement of Profit or Loss and Other Comprehensive Income respectively by referring to IAS 1 x list the items that can be presented on either the face of the Statement of Financial
Position and the Statement of Profit or Loss and Other Comprehensive Income or in the notes to these statements for the particular reporting period per IAS 1 x discuss the purpose of notes, by referring to IAS 1 x discuss, according to IAS 1, the order in which items are disclosed as notes to financial statements
2

x explain or define the following: a financial instrument a financial asset a financial liability fair value a contract x distinguish between financial instruments, financial assets and financial liabilities x recognise, measure and present certain financial assets and liabilities in the financial statements
x
Conceptual Framework x
Underlying assumption x
Qualitative characteristics x
Components of financial statements x
Elements of financial statements x
Recognition x
Measurement of elements x
Capital x
Capital maintenance x
Reporting period x
Financial instruments x
Financial assets x
Financial liabilities x
Fair value
3

In FAC1502, we learnt that every business entity usually uses some accounting system to collect financial data from a multitude of financial transactions. The entity then uses the data and processed information about the entity’s financial performance and financial position to present the information in a usable format (e.g. financial statements, budgets etc.) that will assist the users to make economically viable decisions. Remember that the accounting system covered in FAC1502 forms the foundation for reporting the information to users. In the introduction to this learning unit we will briefly explain the regulatory framework applicable to financial reporting in South Africa and give you an overview of why financial statements must comply with certain requirements and who is responsible for issuing and overseeing compliance with regard to the regulatory framework.
In order to have financial information available that is meaningful and comparable across different types of entities in countries around the world, the quest became to develop a set of prescriptive standards that will provide guidance and prescribe certain principles that can be used to prepare financial statements. Most countries established governing bodies with a mandate to develop these standards. One of the many governing bodies mandated to embark on this quest was the Accounting Practices Board (APB) which was established in South Africa in 1973. The APB issued accounting standards which were collectively known as South
African Statements of Generally Accepted Accounting Practice or SA GAAP. All listed and unlisted companies in South Africa were required to use SA GAAP as their reporting framework when preparing financial statements.
In the 1990s the APB decided to incorporate South Africa into the international accounting standards arena and to harmonise SA GAAP with the standards issued by the International
Accounting Standards Board (IASB) and its predecessor. The predecessor of the IASB issued
International Accounting Standards (IASs) from 1973 until 2001 when the IASB was established. These IASs are now designated as part of International Financial Reporting
Standards (IFRSs) as these international standards are currently called. As from January
2005, the Johannesburg Securities Exchange (JSE) requires all listed companies to comply with IFRS. The Companies Act 71 of 2008 that came into effect in May 2011 established a body known as the Financial Reporting Standards Council (FRSC) which is now the South
African governmental accounting standard-setting body. The South African Institute of
Chartered Accountants (SAICA) serves as the technical advisor to the FRSC.
Because of the high regard of the usefulness of these standards to prepare financial statements that are usable and comparable across countries it became common practice to also apply these statements, either in full or to a limited extend, when preparing the financial statements of entities other than companies. IFRSs deal with recognition, measurement, presentation and disclosure requirements in general purpose financial statements .
These financial standards are directed at a wide range of users such as investors, shareholders, creditors, banks, South Africa Revenue Service (SARS), employees and other interest parties. There are currently two reporting frameworks available namely full IFRS or
IFRS for SMEs.
You can read more on the regulatory reporting framework and which companies must comply with either full IFRS or IFRS for SMEs in section 1.3 in the prescribed textbook.
FAC1502 introduced you to the Conceptual Framework which is also the starting point of this learning unit.
4

The Conceptual Framework for Financial Reporting was issued by the International
Accounting Standards Board (IASB). This document contains a group of interrelated objectives and theoretical principles that serve as a frame of reference for financial accounting and more specifically financial reporting. The content of the Conceptual Framework is discussed in sufficient detail in the prescribed textbook of this module and it is unnecessary to obtain a copy of the Conceptual Framework.
Read paragraph 1.1 and 1.2.1 in the prescribed textbook. Take note of the overview of the conceptual framework diagram which will help you to place the content of the Conceptual Framework into perspective.
Activity 1.1
a) Describe in your own words what you perceive a framework to be.
b) Describe the purpose of the Conceptual Framework. Would you say that the
Conceptual Framework is similar to an IFRS?
Feedback 1.1
a) b)
A framework serves as a reference for an area of enquiry and often provides the theoretical background to test practical problems. The financial accounting framework is a set of theoretical concepts and principles, which forms the basis for establishing and developing reporting practices.
The purpose of the Conceptual Framework inter alia is to assist x in the development of future standards x in harmonising legislation and reducing the number of alternative accounting treatments x standard setters to develop national standards x the preparers of financial statements in applying IFRSs x auditors to form opinions on the compliance of IFRS in financial statements x users in interpreting the information in financial statements when compiled according to IFRS
The Conceptual Framework is not an IFRS and also does not override any particular disclosure or measurement requirement in any IFRS. It is the foundation on which principle-based IFRSs is founded.
5

Study paragraph 1.2.2 in the prescribed textbook. You must also ensure that you can describe in your own words the information that is contained in each of these statements.
Activity 1.2
a) We refer to the communication of financial information as an accounting system.
True or False?
b) List the different components that are normally included in an entities complete set of financial statements.
Feedback 1.2
a) False. Communication of financial information is referred to as financial reporting. The accounting system only provides the accounting data that must be reported.
b) The statement of financial position
The statement of profit or loss and other comprehensive income
The statement of changes in equity
The statement of cash flows
Notes to the financial statements
The objective of general purpose reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. These decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit. Potential and existing investors are interested in the returns they expect, while creditors and other lenders are interested in principal repayments and interest payments they expect.
Read paragraph 1.2.3 in the prescribed textbook.
Activity 1.3
Who do you think are the users of financial statements? Name a few.
6

Feedback 1.3
The primary users of financial statements are present and potential investors of the entity, lenders [private (informal) and corporate lending institutions (formal) such as abomashonisa /loansharks and banks], customers and creditors. Other users include the owners/shareholders of the entity, employees and the entity’s management, regulators such as the South African Revenue Service (SARS) and the general public.
The Conceptual Framework sets out one underlying assumption that should be taken into consideration when preparing financial statements. An underlying assumption is a belief that is assumed to apply in every financial statement that is prepared.
Study paragraph 1.2.3 in the prescribed textbook.
Activity 1.4
Name the underlying assumption that is applicable to the preparation of financial statements according to the Conceptual Framework?
Feedback 1.4
The going concern principle is the one underlying assumption of the Conceptual Framework.
Make sure that you can explain this assumption in your own words.
In paragraph 1.2.5 in the prescribed textbook the qualitative characteristics that make financial information useful are discussed. Study them diligently. You must be able to explain in your own words what each qualitative characteristic entails.
Activity 1.5
a) Name the fundamental and enhancing qualitative characteristics of financial reporting as stipulated in the Conceptual Framework.
b) Should one report all matters irrespective of the cost of reporting?
7

Feedback 1.5
a)
Fundamental qualitative characteristics
Enhancing qualitative characteristics
1. Relevance
2. Materiality
3. Faithful representation
1. Comparability
2. Verifiability
3. Timeliness
4. Understandabilit y b) The cost of providing reporting information must be justified by the benefits derived from the information.
Study paragraph 1.2.6 in the prescribed textbook.
Elements that pertain to the statement of financial position are assets, liabilities and equity whilst elements that pertain to the statement of profit or loss and other comprehensive income are income and expenses. You must learn the definitions of these elements by heart as you will have to apply the definitions to establish whether a transaction results in the creation of an asset, liability, equity, income or an expense.
The value of a reporting entity lies in the net assets (assets minus liabilities) under its control.
It is therefore important to realise that assets can be recognised in the statement of financial position even though the entity may not be the legal owner thereof.
Activity 1.6
Define an asset, a liability and equity according to the Conceptual Framework.
Feedback 1.6
An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.
A liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow of economic resources .
Equity is the residual interest in the assets of the entity after deducting all the liabilities.
Remember to also learn the definition of an income and expense as they are defined in paragraph 1.2.6.3 in the prescribed textbook. Income encompasses revenue and gains and it
8

is important to understand the difference between revenue and gains and give examples.
Revenue and gains are normally separately reported. Expenses on the other hand also encompass losses which are also normally separately reported.
Study paragraph 1.2.7 in the prescribed textbook.
Before an item can be disclosed in a financial statement, it must first be recognised. However, all recognised items need not be disclosed. Take note of when an element of the financial statements should be recognised and what the criteria for the recognition of each element are.
Activity 1.7
b) c)
When will each of the following elements be recognised in the appropriate financial statement?
a) Asset d)
Liability
Income
Expense
Feedback 1.7
a) b) c) d)
An asset is recognised in the statement of financial position when it is probable that the future economic benefits thereof will flow to the entity, and when the asset has a cost or a value that can be measured reliably.
A liability is recognised in the statement of financial position when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation, and the amount at which the settlement will take place can be measured reliably.
Income is recognised in the statement of profit or loss and other comprehensive income when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means that the recognition of income occurs simultaneously with the recognition of increases in assets or decrease in liabilities, for example inventory sold for cash where the bank account
(asset) is debited and sales are credited.
Expenses are recognised in the statement of profit or loss and other comprehensive income when a decrease in future economic benefit related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means that the recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets.
9

“Measurement” means the process of determining the monetary value (amounts) at which the elements of the financial statements are to be recognised and disclosed. Four bases of measurement are listed in the Conceptual Framework, namely (1) historical costs,
(2) realisable value, (3) current costs and (4) present value. Take note that although the
Conceptual Framework doesn’t specifically mention “fair value” as a measurement basis, there is a tendency to move more towards fair value and to move away from historical cost.
This was necessitated due to the many corporate failures that you so often read about in the press.
Study historical cost and realisable value carefully as these are the two bases you will encounter the most in this module. Remember from FAC1502 that inventory is measured at the lowest of cost (historical) or net realisable value. Financial instruments which you will encounter later in this learning unit are mainly measured at fair value whereas property, plant and equipment are often measured at historical cost less accumulated depreciation and impairment unless entities choose to incorporate a revaluation model which will allow these assets to be revalued to more recent values. Revaluations are covered in more detail in advanced accounting studies.
In paragraph 1.2.8 in the prescribed textbook each of these measurement bases are explained. Make sure that you can describe each in your own words.
Activity 1.8
Name five measurement bases that are often encountered in a set of financial statements.
Feedback 1.8
Historical cost, realisable value, current cost, present value and fair value.
The selection of a measurement basis and the concepts of capital and capital maintenance determine the model according to which financial statements are prepared. There are two basic concepts of capital and capital maintenance, namely (1) the financial concept and (2) the physical concept.
The financial concept of capital is synonymous with the net assets or equity of a business entity. The physical concept pertains to the productive capacity of the entity, for example the units of production per day.
Read paragraph 1.2.9 in the prescribed textbook.
10

IFRS must be applied when the financial statements of entities that are incorporated under the Companies Act No 71 of 2008 (hereinafter referred to as the Companies Act) are prepared.
The fact that such compliance is not required by any other form of business ownership does not mean that the requirements of these statements cannot be applied when the financial statements of business entities other than companies are prepared. In the remainder of your accounting studies IFRS is taught and made applicable to all types of reporting entities.
The remainder of this learning unit deals with some important IFRSs issued to assist us to present financial statements in a useful and comparable way, namely IAS 1, IFRS 7 and 9 and IAS 32 and 39. In IAS 1, many of the concepts that you have encountered in the
Conceptual Framework are enforced for example the purpose of general purpose financial statements, the users thereof, the elements of financial statements and the underlying principle of going concern. Although you will encounter financial instruments (IFRS 7 and 9 and IAS 32 and 39) in more advanced accounting studies, this learning unit introduces the concept and the main definitions. The aim is to lay a foundation as all entities encounter financial instruments in some form and have to include them in their respective financial statements. Ensure that your foundation on financial instruments as presented in this learning unit is solid and that you know and understand the content as presented in the textbook and this learning unit.
Read the overview of IAS 1 in the prescribed textbook.
The objective of IAS 1 is to prescribe the basis for the presentation of general purpose financial statements to ensure comparability with: x an entity's financial statements of previous financial periods x the financial statements of other comparable entities.
Read paragraph 1.4.1 in the prescribed textbook to learn more about the objective and purpose of IAS 1.
11

Certain accounting terms are defined in IAS 1 and are listed in paragraph 1.4.2 in the prescribed textbook.
Study the definitions in paragraph 1.4.2 in the prescribed textbook.
Activity 1.9
Make a list of the new definitions that you will encounter in IAS 1. You don’t have to define them for the purpose of this activity.
Feedback 1.9
x
General purpose financial statements x
Impracticable x
Material omissions x
Notes x
Owners x
Profit or loss x
Other and total comprehensive income.
The main purpose of financial statements is to provide useful information to the users thereof.
To achieve this purpose, financial statements must provide information about each of the elements that are listed in the Conceptual Framework in a specific format.
Read paragraph 1.4.3 in the prescribed textbook, which explains the elements that should be reported on, and what IAS 1 regards as a complete set of financial statements.
You have already encountered some of the overall considerations when preparing financial statements in the Conceptual Framework such as going concern, materiality, comparability and consistency. Make sure that you understand the addition ones such as fair presentation, accrual basis, offsetting and the frequency of reporting
Study paragraph 1.4.4 in the prescribed textbook.
12

Structure and contents have to do with the format in which financial statements must be presented and with the items that must be disclosed. Structure and contents are essential aspects that pertain to the preparation of financial statements and you must study them carefully.
Read paragraph 1.4.5.1 in the prescribed textbook.
1.4.5.1 Identification of financial statements
Each financial statement and its component(s) must be identified by giving it a name that pertains to its particular function.
Study paragraph 1.4.5.2 in the prescribed textbook.
1.4.5.2 Statement of financial position
Remember that the purpose of a statement of financial position is to report on the financial position of an entity. It consists of three elements namely assets, liabilities and equity. In this paragraph the minimum line items that must be included in a statement of financial position are listed. Study them by heart. The classification of assets into non-current and current assets, and of liabilities into non-current and current liabilities, is highlighted. Make sure that you know when assets or liabilities must be classified as “current”.
You will also learn which information must be presented: x on the face of a statement of financial position, and x either on the face or in the notes to the statement of financial position. Further subclassification of the main line items are normally presented in notes.
Study paragraph 1.4.5.3 in the prescribed textbook.
1.4.5.3 Statement of profit or loss and other comprehensive income
Study paragraph 1.4.5.4 in the prescribed textbook.
A statement of profit or loss and other comprehensive income provide information about the results of its operations. In simple terms, it shows whether the entity made a profit or loss on its operating activities during a financial period.
In this section the line items which must be presented on the face of the statement of profit or loss and other comprehensive income, and which can be presented either on the face of the statement of profit or loss and other comprehensive income or in the notes are presented.
13

Note that for the purpose of this module, expenses are disclosed in a statement of profit or loss and other comprehensive income according to their function, and that IAS 1 requires certain minimum disclosures when this method is applied.
1.4.5.4 Statement of changes in equity
A statement of changes in equity is a statement of changes in the capital structure of an entity and shows the movement in equity (ownership) between two reporting periods. Information can again be presented (disclosed) either on the face or in the notes to a statement of changes in equity.
Study paragraph 1.4.5.5 in the prescribed textbook.
Note that the format of the statement of changes in equity depends on the type of business ownership for which it is prepared. Also note that if this statement is prepared for a close corporation, the name of the statement is shown as: "Statement of changes in net investment of members". The learning unit on close corporations will discuss this statement in greater detail.
1.4.5.5 Statement of cash flows
Although a statement of cash flows is a financial statement, we discuss it separately in a later learning unit in this module.
Read paragraph 1.4.5.6 in the prescribed textbook.
1.4.5.6 Notes x
Notes represent information about the basis of preparation and the accounting policies that an entity subscribe to in the preparation of financial statements. Usually an affirmation that the financial statements were prepared according to the requirements of IFRS is given as well as a list and description of the significant accounting policies adapted in the preparation of the financial statements.
x
Notes also disclose information prescribed by other IFRSs that is not presented elsewhere and is relevant to an understanding of the different IFRSs.
Study paragraph 1.4.5.7 in the prescribed textbook.
Please take note that a calculation, for example the calculation of depreciation, is NOT a note to a financial statement and must not be indicated as such.
14

Activity 1.10
When are assets regarded as being current in nature and when are liabilities regarded as being current in nature per IAS 1?
Feedback 1.10
An asset is classified as current when it satisfies any of the following criteria: x
It is expected to be realised, or intended for sale or consumption, in the entity's normal operating cycle.
x
It is held primarily for the purpose of being traded.
x
It is expected to be realised within 12 months after the statement of financial position date.
x
It is cash or a cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least 12 months after the statement of financial position date.
A liability is classified as current when it satisfies any of the following criteria: x
It is expected to be settled in the entity's normal operating cycle.
x
It is held primarily for the purpose of being traded.
x
It is due to be settled within 12 months after the statement of financial position date.
Read the overview of financial instruments in paragraph 1.5 in the prescribed textbook.
Read paragraph 1.5.1 in the prescribed textbook to learn more about the reason why financial instruments are dealt with and which standards were issued to cover this important topic.
Study paragraph 1.5.2 in prescribed textbook where various definitions applicable to financial instruments are discussed.
Activity 1.11
Make a list of the definitions that you will encounter in dealing with financial instruments. You don’t have to define them for purposes of this activity.
15

Feedback 1.11
x
Financial asset x
Financial liability x
Equity instrument x
Fair value x
Contract
Read paragraph 1.5.3 in the prescribed textbook where the different financial assets and liabilities that you will encounter in first-level accounting are discussed .
Activity 1.12
Classify the following financial statement line items as financial assets, financial liabilities or other (indicate if it is a non-current assets/liability or a current asset/liability): x
Cash deposit with a bank or in a stokvel x
Inventory x
Trade receivable accounts x
Trade payable accounts x
Loans receivable x
Bank overdraft x
Property plant and equipment x
Trademark for example “Apple” or “Dell” x
Prepaid rent x
Income received in advance x
VAT payable
Feedback 1.12
Financial assets x
Cash deposit with a bank or in a stokvel x
Trade receivable accounts x
Loans receivable
Financial Liabilities x
Trade payable accounts x
Bank overdraft
Other x
Inventory – current asset x
Property plant and equipment – non- current asset x
Trademark for example “Apple” or “Dell” – non-current asset x
Prepaid rent – current asset x
Income received in advance – current liability x
VAT payable – current liability
16

Read paragraph 1.5.4.1 to 1.5.4.4 in the prescribed textbook.
Financial assets are classified as:
• financial assets at fair value through profit or loss
• financial assets at amortised cost
• equity investments at fair value through other comprehensive income.
Financial assets that are not equity instruments are measured at initial recognition and subsequently at either fair value or amortised costs depending on the abovementioned classification. You must be able to identify which financial assets are measured at amortised cost and which at fair value. If the financial asset is an equity instrument and it is held for trading it must be measured at fair value through profit or loss.
Financial liabilities are classified as:
• financial liabilities at fair value through profit or loss (not in the syllabus for first level accounting
• financial liabilities at amortised cost.
You must be able to name financial liabilities that are measured at amortised cost.
Study the overview of financial instruments to determine when transactions costs must form part of a financial asset /liability (capitalised) and when it must be expensed.
Activity 1.13
Work through example 1.1 in the prescribed textbook.
Before we get to more advanced examples and solutions, the practical application of IAS 1 and financial instruments must be studied.
In paragraph 1.6 in the prescribed textbook the theory discussed in this learning unit is applied in the preparation and presentation of financial statements.
Study the example in paragraph 1.6 in the prescribed textbook.
Read paragraphs 1.7 and 1.8 in the prescribed textbook.
17

EXERCISE 1.1- Conceptual framework ( adapted from Introduction to the understanding of accounting question book )
Vusi Mailane was a famous sculptor who recently passed away. His daughter, Grace Modise, bequeathed a sculpture of one of the founder members in distance education to UNISA. The cost of creating the sculpture amounted to R25 000. A few weeks ago, while his estate was being finalised, a similar sculpture from Mailane was sold for £80 000 (£ = British pound) which when converted to rand, amounted to R1 240 000 on 28 February 20.17 which is also the date of the donation. The university approached your audit firm for advice on the treatment of the sculpture in the financial statements at year end on 28 February 20.17.
REQUIRED
With reference to the Conceptual Framework only, discuss the treatment of the sculpture in the financial statements of UNISA on 28 February 20.17. Explain which measurement base would be appropriate to use to determine the value at which the sculpture can be recorded in the financial statements of UNISA.
SOLUTION 1.1
Recognition of the element as an asset:
Resource under the control
Recognition criteria:
Realisable measurement
Probability of a future economic benefit
The university as the rightful owner now owns the sculpture and also controls what happens with the sculpture from hereon.
As a result of a past event The university is in possession of the sculpture as a result of the inheritance.
Future economic benefits Should the university decides to sell the sculpture in future, future economic benefits in the form of money is expected from the sale of the sculpture.
The value of the sculpture can be determined reliably by looking at the value of similar sculptures that the artist sold.
Conclusion
It is probable that the sculpture will retain its value and that it may be sold, which would result in an inflow of economic benefits (money) to the university.
The sculpture must be treated as an asset in the financial statements of UNISA because it complies with the recognition criteria as well as the definition of an asset.
Measurement basis The asset should be measured at its realisable value, which is the cash or cash equivalents that could currently be obtained by selling the sculpture in an orderly disposal.
Because UNISA did not pay for the sculpture it cannot be recorded at its historical cost of R25 000 and it should be accounted for at R1 240 000.
18

EXERCISE 1.2 – Financial instruments
On 1 March 20.14 Louis CC purchased 100 ordinary shares of R100 each in Marble Ltd, a company listed on the Johannesburg Securities Exchange (JSE). The purpose of this investment was speculative in nature. The transaction costs amounted to R500. On
28 February 20.15, the end of the financial year of Louis CC, the shares were trading at R125 per share on JSE.
REQUIRED
Record the above transactions in the general journal of Louis CC.
SOLUTION 1.2
LOUIS CC
GENERAL JOURNAL
Debit Credit
R R
20.14
Mar 1 Investment: Shares in Marble Ltd (R100 x 100)
Investment expenses (transaction costs)
10 000
500
Initial recognition of investment at cost and recording of investment expenses
20.15
Feb 28 Profit or loss account
Investment expenses
Closing off of investment expenses
Investment: Shares in Marble Ltd (R25 x 100)
Fair value adjustment: Listed investment
Adjustment on subsequent measurement of investment in the shares of Marble Ltd at the financial year end
Fair value adjustment: Listed investment
Profit or loss account
Closing-off of fair value adjustment of listed investment
500
2 500
2 500
500
2 500
2 500
EXERCISE 1.3 – IAS 1
N Naidoo purchased a diamond cutting machine for her jewellery manufacturing business on
2 March 20.16. She incurred the following costs to get the machine installed and ready for use:
Cost of the machine R627 000
Delivery cost R1 425
Installation cost R4 332
Training cost to operate the machine R855
During the year she also paid R2 750 to a repairman to fix the machine. The repairman was not a registered VAT vendor.
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N Naidoo currently depreciates all manufacturing equipment at 25% according to the diminishing balance method. The residual value of the machine is R5 000 (VAT exclusive).
N Naidoo is a registered VAT vendor and VAT at 14 % is included except where stipulated to the contrary.
REQUIRED
Disclose the machine and related costs in the financial statements of N Naidoo at
31 December 20.16 to comply with the requirements of IAS 1. The accounting policy note is not required.
SOLUTION 1.3
1.
Calculation of the cost of the machine
Purchase price (R627 000 x 100/114)
Delivery cost (R1 425 x 100/114)
Installation cost (R4 332 x 100/114)
Training cost (R855 x 100/114)
Total cost of the machine
2.
Calculation of depreciation
R(555 800 – 5 000) x 25% x 10 /
12
R
550 000
1 250
3 800
750
555 800
114 750
N NAIDOO
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20.16 (EXTRACT)
Other expenses
Depreciation - machinery
Repair costs
R
114 750
2 750
N NAIDOO
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.16 (EXTRACT)
ASSETS
Non-current assets
Property, plant and equipment R(555 800 – 114 750)
Note
3
R
441 050
20

SOLUTION 1.3 (continued)
N NAIDOO
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED
31 DECEMBER 20.16 (EXTRACT)
Property, plant and equipment
Carrying amount – 1 January 20.16
Cost
Accumulated depreciation
Movement during the year
Additions
Disposals
Depreciation
Carrying amount – 31 December 20.16
Cost
Accumulated depreciation
Machinery
R xxx xx
(x)
555 800
(x)
(114 750) xxx xxx
(xx)
21

After having worked through this learning unit, are you able to do the following?
Explain the acronyms IFRS, IAS, APB, FRSC and SAICA.
Describe what the concept "Conceptual Framework" entails.
List the specific purposes of the Conceptual Framework regarding the preparation and presentation of financial statements.
Explain the main objectives of financial statements per the Conceptual
Framework.
Explain the underlying assumption when preparing financial statements per the Conceptual Framework.
Discuss the qualitative characteristics of financial statements per the
Conceptual Framework.
Explain what the Conceptual Framework implies when it refers to the constraints in preparing financial statements as it is referred to in the
Conceptual Framework.
Discuss the elements of financial statements as explained in the
Conceptual Framework and indicate which elements pertain to the statement of financial position and which to the statement of profit or loss and other comprehensive income.
Yes No
Discuss the concepts of recognition and disclosure of the elements incorporated in financial statements, as explained in the Conceptual
Framework.
Explain what is meant by the measurement of the elements of financial statements by referring to the measurement methods discussed in the
Conceptual Framework.
Explain what type of business ownership must comply with IFRS.
Define each of the following terms imply per IAS 1: fair presentation going concern accrual basis of accounting materiality and aggregation offsetting frequency of reporting comparative information and consistency of presentation.
List the individual statements that, per IAS 1, together form the complete set of financial statements of a reporting entity.
22

Explain what is meant by the identification of financial statements.
Explain what is meant by reporting period.
Explain which items comprise current assets and current liabilities per
IAS 1.
List the items that must be presented on the face of the Statement of
Financial Position and the Statement of Profit or Loss and Other
Comprehensive Income respectively by referring to IAS 1.
List the items that can be presented on either the face of the Statement of
Financial Position and the Statement of Profit or Loss and Other
Comprehensive Income or in the notes to these statements for the particular reporting period per IAS 1.
Discuss the purpose of notes, by referring to IAS 1.
Discuss, according to IAS 1, the order in which items are disclosed as notes to financial statements.
Explain or define the following: a financial instrument a financial asset a financial liability fair value a contract.
Yes No
Distinguish between financial instruments, financial assets and financial liabilities.
Recognise, measure and present certain financial assets and liabilities in the financial statements.
If you answered "yes" to all of the above assessment criteria, you can move on to learning unit 2. If your answer was "no" to any of the above criteria, revise those sections concerned before progressing to learning unit 2.
23

24

2
2
Learning outcomes ............................................................................................................26
Key concepts .....................................................................................................................26
2.1
Introduction ...............................................................................................................27
2.2
Establishment of a sole proprietorship ......................................................................28
2.3
Statement of profit or loss and other comprehensive income ....................................28
2.4
Statement of changes in equity .................................................................................30
2.5
Statement of financial position and notes..................................................................31
2.6
Exercises and solutions ............................................................................................32
Self-assessment ................................................................................................................44
25

After studying this learning unit you should be able to: x record adjustments in the financial statements of a sole proprietorship x prepare a statement of profit or loss and other comprehensive income of a sole proprietorship x prepare a statement of changes in equity of a sole proprietorship x prepare a statement of financial position of a sole proprietorship x draft the notes to the financial statements of a sole proprietorship
x
Sole proprietor/sole trader x
Investment in a sole proprietorship x
Equity x
Capital x
Profit/loss for the period/year x
Drawings
26

In the FAC1502 module the financial accounting cycle concerning input and processing was dealt with and you were introduced to the preparation of financial statements of a sole proprietorship.
In FAC1601 we deal specifically with the preparation of the output (financial statements) for different entities such as sole proprietorships (revision), partnerships and close corporations.
We also introduce you to companies. However, the statement of cash flows for these different entities (except companies) is covered in learning unit 9.
The accounting process that presents the output can be illustrated as follows:
Input
FAC1502
ƒ Transaction data is recorded on
ƒ Source documents which is used to prepare
Processing
FAC1502
ƒ Subsidiary journals which is posted to
ƒ General ledger which is used to
ƒ Prepare a pre-adjustment trial balance
ƒ Adjustments are done
ƒ Post-adjustment trial balance is prepared
ƒ Closing transfers are done
Output
FAC1601
ƒ Statement of profit or loss and other comprehensive income
ƒ Statement of financial position
ƒ Statement of changes in equity
ƒ Statement of cash flows (dealt with in learning unit 9)
ƒ Notes
When closing transfers are done as part of the accounting process, two accounts are created in the general ledger, namely the trading account and the profit or loss account. Generally, the gross profit of the entity is calculated in the trading account whilst the profit and loss account presents the income and expenditure of the entity. These two accounts pave the way to prepare financial statements. Financial statements are prepared to provide information on the state of financial affairs of the entity and to enable decision making.
This learning unit is a revision of the preparation of the financial statements of a sole proprietorship (also known as a sole trader). Sole proprietorship is the simplest form of business ownership and is often managed by the owner himself. There is no legislation prescribing how a sole proprietorship should be established. The accounting process and preparation of financial statements have been dealt with extensively in FAC1502 and we therefore mainly provide you with additional questions and suggested solutions to refresh your knowledge. Reference to Volume 1 of the prescribed textbook is given to help you to refer back if you feel that your knowledge may be lacking. However, Volume 1 is not prescribed for this module.
27

Cash and/or any other type of asset, for example a motor vehicle, are required to start the business entity. The equity simply consists of the capital invested in the business entity plus the profit made (or less a loss suffered), and less any money and/or goods withdrawn by the owner for personal use.
Read paragraphs 15.1 in your prescribed textbook – About financial accounting Volume 1 to refresh your memory on sole proprietorships.
A sole proprietor usually contributes capital in the form of cash, and/or non-current assets in the form of property, plant and equipment towards the starting of the business. The following example illustrates the accounting entries that are made when a sole proprietorship is established.
Activity 2.1
On 1 March 20.1, J Manjane invests R25 000 to start JM Spaza Supplies. His investment consists of R3 000 cash, equipment valued at R8 000 and a motor vehicle valued at R14 000.
Prepare the general journal entry that will be made to record the relevant information of JM
Spaza Supplies on the date of the investment.
Feedback 2.1
JM SPAZA SUPPLIES
GENERAL JOURNAL
20.1
Mar 1 Bank
Equipment
Motor vehicles
Capital
Deposit of cash in the bank account of the entity and recording of other assets brought into the entity at valuation
DR
R
3 000
8 000
14 000
CR
R
25 000
In the above activity, no other journals were requested. Normally the cash portion of the capital is recorded in the cash receipts journal.
Once the sole proprietorship is established, the accounting cycle commences. At the end of the accounting period a trail balance is prepared. As explained in the introduction, in this module you will be required to do some adjustments whilst preparing the financial statements and accompanying notes. It is therefore in your own interest to study the layout of a statement of profit or loss and other comprehensive income to be able to present the accounting information in the required format as prescribed by IAS 1.
28

Activity 2.2
Study the layout illustrated in paragraph 1.6 in Volume 2 of the prescribed textbook.
A statement of profit or loss and other comprehensive income is the statement that indicates the result of the operating performance of the entity for a specific period.
Recall that revenue (in the example revenue consists of net sales) is calculated as the balance of the sales account in the general ledger minus settlement discount granted and less any adjustments that may be applicable to sales which have not been taken into account yet.
Assuming that the sole proprietorship is also a registered VAT vendor, you have to realise that
VAT is already excluded from applicable amounts such as sales, purchases, etc. The reason is that in the journals of first entry, VAT input and VAT output have been separately accounted for and transferred to a VAT control account which is either a VAT receivable (debit control account) or a payable (credit control account).
When the perpetual inventory system is used, cost of sales in the statement of profit or loss and other comprehensive income is the balance of the cost of sales account in the general ledger less settlement discount received plus an inventory deficit (if a deficit exists when the physical inventory count shows less closing inventory than the inventory account at the end of the accounting period). When the periodic inventory system is in use, the calculation of the cost of sales is shown on the face of the statement of profit or loss and other comprehensive income. The example in paragraph 1.6 in the prescribed textbook illustrates the use of a perpetual inventory system whereas example 15.2 in Volume 1 illustrates the use of a periodic inventory system.
Interest paid is a separate line item and is referred to as finance costs. Interest income is shown separately as part of other income and for purposes of this module it is never offset against interest paid.
Activity 2.3
Based on your FAC1502 knowledge, prepare the layout of the gross profit section of the statement of profit or loss and other comprehensive income of Bibi Traders for the year ended
28 February 20.17. Assume that a periodic inventory system is used.
29

Feedback 2.3
BIBI TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.17
Notes
Revenue
Cost of sales
Inventory – 1 March 20.16
Purchases (net purchases - after purchase returns and settlement
R xxx xxx
(xx xxx) xx xxx discount received)
Carriage on purchases xxx xxx xx xxx
Inventory – 28 February 20.17
Gross profit xxx xxx
(xx xxx) xxx xxx
You will remember that a statement of changes in equity is compiled to show the movement in equity during the financial period. This implies that you commence with the balance of equity at the beginning of the accounting period (normally a year) and you disclose the movements that caused a difference in the opening and closing balance of equity. For a sole proprietorship we also refer to equity as capital.
Activity 2.4
Based on your FAC1502 knowledge, prepare the layout of a statement of changes in equity for a sole proprietorship, Wong Chu Traders. Assume a 30 June 20.17 year end.
Feedback 2.4
WONG CHU TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.17
Balance as at 1 July 20.16
Profit for the year
Additional capital contribution
Drawings
Balance as at 30 June 20.17
R xxx xx xxx
(x) x xxx
30

The statement of financial position indicates the financial position of the owner of the sole proprietorship at a specific date, which is normally year end. Notes are prepared to explain the accounting policies implemented when presenting the financial statements and how the amounts in the financial statements were calculated. Examples of accounting policies are the basis on which the statements are presented (for example historical cost) as well as the accounting framework adapted in the preparation of the financial statements, the methods used to calculate depreciation and value property, plant and equipment, the valuation methods adopted to account for inventory, the valuation methods adopted to account for financial assets/liabilities and many more. Notes must be presented systematically and crossreferenced to the line items in the statement of profit or loss and other comprehensive income, the statement of financial position, statement of changes in equity and the statement of cash flows. Similar as to what you encountered in FAC1502 as notes, we will again introduce you to the most significant notes applicable to first-year accounting. The notes become more complicated in later years and it will ensure a good foundation if you can present the notes that we illustrate in the different learning units.
Activity 2.5
Study the example of a layout of the statement of financial position and the applicable notes to the financial statements in paragraph 1.6 in Volume 2 of the prescribed textbook.
In FAC1601 you will mostly be presented with a pre-adjustment trial balance prepared from the general ledger of the entity. You will then have to do the adjustments and prepare the required financial statements.
The questions and time for completion will not always allow you to do the adjustments in a journal and to post it to a ledger. You will thus be required to do the adjustments while preparing the financial statements; for that reason you must know the journal entries that can be applicable to account for adjustments, by heart. This will enable you to know which account is debited and which credited in order to prepare the financial statements with the doubleentry in mind and without physically posting to a general journal and prepare a post-adjustment trial balance. In paragraph 2.6 of this learning unit we present you with revision exercises and solutions where you will apply your knowledge of adjustments with and without the aid of a general journal in preparing the financial statements of sole proprietors.
Always remember the accounting equation:
31

The adjustments that were covered in FAC1502 and that you may encounter in FAC1601 are:
Adjustments: x
Inventory on hand x
Depreciation x
Expenses payable x
Prepaid expenses x
Income receivable x
Income received in advance (prepaid income) x
Credit losses x
Allowance for credit losses x
Allowance for settlement discount received x
Allowance for settlement discount granted
EXERCISE 2.1
The following information relates to Lebombo Distributors, which is a sole proprietorship of
L Lebombo:
Pre-adjustment trial balance of Lebombo Distributors as at 31 December 20.1
Debit Credit
R R
141 700 Capital (1 January 20.1) ..............................................................
Land and buildings (at cost) .........................................................
Vehicles (at cost)..........................................................................
Equipment (at cost) ......................................................................
Accumulated depreciation: Vehicles (1 January 20.1) .................
Accumulated depreciation: Equipment (1 January 20.1) ..............
Fixed deposit: NBC Bank Ltd (1 January 20.1).............................
Inventory: Merchandise ................................................................
Trade receivables control .............................................................
Bank.............................................................................................
Petty cash ....................................................................................
Cash float.....................................................................................
Trade payables control.................................................................
VAT control ..................................................................................
Long-term borrowing: Bean Ltd ....................................................
Allowance for credit losses ...........................................................
Sales............................................................................................
Cost of sales ................................................................................
Sales returns................................................................................
Wages..........................................................................................
Salaries ........................................................................................
Assessment rates.........................................................................
263 240
40 000
9 000
50 000
8 500
5 200
3 100
100
500
165 400
1 200
2 000
25 000
1 500
11 200
1 710
8 800
750
25 000
300
381 790
32

Settlement discount granted.........................................................
Licences.......................................................................................
Vehicle expenses .........................................................................
Credit losses ................................................................................
Packaging materials.....................................................................
Insurance .....................................................................................
Water and electricity.....................................................................
Telephone expenses....................................................................
Advertising ...................................................................................
Rental income ..............................................................................
Settlement discount received .......................................................
Interest on investment ..................................................................
Credit losses recovered................................................................
Debit
R
380
1 000
3 500
550
4 700
2 250
2 100
1 400
2 000
Credit
R
592 620
15 600
650
5 000
120
592 620
The following adjustments must still be accounted for:
1.
Packaging material on hand at 31 December 20.1 to the value of R980.
2.
The long-term borrowing was entered into on 1 October 20.1. According to the agreement, interest is payable bi-annually at a rate of 18% per annum.
3.
Advertisements includes an amount of R400 paid for January 20.2.
4.
Rental income includes an amount in respect of January 20.2. Rental income was earned evenly throughout the year.
5.
Interest on the fixed deposit has not yet been received for the last two months of the financial year. Interest is calculated at a rate of 12% per annum.
6.
Insurance includes an amount of R750 paid for the period 1 November 20.1 to
31 October 20.2.
7.
The telephone account of R165 for December 20.1 has not yet been paid.
8.
Equipment of R2 000 (cost price) was purchased on 1 July 20.1.
9.
Depreciation must be provided as follows: x
Vehicles: 20% per annum on the diminishing balance method.
x
Equipment: 10% per annum on the diminishing balance method.
10.
The account of Loose-Ends Ltd, a debtor who owes the entity R200, must be written off as irrecoverable.
11.
It was determined that on 31 December 20.1 the allowance for credit losses should amount to R250.
12.
Lebombo Distributors uses a perpetual inventory system.
REQUIRED a) Prepare the journal entries to record the adjustments above.
b) c)
Prepare the closing journal entries. Post these journal entries to the trading and the profit or loss accounts on 31 December 20.1.
Prepare the statement of profit or loss and other comprehensive income of
Lebombo Distributors for the year ended 31 December 20 1.
33

d) e)
Prepare the statement of changes in equity of Lebombo Distributors for the year ended 31 December 20.1.
Prepare the statement of financial position of Lebombo Distributors as at
31 December 20.1.
f) Prepare the following notes to the financial statements of Lebombo Distributors for the year ended 31 December 20.1: x
Accounting policy for the basis of presentation, property, plant and quipment and financial assets x
Property, plant and equipment x
Financial assets
Please note:
Your answer must comply with the requirements of International Financial Reporting
Standards (IFRS) appropriate to the business of the sole trader.
SOLUTION 2.1
a) LEBOMBO DISTRIBUTORS
GENERAL JOURNAL - 31 DECEMBER 20.1
20.1
Dec 31
Inventory: Packaging material
Packaging material
Packaging material on hand at 31 December 20.1
Interest on loan (R25 000 x 18% x 3 /
12
)
Accrued expenses
Interest on loan still payable
Prepaid expenses
Advertisements
Advertisements paid in advance
Rental income (R15 600 x 1 /
3
)
Income received in advance
Rent received in advance
Accrued income
Interest on investment (R50 000 x 12% x
Interest on investment not yet received
Prepaid expenses
Insurance (R750 x 10 /
12
)
Insurance prepaid
2 /
12
)
Telephone expenses
Accrued expenses
Telephone account for December brought into account
Depreciation
Accumulated depreciation on vehicles
Accumulated depreciation on equipment c
Depreciation provided at 20% per annum on the diminishing balance of vehicles and at 10% per annum on the diminishing balance of equipment.
Credit losses
Loose-Ends/Trade receivables control
Account written off as irrecoverable
Allowance for credit losses
Credit losses
Adjustment of allowance for credit losses
Debit
R
980
1 125
400
1 200
1 000
625
165
6 389
200
50
Credit
R
980
1 125
400
1 200
1 000
625
165
5 760
629
200
50
34

SOLUTION 2.1 (continued)
Calculation c
Depreciation
The accumulated depreciation is on the equipment owned by the entity at the beginning of the financial year. Two calculations are therefore needed:
1.1
Equipment purchased in previous years
[(R9 000 – R2 000) – R1 710] x 10%
= R529
1.2
Equipment purchased in the current year
R2 000 x 10% x 6/12
= R100
Total depreciation for equipment:
(R529 + R100) = R629 b) LEBOMBO DISTRIBUTORS
GENERAL JOURNAL Closing journal entries
20.1
Dec 31
Sales
Settlement discount granted
Closing off and transfer of settlement discount granted to sales
Sales
Sales return
Closing off and transfer of sales returns to sales
Sales R(381 790 – 380 – 1 200)
Trading Account
Closing off and transfer of sales to trading account
Settlement discount received
Cost of sales
Closing off and transfer of settlement discount to cost of sales
Trading Account
Cost of sales R(165 400 – 650)
Closing off and transfer of cost of sales account to trading account
Trading Account
Profit or loss
Transfer of gross profit
Rental income R(15 600 – 1 200)
Interest on investment R(5 000 + 1 000)
Credit losses recovered
Profit or loss
Closing off of above accounts against profit or loss
Debit
R
380
Credit
R
1 200
380
380 210
380 210
650
164 750
215 460
14 400
6 000
120
1 200
650
164 750
215 460
20 520
35

SOLUTION 2.1 (continued)
Profit or loss
Wages
Salaries
Assessment rates
Licences
Vehicle expenses
Credit losses R(550 + 200 – 50)
Packaging material R(4 700 – 980)
Insurance R(2 250 – 625)
Water and electricity
Telephone expenses R(1 400 + 165)
Advertising R(2 000 – 400)
Interest on loan
Depreciation
Closing off of above accounts against profit or loss account
Profit or loss R(215 460 + 20 520 – 51 824)
Capital
Transfer of profit to capital account
Debit
R
51 824
Credit
R
2 000
25 000
1 500
1 000
3 500
700
3 720
1 625
2 100
1 565
1 600
1 125
6 389
184 156
184 156
Dr Trading account Cr
20.1
Dec 31 Cost of sales
Profit or loss account
(Gross profit)
R
164 750
215 460
20.1
Dec 31 Sales
R
380 210
380 210 380 210
Dr Profit or loss account Cr
R R
20.1
Dec 31 Wages
Salaries
Assessment rates
Licences
Vehicle expenses
Credit losses
Packaging material
Insurance
Water and electricity
Telephone expenses
Advertising
Interest on loan
Depreciation
Capital (Total comprehensive income for the year)
2 000
25 000
1 500
1 000
3 500
700
3 720
1 625
2 100
1 565
1 600
1 125
6 389
184 156
20.1
Dec 31 Trading account
(Gross profit)
Rental income
Interest on investment
Credit losses recovered
215 460
14 400
6 000
120
235 980 235 980
36

SOLUTION 2.1 (continued) c) LEBOMBO DISTRIBUTORS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20.1
Revenue
Cost of sales
R
380 210
(164 750)
Gross profit
Other income
Rental income
Credit losses recovered
Interest income
215 460
20 520
14 400
120
6 000
Distribution, administrative and other expenses
Wages
Salaries
Assessment rates
Licences
Vehicle expenses
Credit losses
Packaging material
Insurance
Water and electricity
Telephone expenses
Advertising
Depreciation
Finance costs
Interest on long-term loan
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
235 980
(50 699)
2 000
25 000
1 500
1 000
3 500
700
3 720
1 625
2 100
1 565
1 600
6 389
(1 125)
1 125
184 156
–
184 156 d) LEBOMBO DISTRIBUTORS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 DECEMBER 20.1
Balance at 1 January 20.1
Total comprehensive income for the year
Balance at 31 December 20.1
Capital
R
141 700
184 156
325 856
37

SOLUTION 2.1 (continued) e) LEBOMBO DISTRIBUTORS
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.1
Notes ASSETS
Non-current assets
Property, plant and equipment
Fixed deposit: NBC Bank
Current assets
Inventories
Trade and other receivables R(5 200 – 200 – 250 + 1 000)
Prepayments R(625 + 400)
Cash and cash equivalents R(3 100 + 500 + 100)
Total assets
2.1, 3
2.2, 4
4
R
342 941
292 941
50 000
19 955
9 480
5 750
1 025
3 700
362 896
EQUITY AND LIABILITIES
Equity
Capital
Total liabilities
Non-current liabilities
Long-term borrowings
Current liabilities
Trade and other payables R (8 800 + 750 + 1 125 + 165)
Income received in advance
Total equity and liabilities
325 856
325 856
37 040
25 000
25 000
12 040
10 840
1 200
362 896 f) LEBOMBO DISTRIBUTORS
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED
31 DECEMBER 20.1
Accounting policy
1.
Basis of presentation
The annual financial statements have been prepared on the historical cost basis, modified by the fair value of certain financial instruments and comply with International Financial
Reporting Standards (IFRS).
2. Summary of the significant accounting policies
2.1 Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation is written off on land and buildings. Vehicles and equipment are subsequently measured at cost less accumulated depreciation. Depreciation on equipment and vehicles are written off at a rate deemed to be sufficient to reduce the carrying amount of the assets over their estimated useful life. The depreciation rates are as follows:
Vehicles: 20% per annum using the diminishing balance method
Equipment: 10% per annum using the diminishing balance method
2.2 Financial assets
Financial assets are recognised when the entity becomes a party to the provisions of a financial instrument. The entity’s classification depends on the purpose for which the financial asset has been acquired. Financial assets are initially recognised at either fair value (which excludes transaction costs) or amortised cost as required by IFRS. Financial assets are subsequently measured at either fair value or amortised cost.
38

SOLUTION 2.1 (continued)
3.
Property, plant and equipment
Carrying amount – 1 Jan 20.1
Cost
Accumulated depreciation
Additions
Depreciation for the year
Carrying amount – 31 Dec 20.1
Cost
Accumulated depreciation
4.
Financial assets
Land and buildings
R
263 240
263 240
–
–
–
263 240
263 240
–
Vehicles
R
28 800
40 000
(11 200)
–
(5 760)
23 040
40 000
(16 960)
Non-current financial assets
Fixed deposit at amortised cost: NBC Bank Ltd at 12% p.a.
Current financial assets
Trade and other receivables
Trade receivables control R(5 200 – 200)
Allowance for credit losses
Cash and cash equivalents
Bank
Petty cash
Cash float
Equipment
R
5 290
7 000
(1 710)
2 000
(629)
6 661
9 000
(2 339)
R
50 000
50 000
8 450
4 750
5 000
(250)
3 700
3 100
100
500
Total
R
297 330
310 240
(12 910)
2 000
(6 389)
292 941
292 240
(19 299)
EXERCISE 2.2
At 31 March 20.15, Cartoon Traders had the following general ledger balances before any adjustments were made:
CARTOON TRADERS
BALANCES AS AT 31 MARCH 20.15
Rental income ............................................................................................
Stationery...................................................................................................
Capital........................................................................................................
Drawings ....................................................................................................
Accumulated depreciation: Equipment .......................................................
Commission income ...................................................................................
Credit losses ..............................................................................................
Property (at cost)........................................................................................
Equipment (at cost)………………………………………………………………
Bank (favourable) ......................................................................................
Trade receivables control ...........................................................................
Interest on mortgage ..................................................................................
Municipal taxes ..........................................................................................
Insurance ...................................................................................................
Mortgage...................................................... …………………………………
Water and electricity………….....................................................................
R
64 000
3 350
149 000
6 084
15 000
2 700
1 600
350 000
34 000
24 208
26 100
23 870
4 333
2 405
248 000
2 750
39

The following adjustments must still be accounted for:
1.
Cartoon Traders has five tenants, each paying different rental amounts. At the end of
March 20.15, one of the tenants owed two month’s rent to the entity. The monthly rental payable by the tenant is R1 750.
2.
Stationery on hand at 31 March 20.15 amounted to R1 550.
3.
Commission income of R750 was earned for April and May 20.15.
4.
Mr D Poor disappeared and the management decided to write off his debt amounting to
R2 650 as irrecoverable.
5.
Provision should still be made for depreciation on equipment at 10% per annum on the diminishing balance method.
6.
The water and electricity account for March 20.15 amounting to R310, has not yet been paid.
7.
The insurance premium for April 20.15 was paid in advance. The premiums are paid in equal monthly amounts.
8.
Interest on mortgage is calculated at a rate of 10,5% per annum. The interest for
March 20.15 is still to be accounted for.
REQUIRED a) Calculate the total comprehensive income or loss of Cartoon Traders for the year ended 31 March 20.15.
b) Prepare the statement of financial position of Cartoon Traders as at 31 March 20.15.
Please note:
All calculations must be shown.
Your answer must comply with the requirements of International Financial Reporting
Standards (IFRS) appropriate to the business of the entity.
SOLUTION 2.2
a) Calculation of total comprehensive income or loss:
Rental income R(64 000 + 3 500)
Commission income R(2 700 – 750)
Less: Expenses
Interest on mortgage (R248 000 x 10.5%)
Water and electricity R(2 750 + 310)
Municipal taxes
Insurance R(2 405 – (2 405/13))
Stationery R(3 350 – 1 550)
Credit losses R(1 600 + 2 650)
Depreciation R(34 000 – 15 000) x 10%
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
R
67 500
1 950
69 450
(43 603)
26 040
3 060
4 333
2 220
1 800
4 250
1 900
25 847
–
25 847
40

SOLUTION 2.2 (continued) b) CARTOON TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20.15
ASSETS
Non-current assets
Property, plant and equipment R(350 000 + 34 000 – 15 000 – 1 900)
Current assets
Inventories
Trade and other receivables R(26 100 – 2 650 + 3 500 + 185)
Cash and cash equivalent
TOTAL ASSETS
EQUITY AND LIABILITIES
Equity
Capital R(149 000 – 6 084 + 25 847)
Total liabilities
Non-current liabilities
Long-term borrowings
Current liabilities
Trade and other payables R(750 + 310 + 26 040 – 23 870)
Total equity and liabilities
R
367 100
52 893
1 550
27 135
24 208
419 993
168 763
168 763
251 230
248 000
248 000
3 230
3 230
419 993
EXERCISE 2.3
BOJANE TRADERS
PRE-ADJUSTMENT TRIAL BALANCE AT 30 JUNE 20.15
Capital............................................................................................
Drawings ........................................................................................
Trade receivables control ...............................................................
Vehicles (at cost)............................................................................
Accumulated depreciation: Vehicles...............................................
Inventory: Trading (1 July 20.14) ....................................................
Bank...............................................................................................
Mortgage........................................................................................
Loan from Africa Bank....................................................................
Sales..............................................................................................
Carriage on purchases ...................................................................
Import duty on purchases...............................................................
Insurance on purchases .................................................................
Commission income .......................................................................
Depreciation...................................................................................
Insurance .......................................................................................
Packaging materials .......................................................................
Purchases ......................................................................................
Purchases returns ..........................................................................
Debit
R
–
27 000
18 560
202 100
–
28 300
56 520
–
–
–
750
782
329
–
19 100
8 575
4 600
190 800
–
Credit
R
202 000
–
–
–
19 100
–
–
105 000
15 000
272 195
–
18 000
–
–
–
–
–
–
245
41

Rental income ................................................................................
Sales returns..................................................................................
Settlement discount granted...........................................................
Settlement discount received .........................................................
Telephone expenses ......................................................................
Carriage on sales ...........................................................................
Repairs……………… . ………………………………………………….
Fuel………………. ………………………………………………………
Wages............................................................................................
Water and electricity.......................................................................
Debit
R
–
1 860
465
–
2 420
1 250
2 160
3 479
64 115
5 100
638 265 638 265
Credit
R
6 500
–
–
225
–
–
–
–
–
–
The following information must still be taken into account for the year ended
30 June 20.15:
1.
On 1 July 20.15, trading inventory had a balance of R22 750.
2.
Rental income for the year should have been R6 000.
3.
Packaging material on hand at 30 June 20.15 amounted to R1 200.
4.
Commission income of R3 600 is still outstanding.
5.
An account in respect of water and electricity amounting to R500 must still be paid.
6.
The mortgage was obtained from XYZ Bank during the previous financial year and bears interest at a rate of 11,5% per annum. Interest for the current year must still be provided for.
7.
The loan from Africa Bank is unsecured and bears interest at 19,5% per annum. Interest for the current year must still be provided for.
8.
A debtor who owes the business R4 640 was declared insolvent and his account must be written off as irrecoverable.
9.
The insurance amount includes the premiums for the months of July and August 20.15.
REQUIRED a) Prepare the statement of profit or loss and other comprehensive income of Bojane
Traders for the year ended 30 June 20.15.
b) Prepare the statement of changes in equity of Bojane Traders for the year ended
30 June 20.15.
Please note:
Your answers must comply with the requirements of International Financial Reporting
Standards (IFRS) appropriate to the business of the entity. All calculations must be shown.
42

SOLUTION 2.3
a) BOJANE TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 30 JUNE 20.15
R
Revenue R(272 195 – 1 860 – 465)
Cost of sales
Inventory - 1 July 20.14
Purchases R(190 800 – 245 – 225)
Carriage on purchases
Import duty on purchases
Insurance on purchases
Less: Inventory - 30 June 20.15
Gross profit
Other income
Rental income R(6 500 – 500)
Commission income R(18 000 + 3 600)
Distribution, administration and other expenses
Repairs
Insurance R(8 575 – (8 575/14 x 2))
Wages
Water and electricity R(5 100 + 500)
Petrol
Packing materials R(4 600 – 1 200)
Depreciation
Telephone expenses
Carriage on sales
Credit losses
Finance costs
Interest on mortgage (R105 000 x 11,5%)
Interest on short term loan (R15 000 x 19,5%)
Loss for the year
Other comprehensive income for the year
Total comprehensive loss for the year
269 870
(197 741)
28 300
190 330
750
782
329
220 491
(22 750)
72 129
27 600
6 000
21 600
99 729
(113 514)
2 160
7 350
64 115
5 600
3 479
3 400
19 100
2 420
1 250
4 640
(15 000)
12 075
2 925
(28 785)
–
(28 785) b) BOJANE TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.15
Capital
R
Balance as at 1 July 20.14
Comprehensive loss for the year
Less: Drawings
Balance as at 30 June 20.15
202 000
(28 785)
(27 000)
146 215
43

After having worked through this learning unit, are you able to do the following?
Record applicable adjustments in the financial statements of a sole proprietorship.
Yes No
Prepare a statement of profit or loss and other comprehensive income for a sole proprietorship.
Prepare a statement of changes in equity for a sole proprietorship.
Prepare a statement of financial position for a sole proprietorship.
Prepare the required notes to the financial statements of a sole proprietorship.
If you answered "yes" to all of the above assessment criteria, you can move on to learning unit 3. If your answer was "no" to any of the above criteria, revise those sections concerned before progressing to learning unit 3.
44

3
3
Learning outcomes ............................................................................................................46
Key concepts .....................................................................................................................46
3.1
Introduction ...............................................................................................................47
3.2
Reasons for the formation of partnerships ................................................................47
3.3
The legal position of a partner...................................................................................48
3.4
Establishment of a partnership..................................................................................48
3.5
The partnership agreement .......................................................................................48
3.6
Dissolution of a partnership.......................................................................................49
3.7
Accounting procedures and specialised accounts .....................................................49
3.8
Financial statements of a partnership........................................................................52
3.9
Exercises and solutions ............................................................................................53
Self-assessment ................................................................................................................66
45

After studying this learning unit, you should be able to: x define a partnership x explain the reasons why a partnership is formed x discuss the contents of a partnership agreement x explain the ways in which a partnership can be established x explain the factors which can lead to the dissolution of a partnership x record the transactions of a partnership in the accounting records x prepare the financial statements of a partnership in accordance with the requirements of
IFRS, appropriate to the business of the partnership
x
Partnership x
Partners x
Partnership agreement x
Profit-sharing ratio x
Dissolution x
Legal approach x
Entity approach x
Equity x
Appropriation account x
Financial statement
46

Because a sole trader has only one owner and usually limited capital resources, two or more entrepreneurs often opt to form a business entity that can accommodate more than one owner. If their requirement is to establish an entity without the judicial complications associated with a company or close corporation, the formation of a partnership is an appropriate choice of business ownership.
Look at the overview of this learning unit in the prescribed textbook and read paragraph 2.1 in the prescribed textbook. Pay special attention to the definition of a partnership and the difference between a business entity with and without legal status.
Activity 3.1
State whether the following statements are true or false: a) A partnership is a legal entity.
b) The assets and liabilities of a partnership belong to the owners.
c) A partnership agreement must be in writing.
Feedback 3.1
a) False.
A partnership has no legal status. Only the owners have legal status.
b) True. c) False.
An oral agreement is also binding.
There are many reasons why entrepreneurs enter into a partnership agreement. One of the reasons is to have access to more capital and expertise.
Read paragraph 2.2 in the prescribed textbook.
Activity 3.2
Name four reasons for the formation of a partnership.
47

Feedback 3.2
x
Increased access to capital x
Eliminating competition x
Uniting capital and expertise x
Retaining skills and expertise
Read paragraph 2.3 in the prescribed textbook.
Read paragraph 2.4 in the prescribed textbook. Note how a partnership can be established by action or agreement .
Read paragraph 2.5 in the prescribed textbook. Can you name some essential matters of a partnership agreement?
Activity 3.3
a) It is advisable that a partnership agreement must be verbal.
True or False?
b) What is the common law principle concerning the ownership and management of a partnership?
c) What is the common law principle if the partnership agreement does not stipulate a profit-sharing ratio?
Feedback 3.3
a) False. A written agreement is advisable.
b) Partners share ownership in the same ratio as their profit-sharing ratio and have equal rights in the management of the entity.
c) Partners will share the profits/losses in the same ration as their capital contribution ratio to the partnership.
48

Unlike a company or close corporation, a partnership has a limited life span.
Read paragraph 2.6 in the prescribed textbook.
Can you name all the factors that lead to the ending of a partnership?
Just like a sole proprietorship, a partnership is a separate accounting entity (without legal status). It also keeps record of its accounting transactions in journals, subsidiary journals and ledgers and must prepare financial statements as an output. Refer to the accounting process in learning unit 2.
Study paragraph 2.7 in the prescribed textbook. Pay particular attention to the use of capital, current, drawings, loan and appropriation accounts in partnerships.
Two approaches can be followed in preparing the accounts of a partnership namely the legal and the entity approach. Make sure that you understand the difference between the two approaches. For the sake of simplicity, we follow a legal approach in this module.
The recording of equity of a partnership is through the use of capital, current and drawings accounts. The sole proprietorship made use of capital and drawings accounts.
Activity 3.4
a) What approached is followed when the partners and partnership are seen as two different accounting entities?
b) How would interest paid on a capital investment be treated when an entity approach is followed and how is it treated when the legal approach is followed in the accounting records of the partnership?
c) In which account is the initial investment of a partner in a partnership captured? How can a partner increase this account?
d) When is it compulsory to use a drawings account for each partner? And if the drawings account is not compulsory, which other account can be used to record, for example, cash drawings of partners?
e) When is a loan account used in the accounting records of a partnership? How is the interest payable or receivable treated in the statement of profit or loss and other comprehensive income of the partnership?
f) What is the purpose of an appropriation account?
49

Feedback 3.4
a) The entity approach.
b) According to the entity approach – capital is regarded as finance (from a separate entity
– the partner) and the related interest on capital is treated as finance costs.
According to the legal approach – capital is not regarded as finance from a separate entity (the partner) and interest on capital is an appropriation/distribution of profit to the partner and not a finance cost.
c) The initial investment in a partnership is captured in a capital account. The capital account can only increase with an additional investment into the partnership.
d) It is only compulsory when the partnership agreement states the use of drawings accounts. The current account can be used.
e) When a partner, in his/her personal capacity, grants a repayable loan to or receives a repayable loan from the partnership. The interest paid is treated as finance cost whereas the interest received is treated other income in the statement of profit or loss and other comprehensive income.
f) The appropriation account is a final account used to appropriate the profit/loss of the partnership to its partners according to the profit-sharing ratio.
Activity 3.5
Monte and Carlos are partners in Montecarlo Traders. The profit of the partnership for the year
28 February 20.7 amounted to R960 000 before taking the following provisions of the partnership agreement into account:
1. Partners are entitled to 15% interest on the opening balances of their capital accounts.
2. The partners share equally in a profit/loss.
3. Monte receives a salary of R7 000 per month.
The opening balances of the capital accounts amounted to R350 000 for Monte and R450 000 for Carlos.
REQUIRED
Prepare the appropriation account in the general ledger of Montecarlo Traders on
28 February 20.7.
50

Feedback 3.5
MONTECARLO TRADERS
GENERAL LEDGER
Dr
20.7
28 Feb Interest on capital (15% x
R350 000) + (15% x R450 000)
Salary: Monte (12 x R7 000)
Current account: Monte 50% x
R(960 000-120 000-84 000)
Current account: Carlos 50% x
R(960 000-120 000-84 000)
Appropriation account
R
120 000
20.7
28 Feb
Profit or loss account
84 000
378 000
378 000
960 000
Cr
R
960 000
960 000
You can apply the following steps when recording the sharing of profits or losses: x
Allocate the interest on the partners’ capital and current accounts with credit balances.
The interest payable will reduce the profit available for distribution but is not disclosed in the statement of profit or loss and other comprehensive income, the reason being that it forms part of the partnership agreement and do not influence the external parties of the entity.
x
Calculate the interest on drawings (if applicable) and the interest on current accounts with debit balances. The interest receivable will increase the profit available for distribution amongst the partners but is not disclosed in the statement of profit or loss and other comprehensive income.
x
Allocate salaries, commissions and bonuses for services rendered by the partners. These expenses will reduce the profit available for distribution but is not disclosed in the statement of profit or loss and other comprehensive income.
x
Divide the remaining profit/loss according to the agreed profit-sharing ratio.
Activity 3.6
Work through example 2.1 in the prescribed textbook. Pay particular attention to the calculation of the ratio in which profits/losses are shared in the example.
Activity 3.7
DJ Black and CJ Coffee are partners in Black Coffee Music who contributed R180 000 and
R270 000 respectively. The total profit for the year amounted to R225 000.
51

REQUIRED
Calculate the profit distribution for the following three scenarios: a) DJ Black and CJ Coffee share profits in their capital contribution ratio.
b) DJ Black and CJ Coffee share profits equally.
c) DJ Black and CJ Coffee share profits in the ratio of 2:1.
Feedback 3.7
a) The capital contribution ratio is calculated as follows:
Capital contribution 180 000:270 000. Find the greatest common denominator.
90 000 can be divided into both and equals 2:3.
DJ Black’s profit = 2 /
5
CJ Coffee’s profit = 3 /
5 x R225 000 = R90 000 x R225 000 = R135 000 b) Each partner receives and equal share which is 50:50 or 1:1 which is also equal to
½:½
DJ Black’s profit = 1 /
2 x R225 000 = R112 500
CJ Coffee’s profit = 1 /
2 x R225 000 = R112 500 c) DJ Black receives R2 for every R1 that CJ Coffee receives and is stated as 2:1 or 2 /
3
: 1 /
3
DJ Black’s profit = 2 /
3
CJ Coffee’s profit = 1 /
3 x R225 000 = R150 000 x R225 000 = R75 000
By now you are familiar with the different financial statements that can be prepared as well as their accompanying notes. The cash flow statement of a partnership is dealt with in learning unit 9.
Read paragraph 2.8 in the prescribed textbook.
Activity 3.8
Work through example 2.2, 2.3 and 2.4 of the prescribed textbook which illustrates the different financial statements that can be prepared for a partnership. Pay specific attention to the statement of changes in equity which is a summary of the appropriation account. Example 2.2 illustrates the financial statements when a profit is made whilst example 2.3 illustrates the financial statements when a loss is incurred. Example 2.4 is a comprehensive example.
Read paragraph 2.9 in the prescribed textbook.
52

EXERCISE 3.1
The under mentioned information was taken from the accounting records of Bluered Traders, a partnership with B Blue and R Red as partners, on 30 September 20.15 the financial year end of the partnership.
BLUERED TRADERS
BALANCES AS AT 30 SEPTEMBER 20.15
Capital: B Blue ......................................................................................................
Capital: R Red .......................................................................................................
Current account: B Blue (1 October 20.14) (Cr) ....................................................
Current account: R Red (1 October 20.14) (Cr).....................................................
Drawings: B Blue....................................................................................................
Drawings: R Red ....................................................................................................
Mortgage ................................................................................................................
Trade payables control...........................................................................................
Bank overdraft........................................................................................................
Land and buildings at cost .....................................................................................
Equipment at cost ..................................................................................................
Accumulated depreciation: Equipment (1 October 20.14) .....................................
Motor vehicles at cost ............................................................................................
Accumulated depreciation: Motor vehicles (1 October 20.14) ...............................
Office furniture at cost ............................................................................................
Accumulated depreciation: Office furniture (1 October 20.14)...............................
Inventory (30 September 20.15) ............................................................................
Trade receivables control.......................................................................................
Allowance for credit losses (1 October 20.14) .......................................................
Petty cash ..............................................................................................................
Sales ......................................................................................................................
Cost of sales ..........................................................................................................
Advertising costs ....................................................................................................
Salaries and wages................................................................................................
Administrative expenses ........................................................................................
Insurance expenses ...............................................................................................
Carriage on sales ...................................................................................................
Interest on mortgage ..............................................................................................
Additional information:
500
350
50
21 069
16 020
600
32
340 628
306 000
4 409
12 189
2 622
364
203
450
R
20 000
5 000
1 060
2 800
9 000
3 000
10 000
24 150
6 160
19 500
19 840
5 000
900
1. Terms of the partnership agreement
1.1
The partners share profits and losses in the ratio of their fixed capital contribution.
1.2
Interest at 5% per annum is to be allowed on the opening balances of the partners’ capital and current accounts.
1.3
Interest is to be charged at 5% per annum on the average monthly amount outstanding on the partners’ drawings accounts.
1.4
R Red is entitled to a salary of R1 000 per annum plus a management commission of
10% of the comprehensive income for the financial year after his salary and the adjustments for the interest on the capital, current and drawing account have been taken into account.
53

2. Year end adjustments
2.1
An outstanding debt of R20 is irrecoverable and must be written off.
2.2
The allowance for credit losses must be adjusted to R800.
2.3
Depreciation is to be provided as follows:
Equipment: 15% per annum according to the diminishing-balance method
A new machine was purchased on 1 April 20.15 for R1 560
Motor vehicles: 20% per annum according to the straight-line method.
Office furniture: 10% per annum according to the diminishing balance method.
2.4
Interest on the mortgage up to 30 September 20.15 amounts to R600.
R4 000 of the loan is repayable during the 20.16 financial year. The loan is secured by a mortgage over land and buildings. The loan was granted by Corner Bank on
1 October 20.14. The terms of the loan provide for interest on the loan to be charged at a rate of 6% per annum.
2.5
Salaries to employees of R69 have not been paid or taken into account.
2.6
The following expenses have been prepaid:
Insurance, R62
Advertising, R948
2.7
Interest correctly calculated on the partners’ average monthly drawings accounts amounted to R320 for B Blue and R80 for R Red.
2.8
In terms of the partnership agreement, the following must still be provided for:
- Interest on the partners’ capital and current account
- R Red’s salary and management commission
REQUIRED
Prepare the following in respect of Bluered Traders to comply with the requirements of IFRS appropriate to the business of the partnership. Show all calculations but ignore comparatives: a) Statement of profit or loss and other comprehensive income for the year ended 30 September 20.15.
b) Statement of changes in equity for the year ended 30 September 20.15.
c) Statement of financial position as at 30 September 20.15.
d) Notes for the year ended 30 September 20.15.
e) Prepare the current accounts of the partners, properly balanced, in the general ledger of
Bluered Traders for the year ended 30 September 20.15. Show the correct contra ledger accounts.
54

SOLUTION 3.1
a) BLUERED TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 30 SEPTEMBER 20.15
Revenue
Cost of sales
Gross profit
Distribution, administrative and other expenses
Salaries and wages R(12 189 + 69)
Advertising costs R(4 409 – 948)
Delivery expenses
Administrative expenses
Insurance expenses R(364 – 62)
Credit losses 䙵
Depreciation 䙶
Finance costs
Interest on mortgage 䙷
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
Note
2.5
2.1
R
340 628
(306 000)
34 628
(21 385)
12 258
3 461
203
2 622
302
220
2 319
(600)
600
12 643
–
12 643 b) BLUERED TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
30 SEPTEMBER 20.15
Balances at 1 October 20.14
Total comprehensive income for the year
Salaries to partners
Interest on capital ߊ
Interest on current accounts ߋ
Interest on drawings
Commission to partners
ߌ
Drawings
Partners’ share of total comprehensive income ߍ
Capital
Current accounts
B Blue R Red B Blue R Red
R
20 000
R
5 000
R
1 060
R
2 800
1 000
53
(320)
1 000
250
140
(80)
1 060
(9 000) (3 000)
7 632 1 908
Balances at 30 September 20.15
20 000 5 000 425
Appropriation
R
–
12 643 12 643
(1 000)
(1 250)
(193)
400
(1 060)
(12 000)
(9 540)
Total equity
R
28 860
4 078 – 29 503
55

SOLUTION 3.1 (continued ) c) BLUERED TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20.15
Note
ASSETS
Non-current assets
Property, plant and equipment
Current assets
Inventories
Trade receivables R(16 020 – 20 – 800)
Prepayments R(948 + 62) ߎ
Cash and cash equivalents
Total assets
EQUITY AND LIABILITIES
Total equity
Capital R(20 000 + 5000)
Current accounts R(425 + 4 078)
Total liabilities
Non-current liabilities
Long-term borrowings
Current liabilities
Trade and other payables
Current portion of long-term borrowings
Bank overdraft
Total equity and liabilities
2.1, 3
2.3
4
4
5
5
5
5 d) BLUERED TRADERS
NOTES FOR THE YEAR ENDED 30 SEPTEMBER 20.15
Accounting policy
1.
Basis of presentation
The financial statements have been prepared in accordance with the requirements of
IFRS appropriate to the business of the entity. The annual financial statements have been prepared on the historical cost basis, modified by the revaluation of financial assets and financial liabilities at fair value through profit or loss.
2.
Summary of significant accounting policies
The financial statements incorporate the following significant accounting policies which are consistent with those applied in previous years except where otherwise stated.
2.1
Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation is written off on land and buildings. Equipment, furniture and vehicles are subsequently measured at historical cost less accumulated depreciation and accumulated impairment losses. Depreciation on equipment, furniture and vehicles is written off at a rate deemed to be sufficient to reduce the carrying amount of the assets over their estimated useful life to their estimated residual value. The depreciation rates are as follows:
Equipment: 15% per annum according to the diminishing balance method
Motor vehicles: 20% per annum according to the straight-line method
Furniture: 10% per annum according to the diminishing balance method
R
32 721
32 721
37 311
21 069
15 200
1 010
32
70 032
29 503
25 000
4 503
40 529
6 000
6 000
34 529
24 369
4 000
6 160
70 032
56

SOLUTION 3.1 (continued)
2.2
Financial instruments
Financial instruments are recognised in the entity’s statement of financial position when the entity becomes a party to the contractual provisions of an instrument. The entity classification depends on the purpose for which the entity acquired the financial assets.
Financial instruments are initially measured at the transaction price, which is fair value plus transaction costs except for “Financial assets at fair value through profit or loss” which is measured at fair value, transaction costs excluded. Financial instruments are subsequently measured at fair value unless it is measured at amortised cost as required by IFRS. Cash and cash equivalents consists of cash in bank and short-term deposits.
Financial instruments that are subsequently measured at amortised cost are done so using the effective interest rate method.
Debt instruments that are classified as current assets or current liabilities are measured at the undiscounted amount of the cash expected to be received or paid, unless the arrangement effectively constitutes a financing transaction.
2.3
Inventories
Inventories are initially measured at cost and subsequently valued at the lower of cost or net realisable value. Cost is calculated using the first-in-first-out method. Net realisable value is the estimated selling price in the ordinary course of business less any costs of completion and disposal.
2.4
Financial liabilities
Financial liabilities are recognised in the entity's statement of financial position when the entity becomes a party to the contractual provisions of the instrument. The classification depends on the purpose for which the financial liabilities were obtained.
2.5
Revenue
Revenue is measured at the fair value of the consideration received or receivable.
Revenue represents the transfer of promised goods to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods. Revenue from the sale of inventory consists of the total net invoiced sales, excluding value-added tax and settlement discount granted. Revenue is recognised when performance obligations are satisfied.
57

SOLUTION 3.1 (continued)
3.
Property, plant and equipment
Land and buildings
R
Carrying amount at
1 October 20.14
Cost
Accumulated depreciation
Additions
Disposals *
Depreciation for the year
19 500
19 500
–
–
–
–
Carrying amount at
30 September 20.15
19 500
Cost 19 500
Accumulated depreciation –
Equipment
R
13 280
18 280
(5 000)
1 560
–
(2 109)
12 731
19 840
(7 109)
Motor
Vehicles
R
400
900
(500)
–
–
(180)
220
900
(680)
Office
Furniture
R
300
350
(50)
–
–
(30)
270
350
(80)
Total
R
33 480
39 030
(5 550)
1 560
–
(2 319)
32 721
40 590
(7 869)
* Included for illustrative purposes. In cases where there are no disposals, this item is excluded from the note.
Disposals are disclosed at carrying amount.
The partnership has pledged land and buildings with a carrying amount of R19 500 as security for the mortgage obtained from Corner Bank.
Current financial assets
Trade and other receivables:
Trade receivables control R(16 020 – 20)
Allowance for credit losses
Cash and cash equivalents:
Petty cash
20.15
R
15 200
16 000
(800)
32
32
20.15
R
6 000
6 000
Non-current financial liabilities at amortised cost
Long-term borrowings: Mortgage
The mortgage was acquired from Corner Bank on 1 October 20.14 at an interest rate of 6% per annum. This loan is secured by a first mortgage over land and buildings (refer to note 3).
Total loan
Current portion of loan
Current financial liabilities
Trade and other payables:
Trade payables control
Accrued expenses:
Salaries payable
Interest payable on mortgage
Current portion of long-term borrowings at amortised cost
Bank overdraft
10 000
(4 000)
34 529
24 369
24 150
69
150
4 000
6 160
58

SOLUTION 3.1 (continued)
Calculations
߇ Credit losses:
Credit losses written off
Increase in allowance for credit losses
Credit losses
Allowance for credit losses (30 September 20.15)
Allowance for credit losses (1 October 20.14)
Increase in allowance for credit losses
߈ Depreciation:
On equipment
Old equipment R(19 840 – 1 560) = R18 280
R(18 280 – 5 000) x 15%
New equipment R(1 560 x 15% x 6 /
12
)
On office furniture: R(350 – 50) x 10%
On motor vehicles: R900 x 20%
߉ Interest payable on mortgage:
R(600 – 450)
ߊ Interest on capital accounts:
B Blue – R20 000 x 5%
R Red – R5 000 x 5%
ߋ Interest on current accounts:
B Blue – R1 060x 5%
R Red – R2 800 x 5%
ߌ Management commission: R Red
Total comprehensive income for the year
Less: Salary to R Red
Interest on capital
Interest on current accounts
Add: Interest on drawings
Comprehensive income before commission
?
R10 600 x 10% = R1 060
ߍ Partners’ share of total comprehensive income
Total comprehensive income for the year
(before commission to R Red)
Commission to R Red
Comprehensive income available for distributions
B Blue: R9 540 x (R20 000/R25 000) = R7 632
R Red: R9 540 x (R 5 000/R25 000) = R1 908
ߎ Prepayments:
Advertising costs
Insurance expenses
1 992
117
30
180
2 319
150
R
1 000
250
1 250
R
53
140
193
R
12 643
(1 000)
(1 250)
(193)
400
10 600
20
200
220
R
800
(600)
200
R
R
10 600
(1 060)
9 540
R
948
62
1 010
59

SOLUTION 3.1 (continued) e) BLUERED TRADERS
GENERAL LEDGER
Dr Current account: B Blue Cr
20.15
Sep 30 Interest on drawings
Drawings (for the year)
Balance c/d
R 20.14
320 Oct 1
9 000 20.15
Balance b/d
425 Sept 30 Interest on capital
Interest on current account
Appropriation account
9 745
R
1 060
1 000
53
7 632
9 745
20.15
Oct 1 Balance b/d 425
Dr Current account: R Red Cr
20.15
R 20.14
R
2 800 Sep 30 Interest on drawings
Drawings (for the year)
Balance c/d
80 Oct 1
3 000 20.15
Balance b/d
4 078 Sept 30 Salary to partner
Interest on capital
Interest on current account
Commission
Appropriation account
7 158
1 000
250
140
1 060
1 908
7 158
20.15
Oct 1 Balance b/d 4 078
EXERCISE 3.2
The under mentioned information was taken from the accounting records of Toypork Traders, a partnership with T Toy and P Porky as partners on 28 February 20.15 the financial year end of the partnership.
TOYPORK TRADERS
BALANCES AS AT 28 FEBRUARY 20.15
Sales .................................................................................................................
Settlement discount received ............................................................................
Purchases returns .............................................................................................
Administrative expenses ...................................................................................
Sales returns .....................................................................................................
Purchases .........................................................................................................
Credit losses .....................................................................................................
Drawings: T Toy ................................................................................................
Drawings: P Porky.............................................................................................
Depreciation ......................................................................................................
Land and buildings ............................................................................................
Motor vehicles at cost .......................................................................................
Furniture and fittings at cost..............................................................................
Inventory (1 March 20.14) .................................................................................
Trade receivables control..................................................................................
Allowance for settlement discount received......................................................
Current account: T Toy (1 March 20.14) (Dr) ...................................................
Current account: P Porky (1 March 20.14) (Dr) ................................................
Capital: T Toy (1 March 20.14) .........................................................................
Capital: P Porky (1 March 20.14) ......................................................................
Bank overdraft...................................................................................................
Accumulated depreciation: Furniture and fittings..............................................
Accumulated depreciation: Motor vehicles .......................................................
Allowance for settlement discount granted .......................................................
Allowance for credit losses ...............................................................................
Trade payables control......................................................................................
R
97 600
1 450
850
33 750
860
44 000
2 440
3 880
1 800
3 940
20 000
36 000
12 000
21 530
23 520
400
500
600
40 000
20 000
4 922
5 298
14 800
500
2 300
17 500
60

Additional information:
1.
T Toy and P Porky share profits and losses in the ratio of 2:1 respectively.
2.
On 28 February 20.15, salaries for services rendered according to the partnership agreement were paid to the partners as follows: T Toy: R6 000 and P Porky R4 000.
Both these amounts were recorded as administrative expenses.
3.
Interest on the partners’ capital accounts amounted to R2 140 for T Toy and R1 070 for P Porky.
4.
Inventory on 28 February 20.15 amounted to R19 100.
5.
Depreciation amounted to R940 on furniture and fittings and R3 000 on motor vehicles.
REQUIRED
Prepare the following in respect of Toypork Traders to comply with the requirements of IFRS appropriate to the business of the partnership. Show all calculations but ignore comparatives: a) Statement of profit or loss and other comprehensive income for the year ended
28 February 20.15.
b) Statement of changes in equity for the year ended 28 February 20.15.
c) Statement of financial position as at 28 February 20.15.
d) The note pertaining to property, plant and equipment for the year ended
28 February 20.15.
e) Prepare the appropriation account of the partners, properly balanced, in the general ledger of Toypork Traders for the year ended 28 February 20.15. Show the correct contra ledger accounts.
SOLUTION 3.2
a) TOYPORK TRADERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.15
Note
Revenue R(97 600 – 860)
Cost of sales
Inventory (1 March 20.14)
Purchases R(44 000 – 850 – 1 450)
Inventory (28 February 20.15)
R
96 740
(44 130)
21 530
41 700
63 230
(19 100)
Gross profit
Distribution, administrative and other expenses
Administrative expenses R(33 750 – 10 000)
Credit losses
Depreciation
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
2
52 610
(30 130)
23 750
2 440
3 940
22 480
–
22 480
61

SOLUTION 3.2 (continued) b) TOYPORK TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.15
Balances at 1 March 20.14
Total comprehensive income for the year
Salaries to partners
Interest on capital
Drawings (3 880 + 6 000) (1 800 + 4 000)
Partners’ share of total comprehensive income ߇
Capital
T Toy
P
Porky
R R
40 000 20 000
Current accounts
T Toy
P
Porky
Appropriation
R
(500)
R R
(600) –
6 000
2 140
4 000
1 070
(9 880) (5 800)
22 480
(10 000)
(3 210)
6 180 3 090 (9 270)
Total
Equity
R
58 900
22 480
(15 680)
Balances at 28 February 20.15
40 000 20 000 3 940 1 760 – 65 700 c) TOYPORK TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
Note
ASSETS
Non-current assets
Property, plant and equipment
Current assets
Inventories
Trade receivables R(23 520 – 2 300 – 500)
3
Total assets
EQUITY AND LIABILITIES
Total equity
Capital R(40 000 + 20 000)
Current accounts R(3 940 + 1 760)
Total liabilities
Current liabilities
Trade payables R(17 500 – 400)
Bank overdraft
Total equity and liabilities d) TOYPORK TRADERS
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.15
3.
Property, plant and equipment
Carrying amount at 1 March 20.14
Cost
Accumulated depreciation ߈
Depreciation for the year
Carrying amount at 28 February 20.15
Cost
Accumulated depreciation
Land and buildings
R
20 000
20 000
–
–
20 000
20 000
–
Furniture and fittings
R
7 642
12 000
(4 358)
(940)
6 702
12 000
(5 298)
Motor vehicles
R
24 200
36 000
(11 800)
(3 000)
21 200
36 000
(14 800)
R
47 902
47 902
39 820
19 100
20 720
87 722
65 700
60 000
5 700
22 022
22 022
17 100
4 922
87 722
Total
R
51 842
68 000
(16 158)
(3 940)
47 902
68 000
( 20 098)
62

SOLUTION 3.2 (continued)
Calculations
߇ Partners’ share of total comprehensive income
Remaining total comprehensive income to be shared by partners:
R22 480 – R(10 000 + 3 210) = R9 270
T Toy: R9 270 x 2 /
3
P Porky: R9 270 x 1 /
3
= R6 180
= R3 090
߈ Accumulated depreciation at 1 March 20.14:
Accumulated depreciation at 28 February 20.15
Depreciation for the year
Furniture and fittings
R
5 298
(940)
4 358
Motor
Vehicles
R
14 800
(3 000)
11 800 e) TOYPORK TRADERS
GENERAL LEDGER
Dr Appropriation account Cr
20.15
Feb 28 Interest on capital: T Toy
Interest on capital: P Porky
Salary: T Toy
Salary: P Porky
Current account: T Toy
Current account: P Porky
R
2 140
1 070
6 000
4 000
6 180
3 090
22 480
20.15
Feb 28 Profit or loss account
R
22 480
22 480
EXERCISE 3.3
Shoestring Corner Shop is a partnership with S Shoe and S String as partners. The information below pertains to the business activities of the partnership for the year ended
28 February 20.15
.
SHOESTRING CORNER SHOP
BALANCES AS AT 28 FEBRUARY 20.15
Land and buildings ............................................................................................
Motor vehicles at cost .......................................................................................
Trade receivables control..................................................................................
Inventory ...........................................................................................................
Bank (Dr) ...........................................................................................................
Accumulated depreciation: Motor vehicles (1 March 20.14).............................
Allowance for credit losses (1 March 20.14) .....................................................
Capital: S Shoe (fixed) ......................................................................................
Capital: S String (fixed) .....................................................................................
Current account: S Shoe (Cr: 1 March 20.14) ..................................................
Current account: S String (Dr: 1 March 20.14) .................................................
Drawings: S Shoe .............................................................................................
Drawings: S String ............................................................................................
Administrative expenses ...................................................................................
Trading account (gross profit for the year)........................................................
R
100 000
99 000
82 000
135 000
98 000
49 000
1 000
240 000
160 000
50 000
40 000
55 000
11 000
80 000
200 000
63

Additional information:
1.
The partnership agreement stipulates the following: x
Interest is to be calculated at 7,5% per annum on the opening balances of the capital accounts.
x
Interest is to be calculated at 10% per annum on the opening balances of the current accounts . x
S String is entitled to a monthly salary of R1 250.
x
Profit/losses are to be shared equally.
2.
The following must still be accounted for: x
Depreciation on motor vehicles at 30% per annum, according to the diminishing balance method x
Credit losses to the amount of R2 000.
x
Interest on drawings for the current financial year amounted to R5 000 for S Shoe and R1 000 for S String. x
An investigation indicated that credit losses could be as much as R4 000 during the next financial period. The allowance for credit losses must be adjusted accordingly.
REQUIRED
Prepare the following in respect of Shoesting Corner Shop to comply with the requirements of IFRS appropriate to the business of the partnership. Show all calculations but ignore comparatives: a) Statement of profit or loss and other comprehensive income for the year ended 28 February 20.15.
b) Statement of changes in equity for the year ended 28 February 20.15.
SOLUTION 3.3
a) SHOESTRING CORNER SHOP
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.15
Note
Gross profit
Administrative and other expenses
Administrative expenses
Credit losses
߇
Depreciation R(99 000 – 49 000) x 30%
R
200 000
(100 000)
80 000
5 000
15 000
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
100 000
–
100 000
64

SOLUTION 3.3 (continued) b) SHOESTRING CORNER SHOP
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.15
Capital
S Shoe S String
R
240 000
R
160 000
Current accounts
S Shoe S String
R
50 000
R
Appropriation
R
(40 000) – Balances at 1 March 20.14
Total comprehensive income for the year
Salaries to partner
߈
Interest on capital
߉
Interest on current accounts
ߊ
Interest on drawings
Drawings
Partners’ share of total comprehensive income
ߋ
18 000
5 000
(5 000)
(55 000)
30 000
15 000
12 000
(4 000)
(1 000)
(11 000)
30 000
100 000
(15 000)
(30 000)
(1 000)
6 000
(60 000)
Total
Equity
R
410 000
100 000
(66 000)
Balances at
28 February 20.15
240 000 160 000 43 000 1 000 – 444 000
Calculations
߇ Credit losses:
Credit losses written off
Increase in allowance for credit losses *
Credit losses
Allowance for credit losses (28 February 20.15)
Allowance for credit losses (1 March 20.14)
Increase in allowance for credit losses*
߈ Salary to partner: S String
R1 250 x 12 = R15 000
߉ Interest on capital:
S Shoe: R240 000 x 7,5% = R18 000
S String: R160 000 x 7,5% = R12 000
ߊ Interest on current accounts:
S Shoe: R50 000 (Cr) x 10% = R5 000 (payable)
S String: R40 000 (Dr) x 10% = R4 000 (receivable)
ߋ Partners’ share of total comprehensive income:
S Shoe: R60 000 x 50% = R30 000
S String: R60 000 x 50% = R30 000
R
2 000
3 000
5 000
R
4 000
(1 000)
3 000
65

After having worked through this learning unit, are you able to do the following?
Yes
Define a partnership.
Explain the reasons why partnerships are formed.
Discuss the contents of a partnership agreement in general.
Explain the ways in which a partnership can be established.
Explain the factors which can result in the dissolution of a partnership.
Record the transactions of a partnership in its books.
No
Prepare the financial statements of a partnership to comply with the requirements of International Financial Reporting Standards (IFRS), appropriate to the business of the partnership.
If your answer was "no" to any of the above criteria, revise those sections concerned before progressing to learning unit 4.
66

4
4
Learning outcomes ............................................................................................................68
Key concepts .....................................................................................................................68
4.1
Introduction ...............................................................................................................69
4.2
Valuation adjustments...............................................................................................69
4.3
Goodwill ....................................................................................................................70
4.4
The calculation of profit-sharing ratios.......................................................................71
4.5
Recording a change in ownership structure by way of a personal transaction...........72
4.6
Recording a change in ownership structure by way of a transaction with the partnership................................................................................................................72
4.7
Exercises and solutions ............................................................................................74
Self-assessment ................................................................................................................83
67

After studying this learning unit, you should be able to: x briefly describe what a change in the ownership structure of a partnership entails x mention events that cause a change in the ownership structure of a partnership x calculate the new profit-sharing ratio of a partnership x record a change in the ownership structure of a partnership by way of a personal transaction x record a change in the ownership structure of a partnership by way of transaction with the partnership as business entity by applying the accounting procedure which is based on the legal perspective x prepare a statement of financial position for a new partnership at the date of its formation according to the requirements of IFRS appropriate to the business of the partnership, based on the legal perspective
Key concepts x
Change in ownership structure x
Dissolution x
Valuation adjustment x
Goodwill acquired x
Revaluation surplus x
Adjustment of profit-sharing ratio x
Personal transaction x
Transaction with a partnership as a business entity x Accounting procedure based on the legal perspective
68

After having studied learning unit 3 you should have a solid foundation about the accounting procedures and the preparation of financial statements for a partnership. In this learning unit we focus on the change in the ownership structure of partnerships that changes the contractual relationship among partners. A change in the ownership structure of the partnership occurs when a new partner is admitted to a partnership, when an existing partner retires or dies or when the profit-sharing ratio of a partnership changes. In terms of the South
African common law, a partnership is not a separate legal entity and any change in the ownership structure of the partnership terminates the existing partnership and creates a new partnership.
Study paragraph 3.1 in the prescribed textbook. Please note that the goingconcern perspective falls outside the scope of this module.
Activity 4.1
a) Name the two accounting perspectives that can be adopted to record a change in the ownership structure.
b) Explain in your own words what is meant with the legal perspective to account for a change in the partnership structure.
Feedback 4.1
a) The legal and going-concern perspective.
b) The old and the new partnership are regarded as separate business entities and their activities are separately recorded and reported.
Study paragraph 3.2 in the prescribed textbook.
Note that the selling price of a partnership is determined by the fair value, and not the cost price of the partnership. Recall that fair value is the amount for which an asset can be exchanged or a liability can be settled between knowledgeable, willing parties in an arm’s length transaction. As is indicated in the prescribed textbook, the fair value of a partnership refers to the fair value of the net assets (including goodwill) of the partnership. Net assets =
Assets – Liabilities.
69

Activity 4.2
Work through example 3.1 in the prescribed textbook.
Remember that to revalue an asset or liability in lieu of a change in ownership structure, we make use of a valuation account. The valuation account is closed off to the accounts of the existing partners according to their existing profit-sharing ratio. Revaluations enable the value of assets and liabilities to be adjusted to reflect their fair value instead of their cost or carrying amounts.
In example 3.2 in the prescribed textbook, the revaluation is reversed in the new profit-sharing ratio because the new partner paid a certain amount based on the fair value of the assets and liabilities. So any adjustment from fair value back to cost or carrying amount will reduce his capital investment accordingly and similarly so for the remaining partners. However, the goingconcern perspective is excluded from this module and no further discussion is therefore needed.
Study paragraph 3.3 in the prescribed textbook.
Activity 4.3
a) Define goodwill in terms of IFRS 3.
b) Goodwill is classified as a non-current asset in the statement of financial position.
True or False?
c) After initial recognition of goodwill at cost how is goodwill subsequently measured?
Feedback 4.3
a) Goodwill is a future economic benefit arising from assets that are not capable of being individually identified and separately recognised.
b) True. Goodwill is also an intangible asset compared to property, plant and equipment, which are tangible assets.
c) Goodwill is subsequently measured at cost less impairment.
70

Study paragraph 3.4 in the prescribed textbook.
Make sure that you fully understand the various methods according to which the new profitsharing of the partners in a new partnership is calculated. Remember your school maths when you work with fractions. Anything multiplied by 1 remains the same (unchanged) and any nominator divided by the same denominator is equal to 1. Thus 5 /
5
= 1 and so is 125 /
125
= 1.
You can only work with fractions if they have the same denominator. Thus 2 /
3
– 1 /
4 must be converted to have the same denominator and you do that by multiplying each ratio with a ratio equal to 1 (to remain unchanged) that will enable them to have the same denominator. In this case the same denominator will be 12 (3x4).
Thus, each ratio is multiplied with the ratio (1) that will make their denominator 12.
Thus [ 2 /
3 x 4 /
4
]= 8 /
12
– [ 1 /
4 x 3 /
3
] = 8 /
12
– 3 /
12
= 5 /
12
.
x
Partners relinquish a share to a new partner according to their previous profit-sharing ratio.
Activity 4.4
Work through example 3.3 in the prescribed textbook.
x
Partners equally relinquish a share to a new partner.
Activity 4.5
Work through example 3.4 in the prescribed text book.
x
Partners relinquish a share according to a ratio other than equally or according to their previous profit-sharing ratio to the new partner.
Activity 4.6
Work through example 3.5 in the prescribed textbook.
x
New profit-sharing ratio due to a retirement or death of an existing partner.
Activity 4.7
Work through example 3.6 in the prescribed textbook.
x
New profit-sharing ratio due to admission of a new partner and retirement of a partner.
Activity 4.8
Work through example 3.7 in the prescribed textbook.
71

Study paragraph 3.5 in the prescribed textbook.
Make sure that you know what is meant by a personal transaction, and that no valuation adjustments or goodwill acquired are recorded when a change in the ownership structure of a partnership takes place by way of a personal transaction. Take note of the entries that are recorded under these circumstances.
Activity 4.9
Work through examples 3.8 and 3.9 in the prescribed textbook.
In paragraph 3.6 in the prescribed textbook two accounting procedures according to which a change in the ownership structure of a partnership can be accomplished, are discussed. The different procedures are based on two distinct perspectives, namely the legal and the goingconcern perspective. The legal perspective is discussed in paragraph 3.6.1 in the prescribed textbook and must be studied thoroughly. The going concern perspective discussed in paragraph 3.6.2, falls outside the scope of this module and can be ignored.
Study paragraph 3.6.1 in the prescribed textbook.
Remember the steps.
Accounting entries to be made in the books of the existing partnership: x
Close of the books of the existing partnership. (This includes doing the necessary year end adjustments, the closing off of nominal accounts and the closing off of drawings accounts to current accounts and was dealt with comprehensively in learning unit 3.) All that remains will be accounts that must be disclosed in the statement of financial position and if required, a preliminary statement of financial position can be constructed. You will see that in most questions the closing adjustments have been dealt with and only entries affecting the change in the degree of control will have to be made.
x
Close of the balances of current accounts of the existing partners to their respective capital accounts.
x
If a revaluation surplus existed, it forms part of the equity of the partners and must be allocated to the capital accounts of the existing partners in their existing profit-sharing ratio.
x
Record any valuation adjustments (refer to section 4.2) of existing assets and liabilities in a valuation account.
72

x
Record goodwill initially acquired (refer to section 4.3). Remember the formula to calculate if an incoming partner paid for goodwill that must be captured. Example 3.10 – 3.11 will assist you in this regard.
x
Record the dissolution of the partnership. We make use of a transferral account to close of the accounting records of the existing partnership and open the accounting records of the new partnership.
Accounting entries to be made in the books of the new partnership: x
Record the formation of the new partnership.
x
Adjust the capital account balances if required by the partners in the new partnership.
Example 3.10 and 3.11 deal with these entries.
Activity 4.10
Work through example 3.10 – 3.12 in the prescribed textbook. Make sure you understand each step and remember how to calculate the new profit-sharing ratio.
Study paragraph 3.8 in the prescribed textbook. Remember that only the legal perspective has been dealt with and needs to be studied.
73

EXERCISE 4.1 – Recording valuation adjustments in the books of an existing partnership
Work through the exercise, taking note of how valuation adjustments are recorded in the books of an existing partnership in preparation of its change in ownership structure.
Stevie and Bob are in a partnership, Wonder Traders, and they share profits and losses in the ratio of 3:2 respectively. They decided to admit Tina as a partner as from 1 March 20.15 the profit-sharing ratio for Stevie, Bob and Tina will be 3:2:1 respectively. The following information appeared in the accounting records of Wonder Traders, immediately prior to the recording of any valuation adjustments:
WONDER TRADERS
BALANCES AS AT 28 FEBRUARY 20.15
Land and buildings ..........................................................................................
Trade receivables control ................................................................................
Inventory .........................................................................................................
Bank (Dr).........................................................................................................
Capital: Stevie .................................................................................................
Capital: Bob.....................................................................................................
Trade payables control....................................................................................
R
30 000
26 000
44 000
20 000
60 000
40 000
20 000
Additional information:
To prepare for the change in the ownership structure of Wonder Traders, the following agreement was reached on 28 February 20.15:
1.
An allowance of R2 600 must be created for credit losses.
2.
Inventory must be recorded at R50 000.
3.
Land and buildings must be recorded at R50 000.
REQUIRED
Prepare the following accounts, properly balanced or closed off, in the general ledger of
Wonder Traders to record the valuation adjustments on 28 February 20.15: x
Land and buildings x
Inventory x
Trade receivables control and allowance for credit losses x
Valuation account x
Capital: Stevie x
Capital: Bob
74

SOLUTION 4.1
WONDER TRADERS
GENERAL LEDGER
Dr Land and buildings Cr
20.15
Feb 28 Balance
Valuation account
R(50 000 – 30 000) b/d
R
30 000
20 000
50 000
Dr Inventory Cr
20.15
Feb 28 Balance
Valuation account
R(50 000 – 44 000) b/d
R
44 000
6 000
50 000
Dr Trade receivables control Cr
20.15
Feb 28 Balance b/d
R
26 000
Dr Allowance for credit losses Cr
20.15
R
Feb 28 Valuation account 2 600
Dr Valuation account Cr
20.15
Feb 28 Allowance for credit losses
Capital: Stevie ( 3 /
5
)
Capital: Bob ( 2 /
5
)
R
2 600
14 040
9 360
20.15
Feb 28 Land and buildings
Inventory
R
20 000
6 000
26 000 26 000
Dr Capital: Stevie Cr
20.15
Feb 28 Balance b/d
Valuation account
R
60 000
14 040
74 040
Dr Capital: Bob Cr
20.15
Feb 28 Balance b/d
Valuation account
R
40 000
9 360
49 360
75

EXERCISE 4.2 – Recording a change in the ownership structure of a partnership by applying the accounting procedure which is based on the legal perspective
Mahatma and Lerato were trading as The House Care Specialists and they shared profits/losses equally. They decided to admit Enoch as a partner from 1 July 20.15 and to trade as Home Care and Butler Services. Enoch had to deposit a capital sum of R6 500 into the partnership’s bank account for a 1 /
3 share in the net assets (equity) of the new partnership.
The partners will share in the profits/losses equally and the capital accounts’ ratio of the partners must be in the same ratio as their profit-sharing ratio. On 1 July 20.15, Enoch deposited R6 500 into the bank account of the partnership and in order to ensure that the capital ratio of the partnership is in the same ratio as his profit-sharing ratio, a cash repayment to Mahatma and a cash contribution received from Lerato were recorded in their capital accounts.
On 30 June 20.15 the books of The House Care Specialists were closed off. At that date the following items appeared in the preliminary statement of financial position of the partnership and the assets of The House Care Specialists were valued in preparation of the change in its ownership structure:
Items in the preliminary statement of financial position and valued amounts:
Item
Capital: Mahatma .............................................................................
Capital: Lerato ..................................................................................
Current account: Mahatma (Dr) .......................................................
Current account: Lerato (Cr) ............................................................
Revaluation surplus..........................................................................
Land and buildings ...........................................................................
Goodwill
Inventory: Cleaning materials ..........................................................
Trade receivables control.................................................................
Bank (favourable).............................................................................
Allowance for credit losses...............................................................
Statement of financial position
R
4 200
3 200
100
200
1 000
4 500
Nil
1 500
2 000
500
Nil
Valued amounts
R
7 500
2 100
1 200
2 000
500
300
REQUIRED a) Prepare the journal entries on 30 June 20.15 in the general journal of The House Care
Specialists to prepare for the admission of Enoch as a partner and to record the dissolution of the partnership. (Apply steps 2 to 6 of the accounting procedure based on the legal perspective.) b) Prepare the journal entries on 1 July 20.15 in the general journal of Home Care and
Butler Services to record its formation and to give effect to the decisions which pertain to the accounting policy and/or the partnership agreement. (Apply steps 7 to 9 of the accounting procedure based on the legal perspective.) c) Prepare the statement of financial position of Home Care and Butler Services as at
1 July 20.15 according to the requirements of IFRS appropriate to the business of the partnership. Notes and comparative figures are not required.
76

SOLUTION 4.2
a) THE HOUSE CARE SPECIALISTS
GENERAL JOURNAL
Debit
R
20.15
June 30 Capital: Mahatma
Current account: Lerato
Current account: Mahatma
Capital account: Lerato
Closing off the balances of the current accounts of Mahatma and Lerato
Revaluation surplus
Capital: Mahatma (R1 000 x ½)
Capital: Lerato
Revaluation surplus apportioned to the capital accounts of
Mahatma and Lerato according to their profit-sharing ratio
Land and buildings R(7 500 – 4 500)
Inventory: Cleaning materials R(1 500 – 1 200)
Allowance for credit losses
Valuation account (balancing amount)
Recording the valuation adjustments
Valuation account
Capital: Mahatma (R2 400 x ½)
Capital: Lerato (R2 400 x ½)
Closing off the balance amount of the valuation account to the capital accounts of Mahatma and Lerato according to their profit-sharing ratio
Goodwill
Capital: Mahatma (R2 100 x ½)
Capital: Lerato (R2 100 x ½)
Recording goodwill in preparation for the admission of Enoch
Transferral account
Land and buildings
Goodwill
Inventory: Cleaning materials
Trade receivables control
Bank
Closing off the balances of the assets accounts to the transferral account to record the dissolution of the partnership
Capital: Mahatma
Capital: Lerato
Allowance for credit losses
Transferral account
Closing off the balances of the equity and allowance accounts to the transferral account to record the dissolution
100
200
1 000
3 000
2 400
2 100
13 300
6 850
6 150
300
Credit
R
100
200
500
500
300
300
2 400
1 200
1 200
1 050
1 050
7 500
2 100
1 200
2 000
500
13 300
77

SOLUTION 4.2 (continued)
Calculation c
Capital account balances of partners
Mahatma: R(4 200 – 100 + 500 + 1 200 + 1 050) = R6 850
Lerato: R(3 200 + 200 + 500 + 1 200 + 1 050) = R6 150 b) HOME CARE AND BUTLER SERVICES
GENERAL JOURNAL
20.15
July 1 Land and buildings R7 500 x (R6 850 ÷ R13 000)
Goodwill R2 100 x (R6 850 ÷ R13 000)
Inventory: Cleaning materials R1 200 x (R6 850 ÷ R13 000)
Trade receivables control R2 000 x (R6 850 ÷ R13 000)
Bank R500 x (R6 850 ÷ R13 000)
Allowance for credit losses R300 x (R6 850 ÷ R13 000)
Capital: Mahatma c
Recording the capital contribution of Mahatma
Land and buildings R7 500 x (R6 150 ÷ R13 000)
Goodwill R2 100 x (R6 150 ÷ R13 000)
Inventory: Cleaning materials R1 200 x (R6 150 ÷ R13 000)
Trade receivables control R2 000 x (R6 150 ÷ R13 000)
Bank R500 x (R6 150 ÷ R13 000)
Allowance for credit losses R300 x (R6 150 ÷ R13 000)
Capital: Lerato c
Recording the capital contribution of Lerato
Bank
Capital: Enoch
Recording the capital contribution of Enoch
Capital: Mahatma
Bank
Recording the cash repayment to Mahatma so as to bring the capital account ratio in the same ratio as the profit-sharing ratio
Bank
Capital: Lerato
Recording the cash contribution of Lerato so as to bring the capital account ratio in the same ratio as the profit-sharing ratio
Debit
R
3 952
1 107
632
1 054
263
3 548
993
568
946
237
6 500
350
350
Credit
R
158
6 850
142
6 150
6 500
350
350
78

SOLUTION 4.2 (continued)
Calculation c
Adjustment of capital account balances of Mahatma and Lerato
Calculation of capital account balances according to profit-sharing ratio:
Capital: Mahatma R19 500 * x 1 /
3
= R6 500
Capital: Lerato
Capital: Enoch
R19 500
R19 500
*
* x x
1 /
3
1 /
3
= R6 500
= R6 500
* Total amount of capital in the new partnership
R(6 850 + 6 150 + 6 500) = R19 500
OR
Enoch’s capital contribution multiplied by the inverse of his share in the net assets of the new partnership (R6 500 x 3) = R19 500
Difference between recorded and calculated capital account balances:
Mahatma
Lerato
Enoch c c
Recorded capital account balance
R
6 850
6 150
6 500
Calculated capital account balance according to profitsharing ratio
R
6 500
6 500
6 500
Difference
R
350
(350)
–
The recorded capital account balance of Mahatma is greater than his calculated capital account balance. Mahatma’s capital account balance must be reduced by R350. The recorded capital account balance of Lerato is smaller than her calculated capital account balance; therefore, Lerato has to increase her capital contribution by R350. c) HOME CARE AND BUTLER SERVICES
STATEMENT OF FINANCIAL PROSITION AS AT 1 JULY 20.15
ASSETS
Non-current assets
Property, plant and equipment R(3 952 + 3 548)
Goodwill R(1 107 + 993)
Current assets
Inventories R(632 + 568)
Trade receivables R(1 054 + 946 – 158 – 142 )
Cash and cash equivalents R(263 + 237 + 6 500 – 350 + 350)
Total assets
EQUITY AND LIABILITIES
Total equity
Capital R(6 850 + 6 150 + 6 500 – 350 + 350)
Total equity and liabilities
Note R
9 600
7 500
2 100
9 900
1 200
1 700
7 000
19 500
19 500
19 500
19 500
79

EXERCISE 4.3 – Preparation of partner’s capital accounts and valuation account in preparation of the change in the ownership structure of a partnership
Work through the exercise taking note of the following: x
When goodwill is created, it is not recorded in the valuation account, x
When the legal perspective is applied, the valuation and capital accounts are closed off to the transferral account.
x
The retired partner’s capital account is closed-off to a loan account on the last date of the existing partnership if the capital account was not settled by the partnership.
Kally, Rocky and Mike are in a partnership, trading as Fighting Fists, and share profits or losses in the ratio of 2:2:1 respectively. Kally decided to retire from the partnership. His last day as a partner in the partnership will be 31 May 20.15, which is also the financial year end of Fighting
Fists. The new partnership will pay out Kally’s capital in cash on 30 November 20.15. Rocky and Mike decided to admit Gerrie as a partner as from 1 June 20.15. The new partnership will trade as Fighting Fit. The profit-sharing ratio between Rocky, Mike and Gerrie will be 3:2:1 respectively. Gerrie will contribute R80 000 in cash for a 1 /
6 share in the equity (net assets) of the new partnership.
The following information is taken from the accounting records of Fighting Fists at 31 May
20.15, immediately prior to the recording of valuation adjustments in preparation of the change in the ownership structure of the partnership:
List of balances as at 31 May 20.15
Capital: Kally ................................................................................................
Capital: Rocky ..............................................................................................
Capital: Mike ................................................................................................
Land and buildings .......................................................................................
Inventory
Trade receivables control .............................................................................
Trade payables control.................................................................................
Bank (favourable) .........................................................................................
R
56 000
74 000
38 000
80 000
48 000
36 000
14 000
18 000
Additional information:
1.
To prepare for the change in the ownership structure of Fighting Fists, the following agreement was reached on 31 May 20.15:
1.1
Goodwill must be recorded in the books.
1.2
An allowance for credit losses must be created at R3 600.
1.3
Inventories must be valued at R60 000.
1.4
Land and buildings must be valued at R140 000.
2.
The change in the ownership structure of the partnership is viewed from a legal perspective.
REQUIRED
Prepare the valuation account and the capital accounts of Kally, Rocky and Mike (properly closed off) in the general ledger of Fighting Fists at 31 May 20.15.
80

SOLUTION 4.3
FIGHTING FISTS
GENERAL LEDGER
Dr Valuation account Cr
20.15
R 20.15
R
May 31 Allowance for credit
Losses
Capital: Kally ߇
Capital: Rocky ߇
Capital: Mike ߇
3 600
27 360
27 360
13 680
May 31 Land and buildings
R(140 000 – 80 000)
Inventory
R(60 000 – 48 000)
60 000
12 000
72 000 72 000
Dr Capital: Kally
20.15
R 20.15
May 31 Loan: Kally 182 144 May 31 Balance b/d
Valuation account
Goodwill ߈
R
Cr
56 000
27 360
98 784
182 144 182 144
Dr Capital: Rocky Cr
20.15
R 20.15
R
May 31 Transferral account 200 144 May 31 Balance b/d
Valuation account
Goodwill ߈
74 000
27 360
98 784
200 144 200 144
Dr Capital: Mike Cr
20.15
May 31 Transferral account
R
101 072
20.15
May 31 Balance b/d
R
38 000
Valuation account
Goodwill ߈
13 680
49 392
101 072 101 072
Dr Loan: Kally Cr
20.15
May 31 Transferral account 182 144
182 144
20.15
May 31 Capital: Kally
R
182 144
182 144
81

SOLUTION 4.3 (continued)
Comment
The loan account of Kally was not required, and is shown for illustration purposes.
Calculations
߇ Apportionment of the balance of the valuation account to the capital account of the partners of the existing partnership
Balance of valuation account to be apportioned: R(72 000 – 3 600) = R68 400
Kally: R68 400 x 2 /
5
= R27 360
Rocky: R68 400 x 2 /
5
= R27 360
Mike: R68 400 x 1 /
5
= R13 680
߈ Goodwill
Goodwill acquired = (Capital contribution of new partner multiplied by inverse of new partner’s share in the equity [net assets] of new partnership) – Equity of new partnership
= (R80 000 x 6 /
1
) – R(101 360 * + 51 680 * + 80 000)
= R(480 000 – 233 040)
= R246 960
* Balances of capital accounts
Rocky =
=
=
Mike =
=
=
Opening balance + apportionment of profit of valuation account
R(74 000 + 27 360)
R101 360
Opening balance + apportionment of profit of valuation account
R(38 000 + 13 680)
R51 680
Note that the capital account balance of Kally is excluded from the calculation of goodwill, because Kally will not be a partner in the new partnership. A portion of the goodwill is, however, credited in the capital account of Kally (as he is a partner of the existing partnership Fighting Fists) and hence attributed to the creation of the goodwill.
Kally: R246 960 x 2 /
5
= R98 784
Rocky: R246 960 x 2 /
5
= R98 784
Mike: R246 960 x 1 /
5
= R49 392
82

After having worked through this learning unit, are you able to do the following?
Yes No
Briefly describe what a change in the ownership structure of a partnership entails.
Mention events that cause a change in the ownership structure of a partnership.
Calculate the new profit sharing ratio of a partnership.
Record a change in the ownership structure of a partnership by way of transaction with the partnership as a business entity by applying the accounting procedure which is based on the legal perspective.
If an accounting procedure is based on the legal perspective, prepare a statement of financial position of a new partnership at the date of its formation according to the requirements of IFRS appropriate to the business of the partnership.
If you answered "yes" to all of the above assessment criteria, you can move on to learning unit 5. If your answer was "no" to any of the above criteria, revise those sections concerned before progressing to learning unit 5.
83

84

5
5
Learning outcomes ............................................................................................................86
Key concepts .....................................................................................................................86
5.1
Introduction ...............................................................................................................87
5.2
Liquidation methods..................................................................................................87
5.3
The liquidation account .............................................................................................88
5.4
Accounting procedures to record the simultaneous liquidation of a partnership ........88
5.5
Accounting procedures to record the piecemeal liquidation of a partnership .............90
5.6
Exercises and solutions ............................................................................................91
Self-assessment ................................................................................................................99
85

After studying this learning unit you should be able to: x describe the meaning of the term “liquidation” from the perspective of this learning unit x distinguish between a simultaneous liquidation and a piecemeal liquidation x apply the accounting procedure in the case of a simultaneous liquidation of a partnership with
a profit on liquidation
a loss on liquidation, where all of the partners have sufficient personal funds to cover the shortage in their capital account
with a loss on liquidation, where one or more of the partners do not have sufficient personal funds to cover the shortfalls in their capital accounts and where the capital deficit must be apportioned to the remaining solvent partners according to their profitsharing ratio x apply the accounting procedure in the case of a piecemeal liquidation of a partnership and calculate the interim repayment of available cash between partners according to the loss-absorption-capacity method
x
Dissolution x
Liquidation x
Liquidation account x
Simultaneous liquidation x
Piecemeal liquidation x
Loss-absorption-capacity method
86

The liquidation of a partnership is regarded as a form of dissolution which results in the termination of the business activities of solvent partnerships, whereas a sequestration is regarded as a form of dissolution of insolvent partnerships. The accounting procedures that pertain to sequestrations fall beyond the scope of this module. The liquidation of a partnership basically implies that the assets of the partnership must be converted into cash, the liabilities must be settled and the remaining cash must be paid to the partners in an attempt to refund their capital accounts.
Read the overview and paragraph 4.1 in the prescribed textbook.
Activity 5.1
Name the two methods according to which a partnership can be liquidated.
Feedback 5.1
A partnership can be liquidated simultaneously or piecemeal.
Read paragraph 4.2 in the prescribed textbook.
Ensure that you can explain the difference between a piecemeal liquidation and a simultaneous liquidation of a partnership.
Activity 5.2
a) A simultaneous liquidation will ensure that assets are realised at their most advantageous prices.
True or False?
b) A simultaneous liquidation allows a partnership to continue with its business activities but on a decreasing scale.
True or False?
Feedback 5.2
a) False.
A piecemeal liquidation will ensure that assets are realised at the best possible selling price.
b) False.
A piecemeal liquidation allows a partnership to continue with activities.
87

Read paragraph 4.3 in the prescribed textbook.
With a simultaneous liquidation a single liquidation account is prepared. Can you explain why?
Refer back to paragraph 4.3 if you are unsure of the answer.
In the case of a simultaneous liquidation, realise that both methods explained in paragraph
4.3 are correct and eventually will result in the same net result. For the sake of clarity, method
1 is followed in this learning unit. All assets and contra-assets and all liabilities are transferred to a liquidation account on the date the liquidation commences. The liquidation of the assets and the settlement of the liabilities are then recorded in the liquidation account. Any other expenses or income received on liquidation of the assets and settlement of the liabilities is also recorded in the liquidation account and the balance of the liquidation account (a profit or loss on liquidation) is transferred to the partners’ capital accounts in their profit-sharing ratio.
After recording the amounts received/paid in the bank account (the cash received from selling the assets and cash paid towards settling the liabilities), a positive bank balance can be used to refund the partners’ capital accounts.
In the case of a piecemeal liquidation, a liquidation account is prepared for each phase of the liquidation process. Remember the partnership carries on with its activities on a decreasing scale. Again the profit/loss determined in the liquidation account in each phase is closed off to the partners’ capital accounts according to their profit-sharing ratio.
Study paragraph 4.4 in the prescribed textbook.
As suggested in the textbook, following the mentioned steps will assist you to record the simultaneous liquidation. The steps are: x
Close off the balances of the drawings and current accounts to the capital accounts on the date the simultaneous liquidation commences. x
Close off the balances of the goodwill and revaluation surplus account to the partners’ capital accounts according to their profit-sharing ratio.
x
Prepare the liquidation account. Make sure that you understand how to prepare a liquidation account. It is explained in detail in paragraph 4.4 again.
x
Record the once-off settlement of the capital accounts of the partners. Note that after recording the liquidating transactions, the capital accounts of the partners may not necessarily be in their profit-sharing ratio due to agreed assets/liabilities taken over by the partners and the current and drawings accounts not being in the profit-sharing ratio etc.
88

Activity 5.3
Work through example 4.1 in the prescribed textbook which illustrates the accounting process when a profit is made on a simultaneous liquidation.
Activity 5.4
Work through example 4.2 which illustrates the accounting process when a loss is made on a simultaneous liquidation and partners with a deficit on their capital accounts are able to refund the deficit to the partnership.
Please note that the capital account of a partner can in some instances end up with a debit balance. As long as the partner is technically solvent, he/she will have to refund the debit balance from his/her personal funds or obtaining a loan in his/her personal capacity. Should the partner be insolvent, and unable to settle the deficit (debit balance on the capital account), the remaining solvent partners will have to bear the deficit.
Study paragraph 4.4.2 in the prescribed textbook. Make sure you understand the Garner versus Murray rule and how this textbook interprets it.
Please note that in this learning unit and chapter of the textbook, the last agreed capitals, are interpreted as the balances on the capital accounts immediately prior to the liquidation, but after drawings accounts, current accounts, goodwill and revaluations have been transferred to the partners’ capital accounts.
Activity 5.5
Work through example 4.3 in the prescribed textbook where the partnership made a loss on liquidation and some partners do not have sufficient personal funds to cover the deficit on their capital accounts.
Please note in solution a) how the ratio of the capital accounts of Pascoe and Cannon before the liquidation is calculated when applying the Garner versus Murray rule.
Pascoe = R73 000 (see the calculation in the prescribed textbook)
Cannon = R49 500 (see the calculation in the prescribed textbook)
Thus R(73 000/122 500) = 60% (rounded) and R(49 500/122 500) = 40% (rounded)
The ratio 60:40 = 3:2
In solution b) the Garner versus Murray rule is not applied and the deficit is borne in the profitsharing ratio of the remaining solvent partners, who share profits equally; the remaining bank balance is used to refund the solvent partners.
89

Study paragraph 4.5 in the prescribed textbook. Take note that the calculation of interim repayments by applying the surplus capital method does NOT form part of the syllabus .
As suggested in the textbook, following the mentioned steps will assist you to record a piecemeal liquidation. The steps are similar to the simultaneous liquidation and are as follows: x
Close off the balances of the drawings and current accounts to the capital accounts on the date the piecemeal liquidation commences. x
Close off the balances of the goodwill and revaluation surplus account to the partners’ capital accounts according to their profit-sharing ratio.
x
Record the payment of expenses, the settlement of debts, the liquidation of assets, any further income and the interim repayments, as they arise. Note that two methods can be used to calculate interim repayments, namely the surplus-capital and the lossabsorption-capacity methods. However, only the latter is prescribed in this learning unit.
x
Record the settlement (final repayment) of the capital accounts of the partners.
Study paragraph 4.5.2 in the prescribed textbook.
Apply the loss-absorption-capacity method (in step 3). Steps A to D in the prescribed textbook must be applied:
Step A: Determine the general ledger account balances in the partnerships’ books on the date that cash becomes available for interim payments.
Step B: Debit any contingent/budgeted expenses in the partners’ capital accounts according to their profit-sharing ratio. Credit Bank.
Step C: Close off all unsold assets to the capital accounts according to the profitsharing ratio. We assume the unsold assets have no recoverable amount.
Step D: Close off any anticipated capital deficit to the capital accounts of the partners who have favourable anticipated capital balances according to their profitsharing ratio.
Note that steps B to D are not recorded in the books of the partnership – only the interim repayments are recorded.
Activity 5.6
Work through example 4.6 in the prescribed textbook which illustrates the calculation of interim repayments according to the loss-absorption-capacity method.
90

Activity 5.7
Work through example 4.7 which is a comprehensive example that illustrates the piecemeal liquidation of a partnership. You will benefit most from this example if you follow each step as illustrated and draw up your own accounts to follow the process. The table just after (m) illustrates the piecemeal liquidation without physically using general ledger accounts. Make sure that you understand how to draw up such a table to account for the piecemeal liquidation.
Read paragraph 4.6 which, summarises the chapter. Ignore the section on the surplus-capital method.
EXERCISE 5.1 – Simultaneous liquidation
Penn and Penzil were in partnership for 38 years, trading as Manual Accounting Services and shared profits or losses equally. Owing to a steady decline in their clientele and profits, they decided to liquidate the partnership at a public auction on 30 June 20.15. On this date and just prior to the auction, the following trial balance for Manual Accounting Services was prepared:
MANUAL ACCOUNTING SERVICES
TRIAL BALANCE AS AT 30 JUNE 20.15
Land and buildings at valuation
Furniture at cost
Vehicles at cost
Accumulated depreciation: Furniture
Accumulated depreciation: Vehicles
Goodwill
Inventory
Trade receivables control
Allowance for credit losses
Capital: Penn
Capital: Penzil
Current account: Penn
Current account: Penzil
Revaluation surplus
Mortgage (in respect of land and buildings)
Bank overdraft
Trade payables control
Debit
R
500 000
102 000
215 000
Credit
R
20 000
15 000
120 000
45 000
75 000
7 000
150 000
80 000
30 000
10 000
270 000
300 000
90 000
145 000
1 087 000 1 087 000
91

Additional information:
On 30 June 20.15, the following transactions took place:
1.
The land and buildings were sold for R849 500 cash.
2.
The furniture was sold for R60 200 cash.
3.
The inventory was sold for R50 050 cash.
4.
All the debtors (as recorded in the above trial balance) settled their accounts and received a discount of 20%.
5.
A previous client, whose outstanding debtor’s account of R650 was written off as irrecoverable, paid R500 to the partnership.
6.
There were two vehicles in the partnership. Penn took over one of these vehicles at a fair value of R60 000 and Penzil took over the other at its fair value of R70 000.
7.
The liquidation costs amounted to R10 000 and were paid.
8.
The mortgage was paid in full.
9.
All creditors were paid. A settlement discount of R29 000 was received.
10.
Penzil paid R250 for a farewell luncheon out of the funds of the partnership.
REQUIRED
Prepare the liquidation account, the bank account, and the partners’ capital accounts in the general ledger of Manual Accounting Services in order to record its liquidation on
30 June 20.15.
NB: Show all calculations.
SOLUTION 5.1
Dr
20.15
Jun 30
Land and buildings at valuation
Furniture at cost
Vehicles at cost
Inventory
Trade receivables control
Bank (Liquidation costs)
Bank (Mortgage)
Bank (Trade payables control)
R(145 000 – 29 000)
Bank (Luncheon)
Capital: Penn ߈
Capital: Penzil ߈
Liquidation account Cr
R 20.15
Jun 30
R
500 000
102 000
215 000
45 000
75 000
10 000
300 000
116 000
250
137 000
137 000
Accumulated depreciation:
Furniture
Accumulated depreciation:
Vehicles
Mortgage
Trade payables control
Allowance for credit losses
Bank (land and buildings)
Bank (Furniture)
Bank (Inventory)
Bank(Trade receivables control) ߇
20 000
15 000
300 000
145 000
7 000
849 500
60 200
50 050
60 000
1 637 250
Bank (Credit losses recovered)
Capital: Penn (Vehicle)
Capital: Penzil (Vehicle)
500
60 000
70 000
1 637 250
92

SOLUTION 5.1 (continued)
Calculations
߇ Cash received from debtors
Discount = R75 000 x 20% = R15 000
Cash received = R(75 000 – 15 000) = R60 000
߈ Apportioned of profit made on liquidation
R(1 637 250 ᬚ - 1 363 250 ᬛ ) = R274 000 ᬜ
Penn: R274 000 x ½ = R137 000
Penzil: R274 000 x ½ = R137 000
ᬚ The total of the credit side.
ᬛ The total of the debit side before the apportionment of the profit.
ᬜ The balancing amount that must be apportioned to the partners according to their profit-sharing ratio.
Dr
20.15
Jun 30 Liquidation account:
(Land and buildings)
Liquidation account:
(Furniture)
Liquidation account:
(Inventory)
Liquidation account:
(Trade receivables control)
Liquidation account:
(Credit losses recovered)
Bank Cr
R 20.15
R
849 500
60 200
50 050
60 000
Jun 30 Balance b/d
Liquidation account:
(Liquidation costs)
Liquidation account:
(Mortgage)
Liquidation account:
(Trade payables control)
Liquidation account:
(Luncheon)
90 000
10 000
300 000
116 000
250
500 Capital: Penn * 272 000
Capital: Penzil * 232 000
1 020 250 1 020 250
* The settlement of the outstanding balances on the capital accounts of Penn and Penzil. The capital accounts must first be prepared in order to determine these balances. Note how the balance of the bank account (prior to this settlement) is equal to the sum of the outstanding capital account balances (R272 000 + R232 000 =
R504 000).
Dr
Bank *
Capital: Penn Cr
20.15
Jun 30 Current account: Penn
Liquidation account:
(Vehicles)
Goodwill (R120 000 x ½)
R
30 000
60 000
60 000
272 000
20.15
Jun 30 Balance b/d
Revaluation surplus
(R270 000 x ½)
Liquidation account
R
150 000
135 000
137 000
422 000 422 000
* Balancing amount (outstanding balance)
93

SOLUTION 5.1 (continued)
Dr Capital: Cr
20.15
20.15
R
70 000 Jun 30 Liquidation account:
(Vehicles)
Goodwill (R120 000 x ½)
Bank *
60 000
232 000
Jun 30 Balance b/d
Current account: Penzil
Revaluation surplus
(R270 000 x ½)
80 000
10 000
135 000
362 000
Liquidation account 137 000
362 000
* Balancing amount (outstanding balance)
Note that the remaining cash after liquidation is not apportioned to the capital accounts of the partners according to their profit-sharing ratio but according to their outstanding capital account balances.
EXERCISE 5.2 - Piecemeal liquidation: Calculation of interim repayment according to the loss-absorption-capacity method
Sauce, Age and Roll are in a partnership, sharing the profits or losses in the ratio of 5:3:2 respectively. The following information is taken from the accounting records of the partnership at 31 December 20.14:
Capital: Sauce..........................................................................................
Capital: Age .............................................................................................
Capital: Roll..............................................................................................
Equipment at carrying amount..................................................................
Goodwill ...................................................................................................
Bank.........................................................................................................
Trade payables control
R
7 000
14 000
18 000
42 000
3 000
5 000
11 000
The partners decided to liquidate the partnership piecemeal as from 1 January 20.15. The net proceeds will be apportioned amongst the partners in such a way that no partner will find it necessary to repay any amount, which was previously received.
Liquidation of assets
1 February 20.15
2 July 20.15
REQUIRED
Carrying amount
R
13 000
29 000
Proceeds
R
9 000
33 000 a) Calculate the amount of cash that is available for an interim repayment after the first liquidation of the assets and the settlement of the liabilities on 1 February 20.15.
b) Calculate how the cash as determined in (a) must be repaid to the partners by applying the loss-absorption-capacity method. Show all calculations in a columnar format.
94

SOLUTION 5.2 a) C ash available for interim repayment
Bank = Opening balance + Cash sales – Payment of liabilities
Bank = R(5 000 + 9 000 – 11 000)
Bank = R3 000 b) I nterim cash repayment (loss-absorption-capacity method)
Step
A
C
D
D
* Bank
R
3 000
3 000
3 000
Equipment
R
29 000
R
(3 500)
(29 000) ߉ 14 500
–
Capital:
Sauce
–
11 000
(11 000)
–
Capital:
Age
R
(11 900)
8 700
(3 200)
6 600
3 400
(3 400)
–
Capital:
Roll
R
(16 600)
5 800
(10 800)
4 400
(6 400)
3 400
(3 000) 3 000
* The steps, as discussed in paragraph 4.5.2 in the prescribed textbook, are shown for illustrative purposes only.
Comment
Since the anticipated capital accounts of Sauce and Age show deficits, the amount of available cash (namely R3 000) must be paid solely to Roll. Note that the amount of available cash is equal to the amount that must be paid to Roll.
Calculations
Balances immediately prior to first interim repayment
SAUCE, AGE AND ROLL
GENERAL LEDGER (SUMMARISED IN COLUMNAR FORMAT)
Transactions
Bank
R
5 000
Equipment
R
42 000
Trade payables
R
(11 000)
Capital:
Sauce
Capital:
Age
R R
(5 500) ߇ (13 100) ߇
Capital:
Roll
R
(17 400) Balances at 31 Dec 20.14
Sale of assets and allocation of loss
(1 February 20.15)
Payment of creditors
9 000
(11 000)
3 000
(13 000)
11 000
29 000 –
2 000
(3 500)
߈ 1 200
(11 900)
߈ 800
(16 600)
߇
߈
Capital account balances after apportionment of the goodwill:
Sauce: R 7 000 – R(3 000 x 5 /
10
) = R 5 500
Age: R14 000 – R(3 000 x 3 /
10
) = R13 100
Roll: R18 000 – R(3 000 x 2 /
10
) = R17 400
Allocation of loss on first liquidation
Proceeds (selling price)
Carrying amount
Loss on liquidation
R
9 000
(13 000)
(4 000)
95

SOLUTION 5.2 (continued)
Sauce: R(4 000 x 5 /
10
) = R2 000
Age: R(4 000 x 3 /
10
) = R1 200
Roll: R(4 000 x 2 /
10
) = R 800
Apportionment of the anticipated loss as result of the remaining equipment being assumed as worthless
Sauce: R(29 000 x 5 /
10
) = R14 500
Age: R(29 000 x 3 /
10
) = R 8 700
Roll: R(29 000 x 2 /
10
) = R 5 800
ߊ Apportionment of the anticipated capital deficit of Sauce, who must be assumed insolvent, to Age and Roll
Age: R(11 000 x 3 /
5
) = R 6 600
Roll: R(11 000 x 2 /
5
) = R 4 400
EXERCISE 5.3- Recording piecemeal liquidation transactions in columnar format (lossabsorption-capacity method)
Patrys, Pine and Promise are in partnership, trading as African Timber and sharing in the profits or losses in the ratio of 5:3:2 respectively. The following information regarding the statement of financial position in respect of the partnership was prepared at 30 June 20.15:
AFRICAN TIMBER
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.15
Property, plant and equipment
Capital: Patrys
Capital: Pine
Capital: Promise
Trade payables control
R
18 000
8 000
5 000
2 000
3 000
Due to increasing liquidity problems the partners decided to liquidate the partnership piecemeal as from 1 July 20.15. As soon cash becomes available from the liquidation of assets, it must be paid to the partners in such a manner that no partner will have to refund money to the partnership at a later stage.
96

The property, plant and equipment were liquidated as follows:
First liquidation
Second liquidation
Third liquidation
Fourth liquidation
Carrying amount Cash received
R R
2 500
5 600
2 500
5 000
6 000
3 900
6 000
4 000
REQUIRED
Record the liquidation of African Timber in columnar format. Use the format as outlined below. Disclose the credit balances and the credit entries in brackets. Apply the lossabsorption-capacity method to calculate the interim repayments to the partners.
REQUIRED FORMAT
Transaction Bank
R
Trade payables
R
Property, plant and equipment
R
Capital:
Patrys
R
Capital:
Pine
R
Capital:
Promise
R
SOLUTION 5.3
AFRICAN TIMBER
GENERAL LEDGER (SUMMARISED IN COLUMNAR FORMAT)
Transaction Bank
R
–
Trade payables
R
(3 000)
Property, plant and equipment
R
18 000
Capital:
Patrys
R
(8 000) Balances at 1 July 20.15
Sale of assets
(1 st liquidation)
Payment of creditors
Sale of assets
(2 nd liquidation)
Payment of creditors
1 st Interim repayment
2 500
(2 500) 2 500
5 000
(500) 500
4 500 –
(4 500)
–
(2 500)
(5 600)
9 900
9 900
߇ 300
Capital:
Pine
R
(5 000)
߇ 180
(7 700) (4 820)
߇ 2 688 ߇ 1 812
(5 012) (3 008)
Sale of assets
(3 rd liquidation)
2 nd Interim repayment
6 000
6 000
(6 000)
– –
Capital:
Promise
R
(2 000)
߇ 120
(1 880)
(1 880)
(6 000)
3 900 (5 012) (3 008) (1 880)
߉ 3 062 ߉ 1 838 ߉ 1 100
3 900 ߊ (1 950) ߊ (1 170) ߊ (780)
Sale of assets
(4 th liquidation) 4 000 (3 900)
4 000 – –
ߋ (50)
(2 000)
ߋ (30)
(1 200)
ߋ (20)
(800)
Settlement of capital accounts (4 000) 2 000 1 200 800
97

SOLUTION 5.3 (continued)
Calculations
߇ Allocation of loss (R600)
Patrys: R600 x 5 /
10
= R300
Pine: R600 x 3 /
10
= R180
Promise: R600 x 2 /
10
= R120
Interim cash repayment (loss-absorption-capacity method)
Step*
A
C
Bank
R
4 500
Property, plant and equipment
R
9 900
(9 900)
4 500 –
Capital:
Patrys
߈
R
(7 700)
4 950
(2 750)
߉ 62
Capital:
Pine
߈
R
(4 820)
2 970
(1 850)
߉ 38
Capital:
Promise
߈
R
(1 880)
1 980
100
(100) D
4 500 – (2 688) (1 812) –
* The steps, as discussed in paragraph 4.5.2 in the prescribed textbook, are shown for illustrative purposes only.
߈ Allocation of the loss as a result of the remaining property, plant and equipment being assumed worthless
Patrys: R9 900 x 5 /
10
Pine: R9 900 x 3 /
10
Promise: R9 900 x 2 /
10
= R4 950
= R2 970
= R1 980
߉ Allocation of the anticipated capital deficit of Promise, who must be assumed to be insolvent, to Patrys and Pine
Patrys: R100 x 5 /
8
= R62 (Rounded off to the nearest lower “rand”)
Pine: R100 x 3 /
8
= R38 (Rounded off to the nearest lower “rand”)
Interim cash repayment (loss-absorption-capacity method)
Step*
A
C
Bank
R
6 000
Property, plant and equipment
R
3 900
(3 900)
Capital:
Patrys
ߊ
R
(5 012)
1 950
Capital:
Pine
R
ߊ
(3 008)
1 170
Capital:
Promise
R
(1 880)
ߊ 780
6 000 – (3 062) (1 838) (1 100)
* The steps, as discussed in paragraph 4.5.2 in the prescribed textbook, are shown for illustrative purposes only.
ߊ Allocation of the loss as a result of the remaining property, plant and equipment being assumed worthless
Patrys: R3 900 x 5 /
10
= R1 950
Pine: R3 900 x 3 /
10
= R1 170
Promise: R3 900 x 2 /
10
= R 780
ߋ Allocation of profit (R100)
Patrys: R100 x 5 /
10
Pine: R100 x 3 /
10
= R50
= R30
Promise: R100 x 2 /
10
= R20
98

After having worked through this learning unit, are you able to do the following?
Yes No
Describe the meaning the term “liquidation” from the perspective of this learning unit.
Distinguish between a simultaneous and a piecemeal liquidation.
Apply the accounting procedure in the case of a simultaneous liquidation of a partnership with a profit or loss on liquidation.
Apply the accounting procedure in the case of a piecemeal liquidation of a partnership, and to calculate the interim repayments of available cash between partners according to the loss-absorption-capacity method.
If your answer was "no" to any of the above criteria, revise those sections concerned before progressing to learning unit 6.
99

100

6
6
Learning outcomes ..........................................................................................................102
Key concepts ...................................................................................................................102
6.1
Introduction .............................................................................................................103
6.2
Attributes of a close corporation..............................................................................103
6.3
Advantages of a close corporation ..........................................................................104
6.4
Disadvantages of a close corporation .....................................................................104
6.5
Prescribed forms of a close corporation ..................................................................104
6.6
Name and registration number of a close corporation .............................................104
6.7
Membership of a close corporation .........................................................................105
6.8
Internal relations .....................................................................................................105
6.9
External relations ....................................................................................................105
6.10 Joint liability of members and others for the debts of a close corporation................106
6.11 The tax position of a close corporation and its members.........................................106
6.12 Accounting records and financial reporting..............................................................107
6.13 Deregistration .........................................................................................................109
6.14 Exercises and solutions ..........................................................................................110
Self-Assessment ..............................................................................................................142
101

After studying this learning unit, you should be able to: x x briefly discuss the Close Corporations Act 69 of 1984 (Close Corporations Act) in respect of matters concerning the attributes, registration, internal and external relations, accounting records and annual financial statements, joint liability of members and others for certain debts, the tax position of the close corporation and its members, and the deregistration of a close corporation prepare the financial statements (with the exception of a statement of cash flows) of a close corporation according to IFRS or IFRS for SMEs
x x x x x x x x x x x x x x
Close Corporations Act 69 of 1984
Juristic person
Unlimited existence
Limited liability
Member's contribution
Member's interest
Accounting officer
Financial statements
Profit distribution
Loan to members
Loan from members
Retained earnings
South African Revenue Service (SARS)
Profit before tax
102

Learning unit 5 concluded with the partnership as an entity form and you should now have a clear understanding of the disadvantages of using this form of entity to conduct business.
Because of the disadvantages such as dependent corporate status and restricted capital resources, the close corporation as a form of business entity was introduced when the Close
Corporations Act 69 of 1984 was legislated. In terms of this Act a business entity registered as a close corporation is allowed to acquire independent corporate status and unlimited existence (among other things).
When the Companies Act 71 of 2008 came into effect on 1 May 2011, it introduced certain amendments that impacted on the existence of close corporations. These amendments included amongst other things, the discontinuation of the registration of new close corporations. Existing close corporations will however continue to exist under the Close
Corporation Act, as amended, until such time that their members decide to convert to another form of business entity or discontinue its operations. Conversion of a private company into a close corporation is also prohibited from 1 May 2011.
Read the overview of close corporations and paragraph 5.1 in the prescribed textbook.
Read paragraph 5.2 in the prescribed textbook.
Activity 6.1
Summarise the main characteristics of a close corporation as an entity form.
Feedback 6.1
x
A close corporation is a legal entity which implies that it is liable to pay for obligations and acquire assets in its own name.
x
It was fairly simple to register a close corporation before the changes in the Companies
Act were introduced. You can now obtain a close corporation by buying an existing CC which is less cumbersome than having to register a company.
x
A close corporation is taxed separately from its members (as the owners of a CC are called).
x
A close corporation can have up to ten natural persons as members.
x
A close corporation can enter into contracts and can be sued as a legal personality in its own right.
103

x
A close corporation continues to exist under its registered name irrespective of a change in its membership.
x
It provides its members with limited liability.
x
The financial statements of a close corporation are not subject to an annual audit
(under certain conditions – see paragraph 5.12.2).
x
A close corporation may give financial assistance to a person to acquire an interest in the close corporation.
x
No transfer duties are payable on the transfer of an interest of a member.
Many of the advantages of a close corporation are embedded in its characteristics as summarised in feedback 6.1.
Read paragraph 5.3 in the prescribed textbook.
The disadvantages of a close corporation are discussed in detail in the prescribed textbook.
Make sure that you can name a few.
Study paragraph 5.4 in the prescribed textbook.
Prior to the implementation of the Companies Act, a close corporation was formed when the founder member(s) filed a founding statement (CK1) with the Registrar of Close Corporations.
The use of a CK1 has since been terminated and no new close corporations can be registered.
All changes to existing close corporations are now managed by the Companies Intellectual
Property Commission (CIPC). The Commissioner, appointed in terms of section 189 of the
Companies Act, is tasked with managing all the administrative matters previously handled by the Registrar of Close Corporations.
Read paragraph 5.5 in the prescribed textbook for a more detailed discussion.
Read paragraph 5.6 in the prescribed textbook.
104

The Close Corporations Act sets specific requirements in respect of the number of members that a close corporation may have and the qualifications for membership. A close corporation may have one or more members, but at no time may the number of members exceed ten.
With certain exceptions, only a natural person can become a member of a close corporation.
Read more about the legal requirements pertaining to membership in paragraph
5.7 in the prescribed textbook.
Activity 6.2
Work through example 5.1 in the prescribed textbook. Note that in the case of a partnership, capital is credited when a partner makes a contribution, but in the case of a close corporation, a member’s contribution is credited.
The rules governing the internal relations of a close corporation pertain mainly to the fiduciary relationship of members and their liability in the case of negligent conduct. Minimum legislative requirements exist in respect of the managerial duties of members. The members may decide to manage the close corporation within a more formal framework by means of a written association agreement, which they may enter into at any time. Another important aspect that must be taken note of is the fact that a close corporation may grant loans and provide security to members and others only when certain legislative requirements have been met.
Read paragraph 5.8 in the prescribed textbook.
Read paragraph 5.9 in the prescribed textbook.
The rules governing the external relations of a close corporation pertain mainly to the carrying on of its business. Each member of a close corporation has an equal right to take part in the business of the close corporation and is considered an agent of the close corporation in dealings with non-members.
105

The liability of a member for the obligations of the close corporation is limited to the extent of the member’s contribution to the close corporation.
Read paragraph 5.10 in the prescribed textbook for a more detailed discussion on the joint liability of members and others for the debts of a close corporation.
Study paragraph 5.11 in the prescribed textbook.
Please note that we will not require you to calculate the provisional tax or the taxable income for a financial year of a close corporation. You only have to know how provisional tax payments are recorded and how tax matters are disclosed in the financial statements of a close corporation. These are illustrated in the detailed examples in the study guide as well as in the prescribed textbook. What you have to know is that if we provide you with the taxable income and the tax rate, the current tax for the year is calculated as taxable income x tax rate.
Activity 6.3
a) Name the debit and credit entries in the accounting records of a close corporation to account for the payment of provisional tax.
b) Name the debit and credit entriesin the accounting records of a close corporation to account for the current tax payable by the entity.
Feedback 6.3
a) Debit SARS (income tax) and credit Bank b) Debit Income tax expense and credit SARS (income tax).
Comment
Because the close corporation owes the South African Revenue Service (SARS) tax on taxable profits, SARS is a creditor for the payment of current tax. Provisional tax is tax that is paid twice a year on an estimation of what the tax liability for the year would be and therefore reduces the creditor SARS. Also read about a voluntary third provisional tax payment that can be made in paragraph 5.11. Once the actual tax payable is calculated at the end of the financial period, the current tax expense is debited and the creditor SARS credited. SARS can have a debit or credit balance at this point and it is disclosed in the statement of financial position of the close corporation under current assets/liabilities as either current tax receivable
(debit balance) or current tax payable (credit balance).
106

As you can predict by now, the keeping of accounting records and the financial reporting in respect of close corporations are important.
Read paragraph 5.12.1 and 5.12.2 in the prescribed textbook.
Note that the close corporations act stipulated the reports that must be prepared for a close corporation. Make sure that you can recall those or read paragraph 5.12.1.2 again.
You should recall that for a sole proprietorship and for partnerships a statement of changes in equity was required. In the case of a close corporation a statement disclosing the contributions by members, the undrawn profits (retained earnings), revaluation surplus, loans from members and loans to members (debit balance) is required. We refer to this statement as a statement of changes in the net investment of members.
Pay specific attention to the section on the accounting officer, as many of you may in future become the accounting officer of a close corporation.
Also note that the Companies Act Regulations applicable to close corporations state that IFRS or IFRS for SMEs apply to every close corporation with a financial year end starting on or after the effective date of the Act. Therefore, close corporations with a year end after 1 May 2011
(year end of 30 April 2012 and later) are required to prepare annual financial statements in line with IFRS or IFRS for SMEs in accordance with their Public Interest Score (PIS). The calculation of the PIS, however falls outside the scope of this learning unit. The information is outlined in paragraph 5.12.2 in the prescribed textbook. Please take note of these important changes. The table in section 5.12.2.6 should be a handy reference to establish which reporting framework to apply and whether the financial statements of a close corporation must be audited or not. In closing, note that for the purposes of this module, we assume close corporations have a PIS of less than 100; however, the financial statements have to be prepared in accordance with IFRS owing to the fact that this is the reporting framework that is most widely used.
Study paragraph 5.12.3 in the prescribed textbook which deals with the recording of a distribution of total comprehensive income as well as the preparation of financial statements.
Make sure that you can account for a distribution of comprehensive income which is either paid to members or is capitalised as a loan account.
Activity 6.4
S San and X Xai established a close corporation Khoi CC in 20.1 trading in gem stones mined in the Karoo. The following balances were extracted from the financial records of Khoi close corporation on 1 July 20.16:
Members contributions
Retained earnings – 1 July 20.16
Revaluation surplus
Loan to S San
Loan from X Xai
Profit and loss account
R
500 000
341 800
30 000
10 000
24 000
49 200
107

Additional information:
1.
On 15 August 20.16 S San and X Xai each paid R50 000 of their personal funds into the close corporation’s bank account to increase their contribution and to assist with the cash flow position of the close corporation.
2.
A cash distribution of profit of R10 000 to each member was agreed upon on
30 June 20.17. The distribution is payable to the members on 3 July 20.17.
3.
Khoi CC borrowed an additional R4 000 from X Xai on 15 June 20.17 which was lent to
S San to pay towards funeral costs of a close relative.
4.
The provision of current tax to the amount of R13 776 must still be taken into account.
5.
Khoi CC repaid the first annual instalment of R 6 000 of the loan from X Xai on
2 January 20.17. The loan to S San is repayable in full on 1 July 20.20.
REQUIRED
Prepare the statement of changes in net investment of members of Khoi CC for the year ended
30 June 20.17 according to the requirements of IFRS appropriate to the business of the close corporation.
Feedback 6.4
KHOI CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 30 JUNE 20.17
Balances at
1 July 20.16
Additional contributions c
Total comprehensive income for the year d
Distribution to members e
Increase/Decrease in loans f
Balance at
30 June 20.17
Members contributions
R
Revaluation surplus
R
Retained earnings
R
Loan from a member
R
500 000
100 000
600 000
30 000
30 000
341 800
35 424
(20 000)
357 224
24 000
(2 000)
22 000
Loan to a member
R
Total net investment
R
(10 000) 885 800
100 000
35 424
(20 000)
(6 000) (4 000)
(14 000) 995 224
Non-current liability
Current liability c
㻌 R(50 000 + 50 000) = R100 000 d
R(49 200 – 13 776) = R35 424 e
R(10 000 + 10 000) = R 20 000 f
R(4 000 increase less 6 000 repayment) = R2000 repayment
16 000
6 000
108

Activity 6.5
First work through comprehensive example 5.3 in the prescribed textbook.
Then work through comprehensive example 5.2 in the prescribed textbook.
Take note of the following: x
A close corporation discloses its normal income tax expense in the statement of profit or loss and other comprehensive income.
x
The statement of changes in equity, which you studied in the section dealing with the preparation of the financial statements of partnerships, is replaced by a similar statement (namely the statement of changes in net investment of members). Take note of how the format of the statement of changes in net investment of members differs from the format of the statement of changes in equity. Note also how the profits of a close corporation can be retained in a retained earnings account, and that in the statement of changes in net investment no distinction is made between the members as is done between the partners in the statement of changes in equity.
x
Note how the total equity section of the statement of financial position of a close corporation differs from that of a partnership. The reason for the above differences in disclosure between a partnership and a close corporation is that a partnership is not a legal entity whereas a close corporation is.
x
Study the notes to the financial statements of a close corporation. Notes are a component of financial statements and they form an important part of financial reporting in the FAC1601 syllabus.
Read about the deregistration of a close corporation in paragraph 5.13 in the prescribed textbook as well as the summary of the chapter in paragraph 5.14.
Work through the following exercises, taking special note of how to make year end adjustments and how to prepare the financial statements of a close corporation by applying your knowledge of FAC1502, the Conceptual Framework, IAS 1, IFRS, the Close Corporations
Act, the Guide on Close Corporations and the Companies Act regulations concerning close corporations.
109

EXERCISE 6.1
Mr L Left and Mr R Right are the only two members of Centre CC with an equal interest of
50% each. On 30 June 20.15, the end of the financial year, the bookkeeper presented the following trial balance, together with additional information, to you as the accounting officer:
CENTRE CC
TRIAL BALANCE AS AT 30 JUNE 20.15
Debit
R
Credit
R
10 000 Member's contribution: Mr L Left
Loan to member: Mr L Left
Machinery at cost price
18 000
51 000
Trade receivables control
Stationery consumed
Services rendered
16 000
380
382 000
Remuneration: Accounting officer
Deposit: Petrol
12 000
1 500
SARS (income tax) 21 000
458 200 458 200
Additional information:
1.
Provision must still be made for depreciation on the machinery at 10% per annum calculated according to the straight-line method. Machinery with a cost price of
R16 000 was purchased on 30 September 20.14 and recorded in the books.
2.
The members decided to capitalise the improvements to the buildings. Land and buildings consist of Plot 166, Laudia, purchased on 1 August 20.13 for R200 000.
No depreciation is provided for on land and buildings.
3.
Interest on the mortgage (from T Bank) at 20% per annum must still be taken into account. The interest is payable on 1 July 20.15. The loan was obtained on
1 July 20.14 and is secured by a first mortgage over land and buildings. The loan is repayable on 1 July 20.22.
4.
The following accounts were received and were payable at 30 June 20.15 but must still be accounted for:
Telkom, for telephone expenses, R150
Pen & Pencil Stationery, for stationery, R120
110

5.
Mr D Down, a debtor of the close corporation, had a balance of R2 500 on his account on 30 June 20.15. This amount must be written off as irrecoverable.
6.
The members decided that as from 1 July 20.14 interest at a rate of 18% per annum will be taken into account on their loan accounts. A new loan of R10 000 was granted to
Mr Left at 31 January 20.15. Interest on these loans is capitalised. Both loans are unsecured and immediately callable.
7.
The actual current income tax for the year amounted to R83 044 and must still be recorded.
8.
The members decided to distribute R60 000 of the total comprehensive income of the close corporation for the year ended 30 June 20.15 equally between them. These amounts will not be paid out in cash but will be left in the close corporation as loans to the corporation. These loans are unsecured and an interest rate of 20% per annum is applicable. It was further decided that 50% of these loans must be repaid on
31 March 20.16. The balances on these accounts are repayable on 31 December 20.22.
9.
The members' contributions were paid in full and no additional contributions were made during the year.
REQUIRED
With regard to Centre CC: a) Prepare the statement of profit or loss and other comprehensive income for the year ended 30 June 20.15.
b) Prepare the statement of changes in net investment of members for the year ended
30 June 20.15.
c) Prepare the statement of financial position as at 30 June 20.15.
d) Prepare the notes for the year ended 30 June 20.15.
Your answer must comply with the provisions of the Close Corporations Act 69 of 1984 and the requirements of IFRS. Comparative figures are not required.
NB: Show all calculations.
111

SOLUTION 6.1
a) CENTRE CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 30 JUNE 20.15
Revenue
Other income
Interest income c
Administrative and other expenses
Depreciation
Telephone expenses R(1 260 + 150)
Stationery consumed R(380 + 120)
Petrol
Salaries to members
Remuneration: Accounting officer
Credit losses
Water and electricity
Finance costs
Interest on mortgage c
Profit before tax
Income tax expense
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
Notes
2.3
4
2.1, 3
8
5
R
382 000
3 270
3 270
385 270
(90 910)
4 700
1 410
500
4 000
60 000
12 000
2 500
5 800
(8 000)
8 000
286 360
(83 044)
203 316
–
203 316
Comment
Because there is no cost of sales, there can be no gross profit or any distribution expenses. Remember that this is a service entity and not a retail entity.
b) CENTRE CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 30 JUNE 20.15
Members' contributions
Retained earnings
Loans from
Loans to members members
Total
R
20 000
R R R R
9 200 (14 000) 15 200 Balances at 1 July 20.14
Total comprehensive income
for the year
Distribution to members
Loans to members
Balances at 30 June 20.15
203 316
20 000 152 516 60 000
203 316
(13 270) (13 270)
(27 270) 205 246
Non-current liability
Current liability
30 000
30 000
112

SOLUTION 6.1 (continued) c) CENTRE CC
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.15
Note
ASSETS
Non-current assets
Property, plant and equipment
Current assets
Trade receivables
Loans to members
Cash and cash equivalents
Total assets
EQUITY AND LIABILITIES
Total equity
Members' contributions
Retained earnings
Total liabilities
Non-current liabilities
Long-term borrowings
Current liabilities
Trade and other payables
Current portion of long-term borrowings
Current tax payable
Total equity and liabilities
2.1, 3
4
4, 6
4
5, 7
5
5, 7
R
294 300
294 300
48 530
13 500
27 270
7 760
342 830
172 516
20 000
152 516
170 314
70 000
70 000
100 314
8 270
30 000
62 044
342 830
NOTES FOR THE YEAR ENDED 30 JUNE 20.15
1.
Basis of presentation
The financial statements have been prepared in accordance with the requirements of
International Financial Reporting Standards (IFRS) appropriate to the business of the entity.
The annual financial statements have been prepared on the historical cost basis, modified by the revaluation of financial assets and financial liabilities at fair value through profit or loss.
2.
Summary of significant accounting policies
The financial statements incorporate the following significant accounting policies which are consistent with those applied in previous years except where otherwise stated.
2.1 Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation is written off on land and buildings. Machinery is subsequently measured at historical cost less accumulated depreciation and accumulated impairment losses.
113

SOLUTION 6.1 (continued)
Depreciation on machinery is written off at a rate deemed to be sufficient to reduce the carrying amount of the assets over their estimated useful life to their estimated residual value. The depreciation rate is as follows: x
Machinery: 10% per annum according to the straight-line method
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are determined by comparing the proceeds with the carrying amount of the asset. The net amount is included in profit or loss for the year.
2.2 Financial instruments
Financial instruments are recognised in the entity’s statement of financial position when the entity becomes a party to the contractual provisions of an instrument.
Financial instruments are initially measured at the transaction price, which is fair value plus transaction costs, except for “Financial assets at fair value through profit or loss” which is measured at fair value, transaction costs excluded. The entity classification depends on the purpose for which the entity acquired the financial assets. Financial instruments are subsequently measured at fair value unless they are measured at amortised cost as required by IFRS.
Financial instruments that are subsequently measured at amortised cost are done so using the effective interest rate method.
Debt instruments that are classified as current assets or current liabilities are measured at the undiscounted amount of the cash expected to be received or paid, unless the arrangement effectively constitutes a financing transaction.
2.3 Revenue
Revenue is measured at the fair value of the consideration received or receivable.
Revenue represents the delivery of services to customers of an amount that reflects the consideration to which the entity expects to be entitled in exchange for the services and is recognised when performance obligations are satisfied.
3.
Property, plant and equipment
Carrying amount at 1 July 20.14
Cost
Accumulated depreciation
Additions
Depreciation for the year
Carrying amount at 30 June 20.15
Cost
Accumulated depreciation
Land and buildings
R
200 000
200 000
–
55 000
–
255 000
255 000
–
Equipment
R
28 000
35 000
(7 000)
16 000
(4 700)
39 300
51 000
(11 700)
Total
R
228 000
235 000
(7 000)
71 000
(4 700)
294 300
306 000
(11 700)
114

SOLUTION 6.1 (continued)
The land and buildings consist of offices on Plot 166, Laudia, and were purchased on
1 August 20.13. The CC has pledged land and buildings with a carrying amount of
R255 000 as security for the mortgage obtained from T Bank.
Current financial assets
Trade and other receivables:
Trade receivables control
Loans to members
The loans are unsecured and carry interest at 18% per annum. The loans are immediately callable.
Cash and cash equivalents:
Bank
Short-term deposit: Petrol
5.
Financial liabilities
Non-current financial liabilities at amortised cost
Long-term borrowings: Mortgage
The mortgage was acquired from T Bank on 1 July 20.14 at an interest rate of 20% per annum. The loan repayable on 1July 20.22. The loan is secured by a first mortgage over land and buildings (refer to note 3).
Loans from members:
The loans from members are unsecured and carry interest at a rate of
20% per annum. Fifty percent of the loans are repayable on 31 March
20.16, and the remainder on 31 December 20.22.
Total loans from members
Current portion of loans from members
Current financial liabilities
Trade and other payables:
Accrued expenses:
Interest on long-term loan
Telephone expenses
Stationery
Current portion of loans from members at amortised cost
20.15
R
70 000
40 000
30 000
60 000
(30 000)
38 270
–
8 270
8 000
150
120
30 000
6.
Loans to members
20.15
R
48 530
13 500
27 270
7 760
6 260
1 500
Balance at 1 July 20.14
Advances during the year
Repayments during the year
Interest capitalised
Balance at 30 June 20.15
Mr L Left Mr R Right
R R
8 000 6 000
10 000 –
– –
2 190 1 080
20 190 7 080
Total
R
14 000
10 000
–
3 270
27 270
115

SOLUTION 6.1 (continued)
7.
Loans from members
Balance at 1 July 20.14
Advances during the year
Repayments during the year
Balance at 30 June 20.15
Current portion
Non-current portion
8.
Transactions with members
Salaries
Interest earned on loans to members
Calculations c
Interest on loans
Interest on loans
Balance (1 July 20.14)
Interest
(R40 000 x 20%)
(R 6 000 x 18%)
(R 8 000 x 18%)
(R10 000 x 5 /
12 x 18%)
Interest expense
Interest income
Mr L Left
R
Mr R Right
R
Total
R
30 000 30 000 60 000
– – –
30 000
(15 000)
15 000
30 000
(15 000)
15 000
60 000
(30 000)
30 000
Mr L Left
R
24 000
(2 190)
21 810
Mr R Right
R
36 000
(1 080)
34 920
Total
R
60 000
(3 270)
56 730
Mortgage
R
40 000
Loans to members
Mr L Left Mr R Right
R
8 000
R
6 000
8 000
1 080
8 000
1 440
750
2 190 1 080
116

SOLUTION 6.1 (continued) d
Depreciation e
Trade and other receivables
Old
Machinery
R
35 000
(3 500)
New
Machinery
R
16 000
(1 200) f
Trade and other payables
The amount on the statement of financial position was calculated as follows:
Interest in arrears on long-term loan
Telephone expenses in arrears
Stationery in arrears g
Cost price
Depreciation
(R35 000 x 10%)
(R16 000 x 10% x 9 /
12
)
Accumulated depreciation (1 July 20.14)
Carrying amount (30 June 20.15)
Trade receivables control: 30 June 20.15
Credit losses written off
Current tax payable
Income tax expense for the year
Current tax paid during the year
Current tax payable
(7 000)
24 500 14 800
R
16 000
(2 500)
13 500
R
8 000
150
120
8 270
R
83 044
(21 000)
62 044
117

EXERCISE 6.2
The bookkeeper presented you with the following information relating to Note Book CC for the financial year ended 31 December 20.15:
NOTE BOOK CC
BALANCES AS AT 31 DECEMBER 20.15
Member’s contribution: N Note (60%)
Member’s contribution: B Book (40%)
Land and buildings at cost
Equipment at cost
Vehicles at cost
Accumulated depreciation on equipment (1 January 20.15)
Accumulated depreciation on vehicles (1 January 20.15)
Trade receivables control
Trade payables control
Bank (Dr)
Fixed deposit
Mortgage
Allowance for credit losses
Retained earnings (31 December 20.14)
SARS (income tax) (Dr)
Loan to N Note
Loan from B Book
Sales
Purchases
Inventory (1 January 20.15)
Salaries and wages
Water and electricity
Stationery consumed
Carriage on purchases
Telephone and fax expenses
Insurance expenses
Maintenance of vehicles
Credit losses
1 500
18 000
52 000
40 000
60 000
668 300
210 000
30 000
96 000
16 000
2 900
6 500
8 200
4 000
4 400
800
R
120 000
80 000
560 000
40 000
200 000
12 000
72 000
35 000
48 000
14 000
80 000
320 000
Additional information:
1.
The inventory on 31 December 20.15 amounted to R42 000.
2.
An additional amount of R2 000 must be written off as irrecoverable. The allowance for credit losses must be adjusted to R1 650.
3.
The land and buildings consist of a shop and offices on Plot No 157, situated in
Mainland, and were purchased on 8 January 20.13 for R560 000. It is the policy of the close corporation not to depreciate land and buildings.
4.
Depreciation must be provided for as follows:
Vehicles: 20% per annum according to the diminishing balance method
Equipment: 10% per annum according to the straight-line method.
5.
On 31 December 20.15, a trade debtor who owes R1 600 will be entitled to a
10% discount if he settles his account before 15 January 20.16. The bookkeeper recorded the sale transaction correctly but forgot to account for the allowance for settlement discount granted.
6.
Provision must still be made for interest on the fixed deposit at 14% per annum receivable on 1 January of each year. The fixed deposit was made on 1 January 20.15 at Fair Bank for a period of three years.
118

7.
During the financial year, an amount of R15 000 was paid to member N Note as remuneration for specialised services rendered to the corporation. This amount was included in salaries and wages.
8.
Interest on the mortgage from CT Bank at 12% per annum must still be taken into account. The interest is payable on 2 January 20.16. The loan was obtained on
2 January 20.13 and is secured by a mortgage over land and buildings. The loan is repayable in total on 2 January 20.22.
9.
The loan to member N Note was granted on 1 April 20.13. Interest is calculated at
12% per annum and is payable by the member in January 20.16. The loan is unsecured and immediately callable.
10.
On 1 July 20.15 an amount of R60 000 was borrowed from member B Book. The first repayment of R20 000 will be made on 30 June 20.16 and the remainder on
30 June 20.19. Interest is calculated on 31 December at a rate of 10% per annum and is paid in January of every year. The loan is unsecured.
11.
Provision must be made for a distribution of 80% of the total comprehensive income for the financial year to the members.
12.
The actual current income tax for the financial year amounted to R79 515 and must still be recorded.
REQUIRED
With regard to Note Book CC: a) Prepare the statement of profit or loss and other comprehensive income for the year ended 31 December 20.15.
b) Prepare the statement of changes in net investment of members for the year ended
31 December 20.15.
c) Prepare the statement of financial position as at 31 December 20.15.
d) Prepare the notes for the year ended 31 December 20.15.
Your answer must comply with the provisions of the Close Corporations Act 69 of 1984, as well as the requirements of International Financial Reporting Standards (IFRS). Comparative figures are not required.
NB: Show all calculations.
119

SOLUTION 6.2
a) NOTE BOOK CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20.15
Notes
2.4
Revenue R(668 300 – 160 ߇ )
Cost of Sales
Inventory (1 January 20.15)
Purchases
Carriage on purchases
Inventory (31 December 20.15)
Gross profit
Other income
Interest income R(4 800 + 11 200) ߈
Distribution, administrative and other expenses
Salaries R(96 000 – 15 000)
Salaries to members
Water and electricity
Credit losses ߉
Depreciation ߊ
Stationery consumed
Telephone and fax expenses
Maintenance of vehicles
Insurance expenses
Finance costs ߋ
Interest on mortgage
Interest on loan from members
Profit before tax
Income tax expense
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
4
8
2.1, 3
8
R
668 140
(204 500)
30 000
210 000
6 500
246 500
(42 000)
463 640
16 000
16 000
479 640
(164 050)
81 000
15 000
16 000
2 950
29 600
2 900
8 200
4 400
4 000
(41 400)
38 400
3 000
274 190
(79 515)
194 675
–
194 675
120

SOLUTION 6.2 (continued) b) NOTE BOOK CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 31 DECEMBER 20.15
Members'
Contributions
Retained earnings
Loans from members
Loans to members
Total
Balances at 1 January 20.15
Total comprehensive income for the year
Distribution to members ߍ
Loans from/to members
Balances at 31 December 20.15
R R
200 000 18 000
194 675
(155 740)
R
60 000
R R
(40 000) 178 000
194 675
(155 740)
60 000
200 000 56 935 60 000 (40 000) 276 935
Non-current liability
Current liability
40 000
20 000 c) NOTE BOOK CC
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.15
Note
ASSETS
Non-current assets
Property, plant and equipment
Fixed deposit
Current assets
Inventories
Trade and other receivables ߏ
Loans to members
Cash and cash equivalents
Total assets
EQUITY AND LIABILITIES
Total equity
Members' contributions
Retained earnings
Total liabilities
Non-current liabilities
Long-term borrowings ߌ
Current liabilities
Trade and other payables
Current portion of long-term borrowings
Distribution to members payable
Current tax payable ߎ
Total equity and liabilities
2.1, 3
2.2, 4
2.3
4
4, 6
4
5, 7
5
5, 7
5
R
766 400
686 400
80 000
143 190
42 000
47 190
40 000
14 000
909 590
256 935
200 000
56 935
652 655
360 000
360 000
292 655
89 400
20 000
155 740
27 515
909 590
121

SOLUTION 6.2 (continued) d) NOTEBOOK CC
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.15
1.
Basis of presentation
The financial statements have been prepared in accordance with the requirements of
International Financial Reporting Standards (IFRS) appropriate to the business of the entity. The financial statements have been prepared on the historical cost basis, modified by the revaluation of financial assets and financial liabilities at fair value through profit or loss.
2.
Summary of significant accounting policies
The annual financial statements incorporate the following significant accounting policies which are consistent with those applied in previous years except where otherwise stated.
2.1
Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation is written off on land and buildings. Equipment and vehicles are subsequently measured at historical cost less accumulated depreciation and accumulated impairment losses.
Depreciation on equipment and vehicles is written off at a rate deemed to be sufficient to reduce the carrying amount of the assets over their estimated useful life to their estimated residual value. The depreciation rates are as follows: x
Equipment: 10% per annum according to the straight-line method x
Vehicles: 20% per annum according to the diminishing balance method
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are determined by comparing the proceeds with the carrying amount of the asset. The net amount is included in profit or loss for the year.
2.2
Financial instruments
Financial instruments are recognised in the entity’s statement of financial position when the entity becomes a party to the contractual provisions of an instrument.
Financial instruments are initially measured at the transaction price, which is fair value plus transaction costs, except for “Financial assets at fair value through profit or loss” which is measured at fair value, transaction costs excluded. The entity classification depends on the purpose for which the entity acquired the financial assets. Financial instruments are subsequently measured at fair value unless they are measured at amortised cost as required by IFRS.
Financial instruments that are subsequently measured at amortised cost are done so using the effective interest rate method.
122

SOLUTION 6.2 (continued)
Debt instruments that are classified as current assets or current liabilities are measured at the undiscounted amount of the cash expected to be received or paid, unless the arrangement effectively constitutes a financing transaction.
2.3
Inventories
Inventories are initially measured at cost and subsequently valued at the lower of cost or net realisable value. Cost is calculated using the first-in-first-out method. Net realisable value is the estimated selling price in the ordinary course of business less any costs of completion and disposal.
2.4
Revenue
Revenue is measured at the fair value of the consideration received or receivable.
Revenue represents the transfer of promised goods to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods. Revenue from the sale of goods consists of the total net invoiced sales excluding settlement discount granted. The entity is not registered as a VAT-vendor. Revenue from sales is recognised when performance obligations are satisfied.
3.
Property, plant and equipment
.
Carrying amount at 1 January 20.15
Cost
Accumulated depreciation
Depreciation for the year
Carrying amount at
31 December 20.15
Cost
Accumulated depreciation
Land and buildings
R
560 000
560 000
–
–
560 000
560 000
–
Vehicles
R
128 000
200 000
(72 000)
(25 600)
102 400
200 000
(97 600)
Equipment
R
28 000
40 000
(12 000)
(4 000)
24 000
40 000
(16 000)
Total
R
716 000
800 000
(84 000)
(29 600)
686 400
800 000
(113 600)
The land and buildings consist of a shop and offices on Plot No 157, Mainland, and were purchased on 8 January 20.13. The CC has pledged land and buildings with a carrying amount of R560 000 as security for the mortgage from CT Bank.
123

SOLUTION 6.2 (continue)
4.
Financial assets
Non-current financial assets
Fixed deposit:
The fixed deposit was made on 1 January 20.15 for a period of three years at Fair Bank at 14% interest per annum. The deposit is callable at
31 December 20.17.
Current financial assets
Trade and other receivables:
Trade receivables control ߏ
Allowance for credit losses
Accrued income:
Interest on loan to members
Interest on fixed deposit
Loans to members:
The loans are unsecured and carry interest at 12% per annum. The loans are immediately callable.
Cash and cash equivalents:
Bank
20.15
R
80 000
80 000
101 190
47 190
32 840
(1 650)
4 800
11 200
40 000
14 000
14 000
Non-current financial liabilities at amortised cost
Long-term borrowings: Mortgage
The mortgage was acquired from CT Bank on 2 January 20.13 at an interest rate of 12% per annum. This loan is secured by a first mortgage over land and buildings (refer to note 3) and is repayable on
2·January 20.22.
Loans from members:
The loans are unsecured and carry interest at 10% per annum. R20 000 of the loans are repayable on 30 June 20.16 and the remainder on
30 June 20.19.
Total loans from members
Current portion of loans to members
Current financial liabilities
Trade and other payables:
Trade payables control
Accrued expenses:
Interest on mortgage
Interest on loan from members
Current portion of loans from members at amortised cost
Distribution to members payable
20.15
R
360 000
320 000
40 000
60 000
(20 000)
265 140
89 400
48 000
38 400
3 000
20 000
155 740
124

SOLUTION 6.2 (continued)
6.
Loans to members
Balance at 1 January 20.15
Advances during the year
Repayments during the year
Balance at 31 December 20.15
7.
Loans from members
N Note
R
40 000
–
–
40 000
B Book
R
–
–
–
–
Total
R
40 000
–
–
40 000
Balance at 1 January 20.15
Advances during the year
Repayments during the year
Balance at 31 December 20.15
Current portion
Non-current portion
8.
Transactions with members
N Note
R
–
–
–
–
–
–
B Book
R
–
60 000
–
60 000
(20 000)
40 000
Total
R
–
60 000
–
60 000
(20 000)
40 000
Salaries
Interest incurred on loan from members
Interest earned on loan to members
Calculations
߇ Allowance for settlement discount granted
R1 600 x 10 /
100
= R160
߈ Interest income
Interest on loan to members
R40 000 x 12 /
100
= R4 800
Interest on fixed deposit
R80 000 x 14 /
100
= R11 200
N Note
R
15 000
B Book Total
R
–
R
15 000
– 3 000 3 000
(4 800) –
10 200 3 000
(4 800)
13 200
125

SOLUTION 6.2 (continued)
߉ Credit losses
Original amount written off
Additional amount written off
Increase in allowance for credit losses
* New allowance
Old allowance
Increase in allowance
*
R
800
2 000
150
2 950
1 650
(1 500)
150
ߊ Depreciation
Vehicles
Equipment
Total
= R(200 000 – 72 000)
= R128 000 x 20 /
100
= R25 600
= R40 000 x 10 /
100
= R4 000
= R(25 600 + 4 000)
= R29 600
ߋ Finance costs
Interest on mortgage
R320 000 x 12 /
100
= R38 400
Interest on loan from members
R60 000 x 10 /
100 x 6 /
12
= R3 000
ߌ Long-term borrowings
Mortgage
Loan from B Book
Portion to be repaid in 20.16 financial year
60 000
(20 000)
R
320 000
40 000
360 000
Current portion of loans from members
The current portion of loans from members represents that portion of the loan of R60 000 that will be repaid in the 20.16 financial year (refer to calculation).
ߍ Distribution to members payable
R194 675 x 80 /
100
= R155 740
ߎ Current tax payable
Income tax for the year
SARS (income tax)
Current tax payable
ߏ Trade receivables
R(35 000 – 2 000 – 160) = R32 840
R
79 515
(52 000)
27 515
126

EXERCISE 6.3
After the bookkeeper had recorded the transactions during the year, he handed you the following trial balance and additional information with regard to Trade Acc CC:
TRADE ACC CC
TRIAL BALANCE AS AT 31 DECEMBER 20.15
Debit
R
95 000
33 000
21 000
Credit
R
Land and buildings at cost
Furniture and equipment at cost
Vehicles at cost
Accumulated depreciation: Furniture and equipment (1 January 20.15)
Accumulated depreciation: Vehicles (1 January 20.15)
Inventory (1 January 20.15)
Mortgage
Trade receivables control
Allowance for credit losses (1 January 20.15)
Bank
Trade payables control
SARS (income tax)
Sales
Purchases
Import duty on purchases
Railage on purchases
Repairs and maintenance
Assessment rates
Commission on sales
Delivery expenses
Salaries and wages
Stationery consumed
Credit losses
Loss on sale of equipment
Insurance expenses
Water and electricity
Dividends received
Settlement discount received
Investment
Loan from member: A Adam
Loan from member: C Charles
Interest expenses (in respect of loans)
Member's contribution: A Adam
Member's contribution: B Ben
Member's contribution: C Charles
Retained earnings (1 January 20.15)
Allowance for settlement discount granted (1 January 20.15)
54 600
20 500
24 000
6 900
224 700
1 550
2 500
1 315
1 710
1 500
650
36 615
520
460
220
475
2 100
10 000
9 660
548 975
6 700
8 400
50 000
955
37 100
319 950
450
1 000
10 000
8 000
40 000
35 000
25 000
6 220
200
548 975
127

Additional information:
1. The interest of the members in the CC is in the same ratio as their contributions.
2.
The land and buildings consist of a shop and offices on Plot No 32, situated in Clarence, and were purchased on 15 March 20.14 for R95 000. It is the policy of the close corporation not to depreciate land and buildings.
3.
The investment in Vicks limited consists of 10 000 ordinary shares of R1 each and was acquired in 20.14. On 31 December 20.14 the fair value of the investment was determined at R10 000. On 31 December 20.15 the fair value was determined at
R11 000 and is still to be recorded.
4. Included in salaries and wages is an amount of R10 000 which was paid to member
B Ben as remuneration for his special contribution to the management of the enterprise.
5.
Provision for depreciation of R1 650 on furniture and equipment and R2 100 on vehicles must still be made. Depreciation is written off according to the straight-line method on furniture and equipment and vehicles and no sales or purchases of furniture and equipment or vehicles occurred in the year.
6. The interest paid includes R2 160, which represents 12% interest paid to A Adam and
C Charles in respect of the loans they made to the close corporation. The loans are unsecured and are repayable on 31 December 20.19.
7.
The mortgage was acquired on 2 January 20.15 from Bug Bank at 15% interest per annum. Interest is payable on 31 December. The loan is secured by a first mortgage over land and buildings and is repayable in five equal annual instalments as from
2 January 20.18.
8.
The allowance for credit losses must be adjusted to R1 025.
9.
On 31 December 20.15 the inventory on hand amounted to R58 300.
10.
The actual current income tax in respect of the financial year amounted to R11 166 and must still be recorded.
11. A distribution of income of R20 000 must be made to the members.
12. The allowance for settlement discount granted on 1 January 20.15 must be written back since the debtor did not settle his account on time. On 31 December 20.15 a trade debtor who owes R1 500 is entitled to a 5% discount provided he settles his account before
10 January 20.16. The bookkeeper recorded the sales transaction correctly but forgot to account for the allowance for settlement discount granted.
13. Trade Acc CC was offered a discount of 6% on an amount of R 1 200 owing to a supplier provided the supplier is paid before 15 January 20.16. The close corporation intends taking advantage of the discount offered.
14.
On 31 December 20.15 the land and buildings were revalued to R150 000 by Mr Sono, an independent sworn appraiser. This information must still be recorded in the accounting records of Trade Acc CC.
REQUIRED
With regard to Trade Acc CC: a) Prepare the statement of profit or loss and other comprehensive income for the year ended 31 December 20.15.
b) Prepare the statement of changes in net investment of members for the year ended
31 December 20.15.
c) Prepare the statement of financial position as at 31 December 20.15.
128

d) Prepare the notes for the year ended 31 December 20.15.
Your answer must comply with the provisions of the Close Corporations Act 69 of 1984, as well as the requirements of International Financial Reporting Standards (IFRS).
Comparative figures are not required.
NB: Show all calculations.
SOLUTION 6.3
a) TRADE ACC CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20.15
Note
2.4
Revenue R(319 950 – 75 ߇ + 200)
Cost of Sales
Inventory (1 January 20.15)
Purchases R(224 700 – 1 072 ߈ )
Import duty
Railage on purchases
Inventory (31 December 20.15)
Gross profit
Other income
Dividend income: Listed shares
Fair value adjustment: Listed shares
Distribution, administrative and other expenses
Repairs and maintenance
Assessment rates
Commission on sales
Delivery expenses
Salaries and wages R(36 615 – 10 000)
Salary to member
Stationery consumed
Credit losses ߉
Loss on sale of equipment
Insurance expenses
Water and electricity
Depreciation ߊ
Finance costs
Interest on mortgage
Interest on loan from members
Profit before tax
Income tax expense
Profit for the year
Other comprehensive income for the year
Revaluation surplus
7
2.1, 3
5
7
R
320 075
(223 978)
54 600
223 628
1 550
2 500
282 278
(58 300)
96 097
1 450
450
1 000
97 547
(49 385)
1 315
1 710
1 500
650
26 615
10 000
520
530
220
475
2 100
3 750
(9 660)
7 500
2 160
38 502
(11 166)
27 336
55 000
55 000
Total comprehensive income for the year 82 336
129

SOLUTION 6.3 (continued) b) TRADE ACC CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 31 DECEMBER 20.15
Balances at 1 January 20.15
Profit for the year
Revaluation surplus
Distribution to members
Balances at 31 December 20.15
Members' contributions
R
100 000
100 000
Retained earnings
R
Revaluation surplus
R
6 220 –
27 336
55 000
(20 000)
13 556 55 000
Loans from members
R
Total
R
18 000 124 220
27 336
55 000
(20 000)
18 000 186 556 c) TRADE ACC CC
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.15
Notes
ASSETS
Non-current assets
Property, plant and equipment
Current assets
Inventories
Trade receivables ߋ
Listed investment
Cash and cash equivalents
Total assets
EQUITY AND LIABILITIES
Total equity
Members' contributions
Retained earnings
Revaluation surplus
Total liabilities
Non-current liabilities
Long-term borrowings
Current liabilities
Trade payables ߌ
Distribution to members payable
Current tax payable ߍ
2.1, 3
2.3
4
2.2, 4
4
5, 6
5
Total equity and liabilities
R
185 150
185 150
112 700
58 300
19 400
11 000
24 000
297 850
168 556
100 000
13 556
55 000
129 294
68 000
68 000
61 294
37 028
20 000
4 266
297 850
130

SOLUTION 6.3 (continued) d) TRADE ACC CC
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.15
1. Basis of presentation
The financial statements have been prepared in accordance with the requirements of
International Financial Reporting Standards (IFRS) appropriate to the business of the entity. The financial statements have been prepared on the historical cost basis, modified by the revaluation of land and buildings and of financial assets and financial liabilities at fair value through profit or loss.
2. Summary of significant accounting policies
The financial statements incorporate the following significant accounting policies which are consistent with those applied in previous years except where otherwise stated.
2.1 Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation is written off on land and buildings which is revalued at regular intervals by an independent sworn appraiser. Vehicles and furniture and equipment are subsequently measured at historical cost less accumulated depreciation and accumulated impairment losses.
Depreciation on vehicles and furniture and equipment is written off at a rate deemed to be sufficient to reduce the carrying amount of the assets over their estimated useful life to their estimated residual value. Depreciation is written off as follows: x
Vehicles: 10%* per annum according to the straight-line method x
Furniture and equipment: 5%** per annum according to the straight-line method
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are determined by comparing the process with the carrying amount of the asset. The net amount is included in profit or loss for the year.
* R(2 100/21 000) x 100%
** R(1 650/33 000) x 100%
2.2 Financial instruments
Financial instruments are recognised in the entity’s statement of financial position when the entity becomes a party to the contractual provisions of an instrument.
Financial instruments are initially measured at the transaction price, which is fair value plus transaction costs, except for “Financial assets at fair value through profit or loss” which is measured at fair value, transaction costs excluded. The entity classification depends on the purpose for which the entity acquired the financial assets. Financial instruments are subsequently measured at fair value unless they are measured at amortised cost as required by IFRS.
Financial instruments that are subsequently measured at amortised cost are done so using the effective interest rate method.
131

SOLUTION 6.3 (continued)
Debt instruments that are classified as current assets or current liabilities are measured at the undiscounted amount of the cash expected to be received or paid, unless the arrangement effectively constitutes a financing transaction.
2.3 Inventories
Inventories are initially measured at cost and subsequently valued at the lower of cost or net realisable value. Cost is calculated using the first-in-first-out method. Net realisable value is the estimated selling price in the ordinary course of business less any costs of completion and disposal.
2.4 Revenue
Revenue is measured at the fair value of the consideration received or receivable.
Revenue represents the transfer of promised goods to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods. Revenue from the sale of goods consists of the total net invoiced sales excluding settlement discount granted. The entity is not registered as a VAT vendor. The revenue from sales is recognised when the performance obligations are satisfied.
3. Property, plant and equipment
Carrying amount at 31 January 20.15
Cost
Accumulated depreciation
Revaluation surplus
Depreciation for the year
Carrying amount at 31 December 20.15
Cost/Valuation
Accumulated depreciation
Land and buildings
R
95 000
95 000
–
55 000
–
150 000
150 000
–
Furniture and equipment
R
26 300
33 000
(6 700)
(1 650)
24 650
33 000
(8 350)
Vehicles
R
12 600
21 000
(8 400)
(2 100)
10 500
21 000
(10 500)
Total
R
133 900
149 000
(15 100)
55 000
(3 750)
185 150
204 000
(18 850)
The land and buildings consist of a shop and offices on Plot No 32, Clarence, and were purchased on 15 March 20.14. The CC has pledged land and buildings with a carrying amount of R95 000 as security for the mortgage from Bug Bank. The land and buildings were revalued by R55 000 on 31 December 20.15 by an independent sworn appraiser.
Current financial assets
Trade and other receivables:
Trade receivables control R(20 500 – 75)
Allowance for credit losses
Listed investment:
Listed investments held for trading at fair value through profit or loss:
10 000 R1 ordinary shares in Vicks Limited
Cash and cash equivalents:
Bank
20.15
R
54 400
19 400
20 425
(1 025)
11 000
24 000
24 000
132

SOLUTION 6.3 (continued)
5.
Financial liabilities
Non-current financial liabilities at amortised cost
Long-term borrowings: Mortgage
The mortgage was acquired from Bug Bank on 2 January 20.15 at an interest rate of 15% per annum. The loan is repayable in five equal payments from 2 January 20.18. The loan is secured by a first mortgage over land and buildings.
Loans from members:
The loans are unsecured and carry interest at 12% per annum. R20 000 of the loans are repayable on 31 December 20.19.
Current financial liabilities
Trade payables:
Trade payables control
Distribution to members payable
Settlement discount received
Settlement discount received for the period
* Allowance for settlement discount received
Allowance for settlement discount received
R1 200 x 6 /
100
= R72
20.15
R
68 000
50 000
18 000
57 028
37 028
37 028
20 000
6.
Loans from members
Balance at 1 January 20.15
Advances during the year
Repayments during the year
Balance at 31 December 20.15
A Adam
R
10 000
–
–
10 000
B Ben
R
–
–
–
–
C Charles
R
8 000
–
–
8 000
Total
R
18 000
–
–
18 000
The loans are unsecured and an interest rate of 12% per annum is applicable. The loans are repayable on 31 December 20.19.
7.
Transactions with members
Interest on loans from members
Salaries
A Adam
R
1 200
–
1 200
B Ben
R
–
10 000
10 000
C Charles
R
960
–
960
Total
R
2 160
10 000
12 160
Calculations
Allowance for settlement discount granted
R1 500 x 5 /
100
= R75
R
1 000
72
1 072
133

SOLUTION 6.3 (continued)
߉ Credit losses
R[460 + (1 025 – 955)]
= R(460 + 70)
= R530
ߊ Depreciation
R(1 650 + 2100) = R3 750
ߋ Trade and other receivables
Trade receivables control
Allowance for settlement discount granted
Allowance for credit losses
ߌ Trade and other payables
Trade payables control
Allowance for settlement discount received
ߍ Current tax payable
Income tax for the year
Current tax paid during the year
Current tax payable
R
20 500
(75)
20 425
(1 025)
19 400
R
37 100
(72)
37 028
R
11 166
(6 900)
4 266
134

EXERCISE 6.4
The bookkeeper has provided you with the following trial balance and additional information with regard to Loga CC for the year ended 28 February 20.15:
LOGA CC
TRIAL BALANCE AS AT 28 FEBRUARY 20.15
Debit
R
Credit
R
252 000
245 000
Member's contribution: L Lock
Member's contribution: G Gate
Land and buildings at valuation
Vehicles at cost
Equipment at cost
Inventory
Trade receivables control
Trade payables control
Loan to G Gate
Investment (fixed deposit at ABC bank)
Bank
Accumulated depreciation: Equipment (1 March 20.14)
Sales
Cost of Sales
Retained earnings (1 March 20.14)
Revaluation surplus
Rental expenses
Advertising expense
Salaries and wages
Water and electricity
Telephone expenses
Income from investment
Credit losses
Administrative expenses
Remuneration: Accounting officer
SARS (income tax)
Interim profit distribution to members
Interest income
500 000
54 000
18 000
172 080
50 184
12 000
25 000
6 956
778 812
14 400
4 800
168 020
8 640
2 160
540
2 868
4 320
30 000
48 000
1 900 780
83 304
3 600
1 168 236
6 420
140 000
1 500
720
1 900 780
135

Additional information:
1.
A debtor cannot be traced and his debt of R184 must be written off as irrecoverable. At year end the members decided to create an allowance for credit losses of R1 000.
2.
The electricity account for February, R785, was received on 20 March 20.15.
3. On 1 June 20.14 an insurance contract was entered into. The premium of R800, payable annually on 1 June, is included in administrative expenses.
4.
The loan to G Gate was made on 1 March 20.14 at 12% interest per annum, payable every six months. The loan is unsecured and immediately callable.
5.
Included in salaries and wages is an amount of R20 000, paid to L Lock as remuneration for his special contribution to the management of the entity.
6. The investment at ABC Bank was made on 1 May 20.14 for 60 months at 12% interest per annum, which is receivable every six months on 31 October and 30 April.
7.
The land and buildings were acquired on 31 March 20.13 for R300 000 and consist of shops and offices situated at number 23 Rhavi Road, Dealsville. Additions to buildings were completed at a cost of R60 000 on 31 July 20.14.
8.
On 28 February 20.14, the land and buildings were revalued for the first time to
R340 000. The land and buildings are not depreciated.
9. Provision must still be made for the following: x
Depreciation on the vehicle and equipment at 20% per annum on the diminishing balance. The vehicle was acquired on 1 September 20.14. x
Actual current income tax for the financial year amounted to R51 494. x
An additional distribution to members of R36 000. Members share profits equally.
REQUIRED
With regard to Loga CC: a) Prepare the statement of profit or loss and other comprehensive income for the year ended 28 February 20.15.
b) Prepare the statement of changes in net investment of members for the year ended
28 February 20.15.
c) Prepare the statement of financial position as at 28 February 20.15.
d) Prepare only the following notes for the year ended 28 February 20.15: x accounting policy x property, plant and equipment x transactions with members
Your answer must comply with the provisions of the Close Corporations Act 69 of 1984, as well as the requirements of International Financial Reporting Standards (IFRS). Comparative figures are not required.
NB: Show all calculations.
136

SOLUTION 6.4
STATEMENT OF PROFIT OR LOSS AND COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.15
Notes
2.4
Revenue
Cost of Sales
Gross profit
Other income
Interest income R(1 440 + 2 500) ߇
Distribution, administrative and other expenses
Rental expenses
Advertising expense
Salaries and wages R(168 020 – 20 000)
Salary to member
Water and electricity ߈
Telephone expenses
Credit losses ߉
Administrative expenses ߊ
Insurance expense ߋ
Remuneration: Accounting officer
Depreciation ߌ
Profit before tax
Income tax expense
Profit for the year
Other comprehensive income for the year
Revaluation surplus
Total comprehensive income for the year
4
2.1, 3
R
1 168 236
(778 812)
389 424
3 940
3 940
393 364
(215 797)
14 400
4 800
148 020
20 000
9 425
2 160
1 724
2 068
600
4 320
8 280
177 567
(51 494)
126 073
100 000
100 000
226 073 b) LOGA CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 28 FEBRUARY 20.15
Members' contributions
R
Retained
Earnings
R
Revaluation surplus
R
Loans to
Members
R
Total
R
Balances at 1 March 20.14
Total comprehensive income for the year
Profit for the year
Revaluation surplus
Loan to a member
Distribution to members
Balances at 28 February 20.15
497 000
497 000
6 420 40 000 – 543 420
126 073 100 000 226 073
126 073
(84 000)
100 000
126 073
100 000
(12 000) (12 000)
(84 000)
48 493 140 000 (12 000) 673 493
137

SOLUTION 6.4 (continued) c) LOGA CC
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
Notes
ASSETS
Non-current assets
Property, plant and equipment
Fixed deposit
Current assets
Inventories
Trade and other receivables ߎ
Prepayments ߏ
Loan to a member
Cash and cash equivalents
Total assets
EQUITY AND LIABILITIES
Total equity
Members' contributions
Retained earnings
Revaluation surplus
Total liabilities
Current liabilities
Trade and other payables
ᬎ
Distribution to members payable ߍ
Current tax payable
ᬏ
Total equity and liabilities
2.1, 3
2.2
2.3
R
585 120
560 120
25 000
241 956
172 080
50 720
200
12 000
6 956
827 076
685 493
497 000
48 493
140 000
141 583
141 583
84 089
36 000
21 494
827 076 d) LOGA CC
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.15
1. Basis of presentation
The financial statements have been prepared in accordance with the requirements of
International Financial Reporting Standards (IFRS) appropriate to the business of the entity. The financial statements have been prepared on the historical cost basis, modified by the revaluation of land and buildings as well as financial assets and financial liabilities at fair value through profit or loss.
2. Summary of significant accounting policies
The financial statements incorporate the following significant accounting policies which are consistent with those applied in previous years, except where otherwise stated.
2.1 Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation is written off on land and buildings which is revalued at regular intervals by an independent appraiser. Equipment and vehicles are subsequently measured at historical cost less accumulated depreciation and accumulated impairment losses.
138

SOLUTION 6.4 (continued)
Depreciation on equipment and vehicles is written off at a rate deemed to be sufficient to reduce the carrying amount of the assets over their estimated useful life to their estimated residual value. The depreciation rates are as follows: x
Equipment: 20% per annum according to the diminishing balance method x
Vehicles: 20% per annum according to the diminishing balance method
.
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are determined by comparing the proceeds with the carrying amount of the asset. The net amount is included in profit or loss for the year.
2.2
Financial instruments
Financial instruments are recognised in the entity’s statement of financial position when the entity becomes a party to the contractual provisions of an instrument.
Financial instruments are initially measured at the transaction price, which is fair value plus transaction costs, except for “Financial assets at fair value through profit or loss” which is measured at fair value, transaction costs excluded. The entity classification depends on the purpose for which the entity acquired the financial assets. Financial instruments are subsequently measured at fair value unless they are measured at amortised cost as required by IFRS.
Financial instruments that are subsequently measured at amortised cost are done so using the effective interest rate method.
Debt instruments that are classified as current assets or current liabilities are measured at the undiscounted amount of the cash expected to be received or paid, unless the arrangement effectively constitutes a financing transaction.
2.3 Inventories
Inventories are initially measured at cost and subsequently valued at the lower of cost or net realisable value. Cost is calculated using the first-in-first-out method. Net realisable value is the estimated selling price in the ordinary course of business less any costs of completion and disposal .
2.4
Revenue
Revenue is measured at the fair value of the consideration received or receivable.
Revenue represents the transfer of promised goods to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods. Revenue from the sale of goods consists of the total net invoiced sales excluding value added tax and settlement discount granted. The revenue from sales is recognised when the performance obligations are satisfied.
139

SOLUTION 6.4 (continued)
3. Property, plant and equipment
Carrying amount at 1 March 20.14
Cost/Valuation
Accumulated depreciation
Revaluation surplus for the year
Additions
Depreciation for the year
Carrying amount at 28 February 20.15
Cost
Accumulated depreciation
Land and buildings
Furniture and equipment
R R
340 000
340 000
–
14 400
18 000
(3 600)
100 000 –
60 000 –
– (2 880)
500 000
500 000
–
11 520
18 000
(6 480)
Vehicles
R
–
–
–
–
54 000
(5 400)
48 600
54 000
(5 400)
Total
R
354 400
358 000
(3 600)
100 000
114 000
(8 280)
560 120
572 000
(11 880)
Land and buildings consists of shops and offices at 23 Rhavi Road, Dealsville. Land and buildings are revalued annually by an independent sworn appraiser.
4.
Transactions with members
Salary
Interest on loan to member
L Lock G Gate
R R
20 000 –
– (1 440)
20 000 (1 440)
Total
R
20 000
(1 440)
18 560
Calculations
߇ Interest on loan to member
R12 000 x 12% = R1 440
Interest on investment
R25 000 x 12% x 10 /
12
= R2 500
߈ Water and electricity
R(8 640 + 785) = R9 425
߉ Credit losses
Original amount written off
Further amount written off
Allowance for credit losses
ߊ Administrative expenses
R(2 868 – 800) (R800 = insurance premium) = R2 068
R
540
184
1 000
1 724
ߋ Insurance
The R800 was paid for a period of one year starting on 1 June 20.14. Only 9 months of this period falls within the current financial year. Therefore, only R800 x 9 /
12
=
R600 of the expense was incurred during the current financial year. The R200 that falls outside this financial period must be shown in the statement of financial position as a prepayment for the next financial period.
140

SOLUTION 6.4 (continued)
ߌ Depreciation
Equipment:
Accumulated depreciation
Diminished balance (carrying amount)
R14 400 x 20% = R2 880
Vehicle:
R54 000 x 20% x 6 /
12
= R5 400
Total depreciation:
= R(2 880 + 5 400) = R8 280
R
(3 600)
14 400
ߍ Distribution to members and distribution to members payable
Distribution to members R(48 000 + 36 000)
Interim distribution paid to members
Distribution to members payable
R
84 000
(48 000)
36 000
ߎ Trade receivables
Trade receivables control R(50 184 – 184)
Allowance for credit losses
Accrued interest on loan to member R(1 440 – 720)
Accrued interest on investment R(2 500 – 1 500)
R
50 000
(1 000)
49 000
720
1 000
50 720
ߏ Prepayments
R
200 Prepayments represent insurance prepaid (refer to Insurance)
ᬎ
Trade payables
Trade payables control
Accrued expenses (water and electricity)
R
83 304
785
84 089
ᬏ
Current tax payable
Income tax for the year
SARS: Income tax paid during the year
Current tax payable
R
51 494
(30 000)
21 494
141

After having worked through this learning unit, are you able to do the following?
Briefly discuss the Close Corporations Act in respect of matters concerning the attributes, registration, internal and external relations, accounting records and annual financial statement, joint liability of members and others for certain debts of a close corporation, tax position of a close corporation and its members, as well as the deregistration of a close corporation.
Yes
Prepare the financial statements (except for a statement of cash flows) of a close corporation according to the provisions of the Close Corporations Act and the requirements of IFRS and, where applicable, the guidelines as presented in the Guide on Close Corporations and Companies Act No. 71 of 2008 Regulations (as issued by SAICA, December 2001).
No
If you answered "yes" to all of the above assessment criteria, you have completed your studies on close corporations and can move on to learning unit 7. If you answered
"no" to any of the above criteria, you must revise those sections before progressing to learning unit 7.
Food for thought:
Do you think that you would prefer to establish a partnership if you had the opportunity or would you have preferred to establish a close corporation instead?
142

7
7
Learning outcomes ..........................................................................................................144
Key concepts ...................................................................................................................144
7.1
Introduction .............................................................................................................145
7.2
Characteristics of a profit company .........................................................................146
7.3
Formation (incorporation) of a profit company.........................................................146
7.4
Types of companies................................................................................................147
7.5
Shareholders ..........................................................................................................148
7.6
Rights of shareholders ............................................................................................148
7.7
Share transactions ..................................................................................................149
7.8
Dividends ................................................................................................................151
7.9
Debenture transactions ...........................................................................................151
7.10 Annual financial statements of companies ..............................................................152
7.11 Exercises and solutions ..........................................................................................153
Self-assessment ..............................................................................................................162
143

After studying this learning unit, you should be able to: x distinguish between authorised share capital and issued share capital x distinguish between ordinary shares and preference shares x record transactions pertaining to the issue of shares x record the issue of capitalisation shares x record the underwriting of shares x explain the term “dividends” and the calculation thereof x record dividend transactions x record transactions pertaining to the issue of debentures x calculate and record interest on debentures
x
Companies Act 71 of 2008 x
Public company x
Private company x
Shareholders x
Authorised share capital x
Issued share capital x
Share capital account x
Ordinary shares x
Preference shares x
Capitalisation shares x
Underwriting share issues x
Interim dividends x
Final dividends x
Debenture issue x
Debenture interest
144

The previous learning units introduced you to some entity forms that can be used to conduct business. From the discussions, you should realise that providing entrepreneurs with limited liability and continued existence as well as affording them access to funding are major considerations when decisions are made on the business form. Sole traders, partners of partnerships and members of close corporations mainly have to provide their own capital or borrow money from financial institutions to finance their businesses. Because such financing options are expensive, subject to guarantees and limited, entities that need large sums of money (such as mines) form public companies which enable them to issue shares (shares will be described later in the learning unit) to the public to increase their financing resources.
Companies came into existence during the Industrial Revolution to meet the following needs: x to acquire more capital x to ensure the continued existence of the entity x to limit the financial liability of the owners.
In general, a company can be described as an association of persons who work together with the aim of making a profit. A company is a legal entity, incorporated in terms of extensive legislation and independent from its owners. The owners of a company are called shareholders. Can you remember what the owners of a close corporation and a partnership are called?
The aim of this chapter is to introduce you to the company as an entity form and to familiarise you with the terminology used in company reporting pertaining to the capital structure of a company. Companies are widely used as an entity form and because of the extensive legislation governing the formation, administration and reporting for companies, this entity form will be covered in detail in further accounting studies. This learning unit is merely an introduction to this important entity form and consists mainly of how to account for the issue of shares, different types of shares, the issue of debentures and the declaration of dividends.
Read through paragraph 6.1 in the prescribed textbook and the overview of the introduction to companies.
Activity 7.1
a) Define a company in your own words.
b) What is the name of the Act that governs companies in South Africa?
c) When was the effective date of the above Act?
d) What is the name of the governing body responsible for registering companies in South
Africa?
145

Feedback 7.1
a) A company can be defined as a collection of natural and/or legal persons incorporated to achieve certain business objectives. A company is a legal entity and is governed by law.
b) The Companies Act 71 of 2008.
c) The Companies Act 71 of 2008 came into effect on 1 May 2011 and replaced the previous Companies Act 61 of 1973.
d) The Companies and Intellectual Property Commission (CIPC).
Study Table 6.1 in the prescribed textbook which is a comparison of the company as a business form compared with the other business forms you have encountered in earlier learning units.
Two main types of companies can be established namely: x
Profit companies which are incorporated for the financial gain of the shareholders without restricting the transfer of ownership and x
Non-profit companies which are incorporated for public benefit. All assets and liabilities must be applied to advance this objective.
Read paragraph 6.2 in the prescribed textbook which lists the characteristics of profit companies.
A profit company is established by complying with specific legal requirements. Usually, the main reason behind the formation of a profit company determines the type of company that will be established. Types of profit companies that can be formed are private, public, stateowned or personal liability companies (refer to 7.4 for a detailed discussion).
The first step in the process of establishing a profit company is to apply for the registration of its proposed name with the Companies and Intellectual Property Commission (Commission).
Once the name has been approved, the company is incorporated by adopting a single document, namely the Memorandum of Incorporation (MoI). The MoI serves to protect the interests of the shareholders and it includes information particular to each company and binds the company and shareholders to rules under the Companies Act.
146

Read paragraph 6.3 in the prescribed textbook and acquaint yourself with the procedure that must be followed to register a profit company and the information that must be disclosed in the required documents.
In terms of Section 8 of the Companies Act, there are two types of companies that can be formed, namely profit companies and non-profit companies.
Study paragraph 6.4 in the prescribed textbook. Make sure that you can define the different types in your own words.
Activity 7.2
a) Pair the type of company to be formed with its correct abbreviation.
Type of company
1.
Private company
2.
State-owned company
3.
Public company
4.
Personal liability company
5.
Non-profit company b) Company types 1-4 are collectively referred to as …
Ranking
A
B
C
D
E
Abbreviation
NPC
(Pty) Ltd
SOE Ltd
Ltd
Inc
Feedback 7.2
a) 1. B
2. C
3. D
4. E
5. A b) Profit companies.
Please note
The remainder of the learning unit deals with companies that are allowed to trade their shares.
147

To enable members of the public (who generally have limited financial resources available for investment) to invest in a large business entity such as a public company, the capital of a profit company is divided into more affordable units that are called “shares”. When an investor buys shares in a company, a securities certificate (share certificate) is issued that provides proof that an investor owns a certain number of shares in a company. The ownership is a percentage of the number of shares acquired in relation to the total number of issued shares and the investment made is called share capital. Shares of listed companies are traded on securities
(stock) exchanges. Share prices fluctuate according to supply and demand. The supply and demand of shares are determined by various factors, such as the financial performance of a company, future prospects in the marketplace and legislation.
Read paragraph 6.5 in the prescribed textbook.
Read paragraph 6.6 in the prescribed textbook.
Since a company is regarded as a legal person, the trading of shares (which changes the ownership of a company) does not influence the continued existence of the company as is the case with a sole trader or a partnership.
The shareholders of a company may share in the profits of the company, and under certain circumstances they have voting rights in relation to the number of shares that they have purchased. The shareholders appoint the directors of a company in terms of the Companies
Act and the directors are responsible for the management of the company. Directors can be executive or non-executive depending on their responsibilities towards managing the company. They will appoint and delegate responsibilities to the Chief Executive Officer (CEO) and top management who in turn will manage the day-to-day activities of the company.
Now that you are familiar with the incorporation of a company, the key players, and the working of a company, we come to the recording and accounting that are required from you as accounting I students. These can be summarised as the recording and accounting for share transactions (section 7.7 of the learning unit), dividends (section 7.8 of the study guide) and debentures (section 7.9 of the study guide) in the financial statements of companies.
148

Read paragraphs 6.7.1 to 6.7.3 and paragraph 6.7.5.1 in the prescribed textbook.
The first issue of shares will be to the incorporators of the company. The remaining unissued shares can be offered to the public to raise capital. To attract the public as investors, the company issues a prospectus. A prospectus must contain a reasonable representation of the affairs of the company and it must comply with certain requirements prescribed by the
Companies Act. The following diagram pictures the procedure of how a company that is allowed to trade shares, raises share capital:
Study paragraph 6.7.4 in the prescribed textbook. This knowledge is very important and forms the building blocks in future accounting studies. Make sure that you can define ordinary and preference shares and the different classes of preference shares, and that you understand the shareholders’ rights in respect of profits of the company declared as dividends for the different classes of shares.
Once you grasped that different classes of shares can be issued and know the rights of the different classes in respect of dividends declared by the company, the recording of the issue of shares follows.
Study paragraph 6.7.5.2 in the prescribed textbook.
149

When the company receives applications and money from the public to acquire shares (refer to the diagram in section 7.7), the bank account must be debited and a temporary “application and allotment account” is credited. Such entries can occur at any time between the prospectus date and the closing date for applications. Because a company cannot control the number of applications received from the public, it can supersede the available unissued shares or even the available number of authorised shares. After the closing date for applications, the allocation of shares is done and the oversubscribed applicants are refunded.
Activity 7.3
x
Work through example 6.1 in the prescribed textbook.
x
Work through example 6.2 in the prescribed textbook, which illustrates an over-application of shares.
The use of an allotment schedule is handy when a company has a large share issue and expects a large number of applications.
Read paragraph 6.7.6 in the prescribed textbook.
Activity 7.4
Work through example 6.3 in the prescribed textbook where an allotment schedule is used.
Make sure that you can account for the share issue when you are provided with an allotment schedule.
Shares can also be issued at no consideration for various reasons and this is referred to as a capitalisation of shares.
Study paragraph 6.7.7 in the prescribed textbook.
Activity 7.5
Work through example 6.4 in the prescribed textbook, which illustrates a capitalisation of shares.
The administration of a share issue can be very costly. To ensure that a share issue is fully subscribed and the company receives the number of applications it needs to satisfy the demand for capital, companies make use of underwriters.
Study paragraph 6.7.8 in of the prescribed textbook.
150

Activity 7.6
Work through example 6.5 in the prescribed textbook which illustrates the underwriting of a share issue.
One of the reasons why shareholders invest money in a company is to share in the company’s growth and profits. Dividends are the returns (the distribution of profit) on a shareholder investment in a company. Depending on the classes of issued shares of a company, two dividend types can be declared namely ordinary dividends and preference dividends
(paragraph 6.7.4).
Dividends can be declared if a company has adequate cash resources (verified by the solvency and liquidity test). Preference shareholders have a preferential right to dividends above the right of ordinary shareholders and cumulative preference shareholders maintain the right to dividends even if a dividend is not declared in a financial period. The dividends on ordinary shares are calculated per share, whereas dividends on preference shares are calculated as a fixed percentage of the nominal value of the preference shares.
Study paragraph 6.8 in the prescribed textbook. The calculation of dividends is another building block for future accounting studies.
Activity 7.7
Work through example 6.6 in the prescribed textbook.
Apart from acquiring capital from the public, a company can borrow money from the public by issuing debentures. Debentures, like shares are divided into affordable units that enable the public to lend money to a company at a fixed interest rate. Debentures do not form part of the equity of a company, but are classified as non-current liabilities if repayable after the end of the next 12-month period, or as a current liability if repayable within or up to the end of the following 12-month period. The interest on debentures is a financing expense and must be paid, irrespective of whether a company is making a profit or not.
Study paragraph 6.9 in the prescribed textbook.
It is important to understand the influence of interest rates on the issue of debentures. You need to distinguish (define in your own words) between the market interest rate and the nominal interest rate at which the debentures are issued and the effect of issuing debentures at a higher or lower nominal rate than the current market interest rate.
151

Activity 7.8
Work through example 6.7 in the prescribed textbook. The example illustrates an issue of debentures where the nominal interest rate and the market interest rate are equal.
Work through examples 6.8 and 6.9 which illustrates the issue of debentures at a nominal interest rate higher and lower than the market interest rate. Make sure that you understand the comments made about the two examples.
Once you are sure you understand the accounting principles illustrated in this chapter, tackle the comprehensive example in the prescribed textbook.
Activity 7.9
Work through example 6.10 in the prescribed textbook.
Read paragraph 6.10 in the prescribed textbook.
The financial statements that a company prepares can be divided into two categories, namely, internal statements and published/external statements. x
Internal statements
Internal statements are detailed financial and cost statements that pertain to a company and that are intended for managerial (internal) use in the company.
x
Published statements (or external) statements
These statements are not as detailed as internal statements. IAS1 requires that these statements be prepared at least once a year and presented to shareholders. The statements must include the minimum information as specified in IAS1.
The fact that IAS1 requires companies to disclose certain minimum information serves the interests of the external users of financial statements of a company such as its shareholders, investors, creditors and bankers. IAS1 ensures that companies disclose their latest financial statements (and preliminary financial statements) and interim reports to external parties.
Companies have to send copies of their financial statements to their shareholders, the holders of their debentures and the Companies and Intellectual Property Commission (CIPC). They also have to discuss their financial statements at the annual general meeting of their shareholders.
Read paragraph 6.10 in the prescribed textbook.
152

EXERCISE 7.1 – The issue of shares
Molo Ltd was registered on 1 February 20.15 with an authorised share capital consisting of the following: x
200 000 ordinary shares x
100 000 9% preference shares
On 1 February 20.15 the company offered 20 000 ordinary shares at a consideration of
R200 000 and 10 000 preference shares at a consideration of R150 000 to the incorporators of the company and received payment for them. All the shares were taken up on
5 February 20.15.
On 9 February the company offered 100 000 ordinary shares at a consideration of R1 000 000 and 50 000 preference shares at a consideration of R750 000 for subscription to the public.
By close of business on the closing date, namely 1 May 20.15, applications had been received for the full number of shares that was offered. On 8 May 20.15 all the shares were allotted.
On 31 May 20.15 the company paid R15 000 towards share issue expenses.
REQUIRED
Record the application and allotment of the ordinary and preference shares in the general journal of Molo Ltd for the period 1 February 20.15 to 8 May 20.15. Record the payment of the share issue expenses in the general journal of Molo Ltd. Post the journal entries to the relevant accounts in the general ledger. Assume that the public applied for the shares on 1 May 20.15.
Balance/close off all the ledger accounts.
NB: Show all calculations.
153

SOLUTION 7.1
MOLO LTD
GENERAL JOURNAL
Debit
R
20.15
Feb 1 Bank
Incorporators: Ordinary shares
Incorporators: 9% Preference shares
Receipt of application money from the incorporators of the company
5 Incorporators: Ordinary shares
Incorporators: 9% Preference shares
Share capital: Ordinary shares
Share capital: 9% Preference shares
Allotment of 20 000 ordinary shares and 10 000 9%
200 000
150 000
Credit
R
200 000
150 000
200 000
150 000
May 1 Bank
Application and allotment: Ordinary shares
Application and allotment: 9% Preference shares
Receipt of application money from the public
8 Application and allotment: Ordinary shares
Application and allotment: 9% Preference shares
Share capital: Ordinary shares
Share capital: 9% Preference shares
Allotment of 100 000 ordinary shares and 50 000
9% preference shares
31 Share-issue expenses
Share-issue expenses paid
1 750 000
1 000 000
750 000
1 000 000
750 000
1 000 000
750 000
15 000
MOLO LTD
GENERAL LEDGER
Dr
20.15
R
Bank
20.15
Cr
Feb 1 Incorporators: Ordinary shares 200 000 May 31 Share-issue expenses
Incorporators: 9% Preference 150 000 Balance b/d
May 1 Application and allotment:
Ordinary shares
Application and allotment:
1 000 000
9% Preference shares 750 000
R
15 000
2 085 000
2 100 000 2 100 000
Jun 1 Balance b/d 2 085 000
154

SOLUTION 7.1 (continued)
Dr
20.15
Incorporators: Ordinary shares
R 20.15
Feb 5 Share capital: Ordinary shares 200 000 Feb 1 Bank
Dr Incorporators: 9% Preference shares
20.15
R 20.15
Feb 5 Share capital: 9% Preference h
150 000 Feb 1 Bank
Dr
20.15
Application and allotment: Ordinary shares
R 20.15
May 8 Share capital: Ordinary shares 1 000 000 May 1 Bank
Cr
R
200 000
Cr
R
150 000
Cr
R
1 000 000
Dr
20.15
Application and allotment: 9% Preference shares
R 20.15
May 8 Share capital: 9% Preference h
750 000 May 1 Bank
Dr
Cr
R
750 000
Share capital: Ordinary shares
20.15
Feb 5 Incorporators: Ordinary shares
May 8 Application and allotment:
Ordinary shares
R
Cr
200 000
1 000 000
1 200 000
Dr Share capital: 9% Preference shares
20.15
Feb 5 Incorporators: 9% Preference
May 8 Application and allotment:
9% Preference shares
Cr
R
750 000
900 000
Dr
20.15
May 31 Bank
Share-issue expenses
R
15 000
Cr
Comment
The incorporators and application and allotment accounts are temporary accounts that are closed off once the shares have been allotted.
155

EXERCISE 7.2 – The issue of capitalisation shares
The following balances appeared, inter alia , in the books of Zodiac Ltd on 30 November 20.15:
R
Share capital: Ordinary shares (200 000 shares)
Retained earnings
400 000
160 000
On 1 December 20.15, the directors decided to issue capitalisation shares in the ratio of one ordinary share for every four ordinary shares held by the shareholders as on
30 November 20.15. The board of the company deemed that a fair consideration for the ordinary shares would be R100 000.
REQUIRED
Record the issue of the capitalisation shares in the general journal of Zodiac Ltd on
30 November 20.15.
SOLUTION 7.2
ZODIAC LTD
GENERAL JOURNAL
Debit
R
20.15
Dec 1 Retained earnings
Share capital: Ordinary shares
Capitalisation issue of one share for every four shares held
Calculation of the number of shares to be issued
100 000
Number of capitalisation shares to be issued = 200 000/4 = 50 000 shares
Credit
R
100 000
156

EXERCISE 7.3 – Allotment and issue of shares
SA Cement Ltd is a company which was registered on 1 January 20.13 with an authorised share capital of 200 000 ordinary shares.
The company offered 20 000 of the shares at a consideration of R200 000 to the incorporators of the company, all of which were taken up and paid for on 15 January 20.13.
On 16 January 20.13, the company applied to the JSE for a listing and appointed General
Merchant Bank as the underwriters of the share issue at a commission of 2%. On the basis of favourable prospecting reports, the directors decided to offer 100 000 of the shares to the public at a consideration of R1 200 000.
By 1 March 20.13, applications were received for 180 000 shares. The JSE granted the listing and during the first week the price of SA Cement Ltd stood at R13 per share. The shares were received as follows between 15 January 20.13 and 1 March 20.13:
Number of shares per application
100
200
500
1 000
2 000
4 000
Total
Number of applications received
400
100
20
30
20
10
580
Number of shares applied for
40 000
20 000
10 000
30 000
40 000
40 000
180 000
In order to retain control and to ensure an active market for the shares, the following allotment schedule was approved and ratified on 10 March 20.13 at a meeting of the board of directors:
Group A: Applications for 100 to 200 shares will be granted in full.
Group B: Applications for 500 to 1 000 shares will be granted at 50% of the shares applied for.
Group C: Applications for 1 000 and more will be granted at 25% of the shares applied for.
At the beginning of 20.15, owing to the boom in the building industry, additional capital was urgently needed to expand the business. On 20 March 20.15 the board of directors decided to offer the 80 000 unissued shares at a consideration of R2 000 000 to the public.
Underwriting was arranged with General Merchant Bank at a commission of 4% which had to be settled by 31 May 20.15.
Applications were received for 75 000 shares on 30 April 20.15, the closing date for applications. All the transactions were finalised by 31 May 20.15.
REQUIRED a) Record the issue of shares and the related transactions in the general journal of
SA Cement Ltd for the period 1 January 20.13 to 31 May 20.15.
b) Post the journal entries in (a) to the relevant general ledger accounts of SA Cement Ltd for the period 1 January 20.13 to 31 May 20.15. The financial year of the company ends on 31 December .
157

SOLUTION 7.3
a) SA CEMENT LTD
GENERAL JOURNAL
20.13
Jan 15 Bank
Incorporators: Ordinary shares
Receipt of application money from the incorporators of the company
16
Incorporators: Ordinary shares
Share capital: Ordinary shares
Allotment of 20 000 ordinary shares to the incorporators of the company
Underwriter's commission (R1 200 000 x 2%)
General Merchant Bank
2% underwriter's commission due on R1 200 000 in terms of the underwriting agreement
Mar 1
10
Bank
Application and allotment: Ordinary shares
Receipt of application money from the public
Application and allotment: Ordinary shares
Share capital: Ordinary shares
Allotment of 100 000 ordinary shares
Application and allotment: Ordinary shares
Bank
Cash refund to unsuccessful applicants
General Merchant Bank
Bank
Underwriter's commission paid
Dec 31 Profit and loss
Underwriter’s commission
Closing entry at year end
20.15
Mar 20 Underwriter's commission (R2 000 000 x 4%)
General Merchant Bank
4% underwriter's commission payable on R2 000 000 in terms of the underwriting agreement
Apr 30 Bank
Application and allotment: Ordinary shares
Receipt of application money from the public
Application and allotment: Ordinary shares
General Merchant Bank e
Share capital: Ordinary shares
May 1
Allotment of 80 000 ordinary shares
Bank R(125 000 – 80 000)
General Merchant Bank
Settlement by the underwriters
80 000
80 000
1 875 000
1 875 000
1 875 000
125 000
2 000 000
45 000
45 000
Debit
R
200 000
Credit
R
200 000
200 000
200 000
24 000
24 000
2 160 000
2 160 000
1 200 000
1 200 000
960 000
960 000
24 000
24 000
24 000
24 000
158

SOLUTION 7.3 (continued)
Calculations c
1 March 20.13: Applications received
1 200 000/100 000 x 180 000 = 2 160 000 d
30 April 20.15: Applications received
2 000 000/80 000 x 75 000 = 1 875 000 e 㻌㻌
Ordinary shares taken up by underwriter
2 000 000/80 000 x 5 000 = 125 000 b) SA CEMENT LTD
GENERAL LEDGER
Dr
20.13
Jan 15 Incorporators: Ordinary
Shares
Mar 1 Application and allotment:
Ordinary shares
20.15
Apr 30
May 31
Application and allotment:
Ordinary shares
General Merchant Bank
R
Bank
20 000
Cr
20.13
Mar 10 Application and allotment:
Ordinary shares
General Merchant Bank
2 160 000
R
960 000
24 000
1 875 000
45 000
Dr
20.13
Jan 15
Incorporators: Ordinary shares
R 20.13
Share capital: Ordinary shares 200 000
Jan 15 Bank
Cr
R
200 000
Dr
20.13
1
Mar 1
Application and allotment: Ordinary shares
Share capital: Ordinary shares
10 Bank
R
1 200 000
20.13
Mar 1 Bank
2 160 000
20.15
Apr 30 Share capital: Ordinary shares
20.15
1 875 000 Apr 30 Bank
Cr
R
2 160 000
2 160 000
1 875 000
159

SOLUTION 7.3 (continued)
Dr Share capital: Ordinary shares
20.13
Jan 15 Incorporators:
Mar 1
Ordinary shares
Application and allotment:
Ordinary shares
Cr
R
200 000
1 200 000
1 400 000
20.15
Apr 30 Application and allotment:
Ordinary shares
General Merchant Bank
1 875 000
125 000
3 400 000
Dr
20.13
Mar 10
20.15
Apr 30
Bank
General Merchant Bank Cr
R 20.13
24 000 Jan 16 Underwriter's commission
Share capital: Ordinary shares 125 000
20.15
May 31 Underwriter's commission commission
Bank
125 000
R
24 000
80 000
45 000
125 000
Dr
20.13
Jan 16
20.15
May 31
General Merchant Bank
Underwriter's commission
R 20.13
24 000 Dec 31 Profit and loss
Cr
General Merchant Bank 80 000
R
24 000
Comment
Only the transactions relating to the issue of the shares for the two periods were recorded in the general journal and the general ledger.
160

EXERCISE 7.4 – The issue of debentures
Zee Ltd issued 100 8% debentures of R1000 each at a discount of 4% on 5 January 20.16.
The debentures are redeemable at par on 31 December 20.19 and interest is payable annually on year end which is 31 December. Land and buildings with a historical cost of R300 000 serve as security for the debenture issue.
REQUIRED
Journalise the transactions in the accounting records of Zee Ltd for the year ending
31 December 20.16 and disclose the note on debentures in the financial statements of Zee Ltd on 31 December 20.16.
SOLUTION 7.4
ZEE LTD
GENERAL JOURNAL
Debit
R
Credit
R
20.16
Jan 5
Dec 31
Dec 31
Bank (100 x R1000 x 96%)
Discount on debentures
8%Debentures
Issue of debentures at a discount
Interest on debentures (8% x R100 000)
Bank
Interest paid to debenture holders
Interest on debentures (R4 000/4)
Discount on debentures
Matching discount with interest paid over the period of the debenture issue
96 000
4 000
8 000
1 000
100 000
8 000
1 000
ZEE LTD
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED
31 DECEMBER 20.16
R
5. Non-current liability
Secured
100 8% Debentures of R1 000 each
Discount on debentures
Discount amount
Discount amortised for the year
100 000
(3 000)
4 000
(1 000)
97 000
Land and buildings with a cost of R300 000 serve as security for the debenture issue. The debentures are repayable in total on 31 December 20.19 and bears interest at 8% per annum.
Comment
The discount of R4 000 is spread evenly over the four-year debenture issue period. In this example the effective interest rate is higher than the nominal interest rate payable on the debentures. The investor in the debentures paid less than par for the debenture although the investor receives interest on the full par value (R1 000).
161

After having worked through this learning unit, are you able to do the following?
Yes No
Distinguish between authorised and issued share capital.
Distinguish between ordinary and preference shares.
Record transactions pertaining to the issues of shares.
Prepare an allotment schedule.
Record the issue of capitalisation shares.
Record the underwriting of shares.
Explain dividends and the calculation thereof.
Calculate dividends.
Record dividend transactions.
Record transactions pertaining to the issue of debentures.
Calculate and record interest and discount or premium on debentures.
If you answered "yes" to all of the above assessment criteria, you have completed your studies on companies and can move on to learning unit 8. If you answered "no" to any of the above criteria, you must revise those sections before progressing to learning unit 8.
162

8
8
Learning outcomes ..........................................................................................................164
Key concepts ...................................................................................................................164
8.1
Introduction .............................................................................................................165
8.2
Accounting for dependent branches........................................................................165
8.3
Recording of transactions where inventory sent to the branch is invoiced at cost price ................................................................................................................165
8.4
Recording of transactions where inventory sent to the branch is invoiced at selling price.............................................................................................................169
8.5
Exercises and solutions ..........................................................................................174
Self-assessment ..............................................................................................................184
163

After studying this learning unit, you should be able to: x explain the concept of branches x briefly explain the differences between dependent and independent branches x identify the information to be included in the reports submitted by a dependent branch to the head office x record the transactions between a head office and a dependent branch in the books of the head office where inventory sent to the branch is invoiced at cost price x record the transactions between a head office and a dependent branch in the books of the head office where inventory sent to the branch is invoiced at selling price x record the transactions of a dependent branch pertaining to the following where inventory is invoiced at cost price or at selling price:
Purchases of inventory by the branch
Sales of inventory by the branch
Inventory damaged or stolen at the branch
Inventory sold by the branch at a discount
Inter-branch inventory transactions
Settlement discount granted to debtors of the branch
Donations made by the branch
Cash embezzled at the branch
Inventory in transit between the branch and the head office x identify and record a shortage or surplus in the inventory of a branch where inventory is invoiced by the branch at selling price
x
Head office x
Dependent branches x
Branch inventory x
Inventory to branch x
Branch adjustments x
Branch gross profit (or loss) x
Branch profit (or loss) x
Inventory transactions x
Other branch transactions
164

A business entity can establish a branch (or branches) which is geographically separated from but still forms part of the main entity. One of the reasons why business entities establish branches is to broaden their markets to increase their potential revenues in order to maximise their profitability. Branches can be managed as dependent or independent units, each with its own distinct accounting requirements. In this module, only dependent branches are addressed.
Read the overview and paragraph 9.1 in the prescribed textbook.
The head office of a dependent branch is responsible for supplying inventory to the branch and for recording all of the accounting transactions of the branch in the accounting records of the head office. The head office can invoice inventory to the branch at either cost or selling price. Each method of invoicing requires a unique set of accounts and recording procedure.
Usually, the head office of a dependent branch is responsible for the payment of the major expenses of the branch. The head office may also decide to provide the branch with petty cash for the payment of minor expenses that are incurred by the branch. A branch may also purchase inventory from other suppliers.
Since the activities of a dependent branch are recorded in the books of its head office, a dependent branch is usually required to submit a report to the head office in respect of the transactions that have occurred at the branch over a given financial period.
Read paragraph 9.2 in the prescribed textbook.
When this method of bookkeeping is followed, two accounts must be opened in the accounting records of the head office:
(1) a branch inventory account
(2) an inventory to branch account
These accounts are specifically for the recording of transactions that pertain to the inventory of the branch. The other business activities of a branch are recorded in other accounts in the accounting records of the head office, for example a branch trade receivables control account, a branch asset account or a branch expenses account.
Paragraph 9.3 in the prescribed textbook discusses the recording of transactions where inventory is invoiced at cost price. Each example in this paragraph builds on the concepts explained in the previous example so make sure that you follow and understand each new entry in the examples in paragraph 9.3.
165

Read paragraph 9.3.1 in the prescribed textbook.
a) b)
Activity 8.1
In the accounting records of the head office when inventory is invoiced to the branch at cost price the branch inventory account serves the same purpose as which other account that you have already encountered and why?
Explain what is meant with “the gross profit/loss of the branch”. A gross profit/loss will be transferred to which account in the accounting records of the head office?
Feedback 8.1
a) b)
The branch inventory account serves the same purpose as the trading account. When balanced at the end of the accounting period the balance on the account represents the gross profit/loss that the branch made.
The gross profit/loss is the result of the difference between the price at which inventory is received (from head office) and the price at which inventory is sold by the branch.
This profit/loss is transferred to the branch expense account.
Read paragraph 9.3.2 in the prescribed textbook.
Activity 8.2
Work through example 9.1 in the prescribed textbook where inventory is sent to the branch and the branch is allowed to purchase inventory from other suppliers as well.
Comment
Remember that we are dealing with a dependent branch and the accounting functions of the branch are performed by the main entity (head office).
Journal entry to record the inventory sent to the branch at cost :
Dr Branch inventory
Cr Inventory to branch
Do you know the journal entry to account for purchases of inventory from other suppliers
(cash or credit)?
Read paragraph 9.3.3 in the prescribed textbook.
166

Activity 8.3
Work through example 9.2 in the prescribed textbook where inventory is returned to the head office.
Journal entry to record the inventory returned to head office :
Dr Inventory to branch
Cr Branch inventory
Read paragraph 9.3.4 in the prescribed textbook.
Activity 8.4
Work through example 9.3 in the prescribed textbook where inventory is sold by the branch.
Journal entry to record the cash/credit sale of inventory by the branch :
Dr Bank (cash sale) or Branch trade receivables control (sale on credit)
Cr Branch inventory
Read paragraph 9.3.5 in the prescribed textbook.
Activity 8.5
Work through example 9.4 in the prescribed textbook where branch debtors settle their accounts at a discount.
Journal entry to record the settlement of a branch debtor’s account at a discount :
Dr Settlement discount granted
Cr Branch trade receivables control
Comment
At the end of the accounting period the settlement discount granted is closed off to the branch inventory account (where the sale was recorded). This ensures the similar treatment of discounts granted in the accounting records of an entity without a branch (settlement discount granted reduces sales).
Read paragraphs 9.3.6 and 9.3.7 in the prescribed textbook.
When inventory is sold by the branch at a marked down price (below the normal selling price of the branch), the entries remain the same as in paragraph 9.3.4 of the textbook (refer to
Activity 8.4). Please make sure that you follow what will happen if the inventory is sold below cost price.
167

Activity 8.6
Work through example 9.5 in the prescribed textbook where cash is embezzled or stolen at the branch.
Journal entry to record the embezzlement of cash at the branch from either a cash or a credit sale :
Cash sale :
Dr Bank (with the actual money banked)
Dr Branch expenses (with the embezzled amount)
Cr Branch inventory account (with the cost of the inventory sold which includes the money banked and the embezzled cash)
Credit sale :
Dr Bank (with the actual amount banked)
Dr Branch expenses (with the embezzled amount)
Cr Branch trade receivables control (with the total amount that the debtor paid, which consists of the banked amount and the embezzled cash).
Read paragraph 9.3.8 in the prescribed textbook.
Activity 8.7
Work through example 9.6 in the prescribed textbook where inter-branch inventory transactions are recorded.
Journal entry to record the inter-branch inventory transactions :
Dr Branch inventory (of the branch that receives the inventory – the receiving branch)
Cr Branch inventory (of the branch that sells the inventory – the transferring branch)
Read paragraph 9.3.9 in the prescribed textbook.
Activity 8.8
Work through example 9.7 in the prescribed textbook where the branch incurs expenses that are paid by head office and pays for minor expenses from its petty cash.
168

Journal entry to record the expenses paid for by head office and expenses paid for from petty cash :
Paid by head office :
Dr Branch expenses
Cr Bank
Paid from petty cash :
Dr Branch expenses
Cr Petty cash
Read paragraphs 9.3.10 to 9.3.12 in the prescribed textbook.
Activity 8.9
Work through example 9.8 in the prescribed textbook where inventory in transit, inventory on hand as well as the closing off, of the accounts in the records of head office are illustrated.
Make sure that you understand how to account for inventory in transit from head office to the branch and inventory in transit from the branch to head office and also how to account for inventory on hand. The branch inventory account (which is similar to the trading account and contains the gross profit of the branch) is closed off to the branch expense account (which is similar to a profit or loss account and contains the branch profit or loss for the period). The branch expense account is closed off to the profit or loss account of the head office.
Activity 8.10
Work through example 9.9 in the prescribed textbook which is a comprehensive example illustrating inventory send to the branch invoiced at cost price.
Paragraph 9.4 in the prescribed textbook discusses the recording of transactions where inventory is invoiced at selling price. Each example in this paragraph builds on the concepts explained in the previous example, so make sure that you follow and understand each new entry in the examples in paragraph 9.4.
When inventory is invoiced to the branch at selling price, the branch inventory account will not reflect the gross profit of the branch (as is the case when the inventory is invoiced to the branch at cost price). An additional account, namely a “branch adjustment account”, is required to reflect the gross profit and to serve the function of a “trading account”. The branch inventory account (at selling price) functions as an inventory control account.
169

The recording of all inventory transactions in the branch inventory account is done at selling price. Each selling price is divided into two amounts, namely the cost price and the profit markup of the inventory. These two amounts are disclosed separately in the branch inventory account (at selling price), and must add up to the selling price. The reason for this separate disclosure in the branch inventory account is that the entries pertaining to the cost price and the entries pertaining to the profit markup have different contra accounts. For example, when inventory that is sent to the branch is recorded (assume a cost of R100 and a markup of R50), the branch inventory account is debited (separately) with the cost price (R100) and the profit markup thereof (R50) against different contra accounts: the inventory to branch account
(R100) and the branch adjustment account (R50) respectively. The inventory to branch account is credited with the cost price (R100) and the branch adjustment account is credited with the profit markup (R50).
Study paragraph 9.4.1 in the prescribed textbook.
The calculation of the profit markup in branch inventory is discussed in paragraph 9.4.2 of the prescribed textbook. Make sure that you can calculate the profit markup and the selling price when given the cost price, and that you can calculate the profit markup and the cost price when given the selling price.
Study paragraph 9.4.2 in the prescribed textbook.
Activity 8.11
a) D Pelser Ltd trades in watercoolers. Calculate the profit that D Pelser Ltd must add to send two watercoolers with a total cost of R6 000 to its branch.
b) D Pelser Ltd invoices inventory to its branch at cost plus 50%. Inventory with a cost price of R50 000 will have a selling price of … c) Damaged inventory with a selling price of R12 000 was returned by the branch to
D Pelser Ltd. What is the cost of the inventory returned?
d) D Pelser Ltd sells inventory to its customers at an additional 20% markup on the selling price to its branch. How much will a customer pay for a watercooler with a cost of R2 500 bought from D Pelser Ltd?
Feedback 8.11
a)
Cost assumed to be
%
100
Profit 50
Selling price 150
R6 000 x 50 /
100
= R3 000
170

b) R50 000 x 150 /
100
= R75 000 c) R12 000 x 100 /
150
= R8 000 d) R2 500 x 180 /
100
= R4 500
Cost assumed to be
Profit
Selling price to branch
Additional profit 20% x 150%
Selling price to customers
%
100
50
150
30
180
Study paragraph 9.4.3 in the prescribed textbook.
Activity 8.12
Work through example 9.10 in the prescribed textbook which illustrates inventory sent to the branch invoiced at selling price and purchases by the branch.
Comment
Remember that we are dealing with a dependent branch and the accounting functions of the branch are performed by the main entity (head office).
Journal entry to record the inventory sent to the branch at selling price :
Dr Branch inventory (with the cost)
Cr Inventory to branch (with the cost)
Dr Branch inventory (with the profit markup)
Cr Branch adjustment account (with the profit markup)
Do you know the journal entry when inventory is purchased from other suppliers and the branch adds the profit markup before selling to customers?
Study paragraph 9.4.4 in the prescribed textbook.
Activity 8.13
Work through example 9.11 in the prescribed textbook where inventory is returned to the head office.
Journal entry to record the inventory returned to head office :
Dr Inventory to branch (with the cost)
Cr Branch inventory (with the cost)
Dr Branch adjustment account (with the profit markup)
Cr Branch inventory (with the profit markup)
171

Study paragraph 9.4.5 in the prescribed textbook.
Activity 8.14
Work through example 9.12 in the prescribed textbook where inventory is sold by the branch.
Journal entry to record the cash/credit sale of inventory by the branch :
Dr Bank (cash sale) at selling price or Branch trade receivables control (sale on credit) at selling price
Cr Branch inventory (at selling price)
Study paragraph 9.4.6 in the prescribed textbook
Journal entry to record the settlement of a branch debtor’s account at a discount :
Dr Settlement discount granted
Cr Branch trade receivables control
Comment
At the end of the accounting period the settlement discount granted is closed off to the branch adjustment account.
Study paragraph 9.4.7 in the prescribed textbook.
When inventory is sold by the branch at a marked down price (below the normal selling price of the branch), the entries remain the same as in paragraph 9.4.5 in the textbook (refer to
Activity 8.14).
Activity 8.15
Work through example 9.13 in the prescribed textbook where inventory is sold at a marked down price that is still above or equal to cost and example 9.14 where inventory is sold below cost.
Study paragraph 9.4.8 in the prescribed textbook.
Journal entry to record the embezzlement of cash at the branch from either a cash or a credit sale :
Cash sale :
Dr Bank (with the actual money banked)
Dr Branch expenses (with the embezzled amount)
Cr Branch inventory account (with the price of the inventory sold which includes the money banked and the embezzled cash)
172

Credit sale :
Dr Bank (with the actual amount banked)
Dr Branch expenses (with the embezzled amount)
Cr Branch trade receivables control (with the total amount that the debtor paid, which consists of the banked amount and the embezzled cash)
Study paragraph 9.4.9 in the prescribed textbook.
Activity 8.16
Work through example 9.15 in the prescribed textbook where inter-branch inventory transactions are recorded.
Journal entry to record the inter-branch inventory transactions :
Dr Branch inventory (receiving branch) with the cost of the transferring branch
Dr Branch inventory (receiving branch) with the markup
Cr Branch adjustment account (receiving branch) with the markup
Cr Branch inventory (transferring branch) with the cost to the receiving branch
Cr Branch inventory (transferring branch) with the markup
Dr Branch adjustment account (transferring branch) with the markup
Study paragraph 9.4.10 to 9.4.14 in the prescribed textbook.
Activity 8.17
Work through example 9.16 in the prescribed textbook which illustrates the closing inventory, inventory in transit and inventory shortage.
Activity 8.18
Work through example 9.17 in the prescribed textbook which is a comprehensive example of inventory sent by head office to its branch invoiced at selling price
Read paragraph 9.5 in the prescribed textbook which summarises branch transactions.
173

EXERCISE 8.1
– Inventory is invoiced to the branch at cost price
The following information pertains to the head office and branch of Boom CC for the year ended 31 December 20.15:
Inventory sent to branch
Inventory returned to head office by the branch
Sales by branch for the year: Cash
Credit
Cash received from branch debtors and paid into the head office bank account
Sundry expenses paid by head office
R
4 800
80
2 000
3 290
2 890
600
Additional information:
1.
The branch began trading on 2 January 20.15 and inventory is invoiced to the branch at cost price.
2.
An amount of R50 must be written off as a credit loss.
3.
Discount on selling prices for cash sales granted to customers amounted to R30.
4.
Inventory at 31 December 20.15 amounted to R480.
REQUIRED
Prepare the following accounts properly balanced/closed off, in the general ledger of the head office for the year ended 31 December 20.15: a) Branch inventory account b) Inventory to branch account c) Branch trade receivables control account d) Branch expenses account e) Bank account (partly)
SOLUTION 8.1
BOOM CC (HEAD OFFICE)
GENERAL LEDGER a) Dr Branch inventory (at cost price)
20.15
Dec 31 Inventory to branch
(Delivery at cost)
Branch expenses
(Branch gross profit for year) *
Cr
R 20.15
4 800 Dec 31 Inventory to branch
1 050
(Returns at cost)
Bank (Cash sales)
5 850
Branch trade receivables control (Credit sales)
Balance c/d
(Closing inventory)
R
80
2 000
3 290
480
5 850
20.16
Jan 1 Balance b/d
(Opening inventory)
480
* Balancing figure
174

SOLUTION 8.1 (continued) b) Dr Inventory to branch (at cost price)
20.15
Dec 31 Branch inventory
(Returns at cost)
Head office: Trading account *
R 20.15
80 Dec 31 Branch inventory
(Deliveries at cost)
4 720
4 800
* Balancing figure
Cr
R
4 800
4 800 c) Dr Branch trade receivables control
20.15
Dec 31 Branch inventory
(Credit sales)
R
3 290 Dec 31Bank (Collections de-
3 290
20.15
posited by branch)
Branch expenses
(Credit losses)
Balance c/d
20.16
Jan 1 Balance b/d 350 d) Dr Branch expenses
20.15
R 20.15
Dec 31 Bank (Sundry expenses)
Branch trade receivables control (Credit losses)
Head office: Profit or loss
(Branch profit for the year)*
600 Dec 31Branch inventory
(Branch gross profit for
50
400 the year)
1 050
* Balancing figure e) Dr Bank (extract)
20.15
Dec 31
R 20.15
Dec 31 Branch expenses Branch trade receivables control
(Collections deposited by branch)
Branch inventory
(Cash sales)
2 890
2 000
R
Cr
1 050
1 050
Cr
R
600
Cr
R
2 890
50
350
3 290
Comments x
The cash discount on sales of R30 will not be recorded because the cash sales of
R2 000 already excludes this amount.
x
Only cash transactions with the branch are shown in the bank account. In practice the bank account will contain the cash transactions of the branch as well as those of the head office.
x
In the above solution we see that the branch inventory is brought down as a balance in the branch inventory account at the end of the financial period. The balances of the branch trade receivables control and the branch asset accounts are added to the head office balances and disclosed as a total amount in the statement of financial position.
175

EXERCISE 8.2 – Inventory is invoiced to the branch at selling price.
The following information pertains to the head office and the branch of Pama CC for the year ended 31 December 20.15:
Inventory sent to branch (selling price)
Cash sales (deposited in bank)
Returns to head office (selling price)
Sundry expenses paid by head office
R
18 750
17 918
186
4 760
Additional information:
1.
All purchases are made by head office and all goods required by the branch are supplied by head office at selling price, which is cost price plus 50%.
2.
A burglary took place during the year and R55 in cash (cash sales) and inventory to the value of R36 (selling price) were stolen. No entries have been made in the records yet.
3.
The net proceeds of the annual sales amounted to R360. Inventory was sold at selling price less 10% and no entries were made in the records concerning this price reduction.
4.
Inventory invoiced to the branch at R75 (included in the amount of R18 750 above) was still in transit at 31 December 20.15 and was therefore not included in the branch’s inventory at 31 December 20.15.
5.
Inventory at selling price:
31 December 20.14
31 December 20.15
R1 500
R1 950
REQUIRED
Prepare the following accounts, properly balanced/closed-off, in the general ledger of the head office for the year ended 31 December 20.15: a) Branch inventory account b) Inventory to branch account c) Branch adjustment account d) Branch expenses account
176

SOLUTION 8.2
PAMA CC (HEAD OFFICE)
GENERAL LEDGER a) Dr Branch inventory (at selling price)
20.15
Jan 1 Balance b/d
Inventory to branch c
(Deliveries at cost)
Branch adjustment d
(Markup on deliveries)
R 20.15
1 500 Dec 31 Bank (Sales)
12 500
6 250
Inventory to branch
(Returns at cost)
Branch adjustment
(Markup on returns)
Branch adjustment
(Inventory surplus) *
10 Branch expenses
(Cash stolen)
Branch expenses
(Inventory stolen at cost)
Branch adjustment g
(Markup on inventory stolen)
Branch adjustment
(Discount on sales)
Balance c/d
(Inventory in transit)
Balance c/d
(Closing inventory)
20 260
20.16
Jan 1 Balance b/d 75
(Inventory in transit)
Balance b/d
(Opening inventory)
1 950
* Balancing figure
40
75
1 950
20 260
Cr
R
17 918
124
62
55
24
12 b) Dr Inventory to branch (at cost price)
20.15
Dec 31 Branch inventory
R 20.15
124 Dec 31 Branch inventory
(Returns at cost)
Head office: Trading account * 12 376
12 500
(Deliveries at cost)
* Balancing figure
Cr
R
12 500
12 500
177

SOLUTION 8.2 (continued) c) Dr Branch adjustment (mark-up at 50% on cost)
20.15
Dec 31 Branch inventory
(Markup on returns)
Branch inventory g
R 20.15
62 Jan 1 Balance
12 i
(Markup b/d 500
(on opening inventory)
Branch inventory
Cr
R
6 250
(Markup on inventory stolen)
Branch inventory 40
(Discount on sales)
Balance
ڡ
(Markup c/d 25 on inventory in transit)
Balance k (Markup c/d 650 on closing inventory)
Branch expenses
(Branch gross profit for the year) *
5 971
(Markup on deliveries)
Branch inventory
(Inventory surplus)
10
6 760 6 760
20.16
Jan 1 Balance (Markup b/d 25 on inventory in transit)
Balance (Markup b/d 650 on opening inventory)
* Balancing figure
Cr
R
5 971 d) Dr Branch expenses
20.15
Dec 31 Bank (Sundry expenses)
Branch inventory
R
55
20.15
4 760 Dec 31 Branch adjustment
(Branch gross profit for the year) (Cash stolen)
Branch inventory
(Inventory stolen)
Head office: Profit or loss
(Branch profit for the year) *
24
1 132
5 971
* Balancing figure
5 971
Calculations c
Cost of inventory sent to branch
Cost
Profit markup
Selling price
%
100
50
150
Inventory sent to branch at cost = R18 750 x 100 /
150
= R12 500 d
Profit markup on deliveries
R18 750 x 50 /
150
= R6 250 e
Cost of returns to head office
R186 x 100 /
150
= R124
178

SOLUTION 8.2 (continued) f
Cost of inventory stolen
R36 x 100 /
150
= R24 g
Profit markup on inventory stolen
R36 x 50 /
150
= R12 h
Discount on sale
R360 = 90% of original selling price
Original selling price = R360 ÷ 90%
= R400
?
Discount = R(400 – 360) = R40 or
Cost
Profit markup
Original selling price
Markdown (10% x 150)
Sold at
%
100
50
1 50
(15)
135
Original selling price
R360 x 150 /
135
= R400
Mark-down on the original selling price
R(400 – 360) = R40
or
R400 x 15 /
150
= R40 i
Profit markup on opening inventory
R1 500 x 50 /
150
= R 500
ڡ
Profit markup on closing inventory in transit
R75 x 50 /
150
= R25 k
Profit markup on closing inventory
R1 950 x 50 /
150
= R650
179

EXERCISE 8.3 – Inventory is invoiced to the branch at selling price
The following information pertains to the head office and branch of Sucro Confectionary CC for the year ended 28 February 20.15:
R
Inventory to branch at selling price
Inventory returned to head office at selling price
64 500
1 800
Cash sales of branch embezzled by cashier
Administrative expenses of branch paid by head office
Discount granted to branch debtors for early settlement
Cash sales by branch (after deducting local purchases) – cost
375
5 000
150
41 500 price R500
Credit sales of branch
Rent expense of branch paid by head office
Inventory damaged – selling price
Credit losses of branch written off
20 000
1 800
300
50
Additional information:
1.
Inventory was supplied to the branch by head office at selling price, that is, cost plus
50%.
2.
Inventory at selling price at:
28 February 20.14
R4 500
28 February 20.15
R4 800
3.
It is estimated that theft of inventory amounting to R360 (selling price) occurred during the year. This amount must be taken into account during inventory reconciliations.
4.
During the year the branch donated inventory (cost R60) towards a local charity fund raising campaign.
5.
Inventory purchased locally was also sold at cost price plus 50%.
REQUIRED
Prepare the following accounts properly balanced/closed-off, in the general ledger of the head office for the year ended 28 February 20.15: a) Branch inventory account b) Branch adjustment account c) Branch expenses account
180

SOLUTION 8.3
a)
SUCRO CONFECTIONERY CC (HEAD OFFICE)
GENERAL LEDGER
Dr Branch inventory (at selling price)
20.14
Mar 1 Balance b/d
R 20.15
4 500 Feb 28 Inventory to branch
Inventory to branch 43 000 (Returns at cost)
(Deliveries at cost)
Branch adjustment d
21 500
Branch adjustment
(Markup on returns)
(Markup on deliveries)
Bank (Local purchases)
Branch adjustment e
(Markup on local
Purchases)
500
167
Branch expenses
(Cash embezzled)
Bank (Cash sales) h
Branch trade receivables control (Credit sales)
Branch expenses i
(Cost of inventory damaged)
Branch adjustment
(Markup on inventory damaged)
Branch expenses
(Cost of inventory stolen)
Branch adjustment l
(Markup on inventory stolen)
Branch expenses
(Cost of inventory donated)
Branch adjustment
(Markup on inventory donated)
Branch adjustment
(Inventory shortage) *
Balance c/d
(Closing inventory)
69 667
20.15
Mar 1 Balance b/d
(Opening Inventory)
4 727
* Balancing figure
Cr
R
1 200
600
375
42 000
20 000
200
100
240
120
60
20
25
4 727
69 667
181

SOLUTION 8.3 (continued) b) Dr Branch adjustment (mark-up at 50% on cost)
20.15
Feb 28 Branch inventory
(Markup on returns)
R 20.14
600 Mar 1 Balance ᬐ b/d
(Markup on opening inventory)
100 Branch inventory
(Markup on inventory damaged)
Branch inventory
(Markup on inventory stolen)
Branch inventory ᬏ
(Markup on inventory
120
20
Branch inventory
(Markup on deliveries)
Branch inventory
(Markup on local purchases) donated)
Branch inventory
(Inventory shortage)
Balance ᬑ c/d
(Markup on closing inventory)
Branch expenses
(Branch gross profit for the year) *
25
1 600
20 702
23 167
20.15
Mar 1 Balance b/d
(Markup on opening inventory)
* Balancing figure c) Dr Branch expenses
20.15
Feb 28 Branch inventory
R 20.15
375 Feb 28 Branch adjustment
(Cash embezzled)
Bank (Admin expenses)
Bank (Rent expenses)
Branch inventory
(Inventory damaged)
Branch debtors control
(Credit losses)
Branch inventory
5 000
1 800
200
50
240
(Branch gross profit for the year)
(Inventory stolen)
Branch inventory
(Inventory donated)
Head office: Profit or loss
(Branch profit for the year) *
60
12 977
20 702
* Balancing figure
Cr
R
1 500
21 500
167
23 167
1 600
Cr
R
20 702
20 702
182

SOLUTION 8.3 (continued)
Calculations
ᬅ Cost of inventory sent to branch
Cost
Profit markup
Selling price
%
100
50
150
Inventory sent to branch at cost = R64 500 x 100 /
150
= R43 000
ᬆ
Profit markup on inventory sent to branch
R64 500 x 50 /
150
= R21 500
ᬇ
Profit markup on local purchases
R500 x 50 /
150
= R167
ᬈ
Cost of returns to head office
R1 800 x 100 /
150
= R1 200
ᬉ Profit markup on returns to head office
R1 800 x 50 /
150
= R600
ᬊ
Bank (Cash sales)
Cash sales (after deduction of R500)
Cash used for local purchases
Total cash sales
R
41 500
500
42 000
ᬋ
Cost of inventory damaged
R300 x 100 /
150
= R200
ᬌ
Profit markup on inventory damaged
R300 x 50 /
150
= R100
ᬍ
Cost of inventory stolen
R360 x 100 /
150
= R240
ᬎ
Profit markup on inventory stolen
R360 x 50 /
150
= R120
ᬏ Profit markup on inventory donated
R60 x 50 /
150
= R20
ᬐ
Profit markup on opening inventory
R4 500 x 50 /
150
= R1 500
ᬑ
Profit markup on closing inventory
R4 800 x 50 /
150
= R1 600
183

After having worked through this learning unit, are you able to do the following?
Yes No
Briefly discuss the concept of branches.
Briefly explain the difference between dependent and independent branches.
Briefly discuss the information to be included in the reports submitted by a dependent branch to a head office.
Record the transactions between a head office and a dependent branch in the books of the head office where inventory sent to the branch is invoiced at cost price.
Record the transactions between a head office and a dependent branch in the books of the head office where inventory sent to the branch is invoiced at selling price.
Record the transactions of a dependent branch pertaining to the following where inventory is invoiced at cost price or at selling price:
Purchases of inventory by the branch
Sales of inventory by the branch
Inventory sold by the branch at a discount
Inventory damaged or stolen at the branch
Inter-branch inventory transactions
Settlement discount granted to debtors of the branch
Donations made by the branch
Cash embezzled at the branch
Inventory in transit from the branch to the head office and from the head office to the branch
Identify and record a shortage or surplus in the inventory of a branch where inventory is invoiced by the head office at selling price.
If you answered "yes" to all of the above assessment criteria, you have completed your studies on branches and can move on to learning unit 9. If you answered "no" to any of the above criteria, you must revise those sections before progressing to learning unit 9.
184

9
9
Learning outcomes ..........................................................................................................186
Key concepts ...................................................................................................................186
9.1
Introduction .............................................................................................................187
9.2
Main objective and advantages of a statement of cash flows ..................................188
9.3
Format of a statement of cash flows........................................................................188
9.4
Relationship between a statement of cash flows and other financial statements .....189
9.5
Identification of non-cash entries in financial statements prepared on the accrual basis of accounting .................................................................................................189
9.6
Preparation of a statement of cash flows from financial statements prepared on the accrual basis of accounting ..............................................................................190
9.7
Exercises and solutions ..........................................................................................194
Self-assessment ..............................................................................................................212
185

After studying this learning unit, you should be able to: x discuss, in general terms, the purpose and importance of a statement of cash flows x explain the relationship between a statement of cash flows and the other financial statements x prepare a statement of cash flows and the note in respect of non-cash transactions pertaining to investing activities and financing activities of a sole proprietor, partnership and close corporation according to the requirements of IAS 7 by utilising information which is mainly obtained from the other financial statements and relevant notes thereto
x
Cash and cash equivalents x
Non-cash transactions x
Operating activities x
Direct and indirect methods x
Investing activities x
Financing activities
186

According to IAS 1, which was covered in learning unit 1 , the objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. The information reported on in a statement of profit or loss and other comprehensive income, a statement of financial position and a statement of changes in equity (in respect of a close corporation) cannot meet all the informational needs of the users. More so in respect of the liquidity of a business entity. A liquidity analysis of a business entity, inter alia, indicates how a business is managing its cash flows. Such information is of great importance, since it shows, for example, from which resources the transactions of a business entity are financed.
Making a profit is one side of the coin for a successful business, but cash management is essential to be able to keep on trading. Cash flow and profit are not necessarily the same the crucial difference between the two concepts is timing. For example, when an entity sells to a customer on credit, the sale is immediately accounted for in the statement of profit or loss and other comprehensive income (referred to as the accrual accounting concept) and will result in a profit if the sale was above the cost of the inventory. However, the entity does not receive the cash immediately and a statement of cash flows will include this credit transaction only when the actual cash is received. Furthermore, the sustainability of a business, for example, will be questioned when its operating activities are predominantly financed with external funds (such as long-term borrowings). The purpose of a statement of cash flows (as prescribed by IAS 7) is to provide information on the cash position of the entity with regard to the inflow and outflow of cash during the year.
You will encounter the statement of cash flows throughout your accounting studies. It is therefore very important that your foundational knowledge of cash flows is good. Although cash flows are dealt with early in the prescribed textbook, we decided to include this as the last learning unit after you have dealt with the different types of entities (which include branch accounting). You may have to spend a lot more time to understand cash flows and we recommend that you do.
Read the overview of a statement of cash flows and paragraph 7.1 in the prescribed textbook. The paragraph illustrates how the financial performance of an illustrious American company was misinterpreted with catastrophic results for the entity – all due to a lack of cash flow information.
187

Read paragraph 7.2 in the prescribed textbook.
The statement of cash flows provides the users with the following valuable information: x
The cash that was generated through operating activities x
Cash used to acquire non-current assets and cash obtained from the disposal of noncurrent assets x
The amount of money invested during the year or money received from the maturity of investments previously made x
Any amounts borrowed and repaid during the financial year x
The extent to which the entity used borrowed funds or obtained equity in the period under review.
Study paragraph 7.3 in the prescribed textbook.
Please make sure that you can define cash, cash equivalents, cash flows and the three sections of a statement of cash flows.
IAS 7 prescribes two methods for the preparation of a statement of cash flows, namely the direct or the indirect method. Both are discussed in detail further on in this learning unit. Note that the format presented in paragraph 7.3 is a comprehensive illustration of entries that can be included in a statement of cash flows for different types of entities. Further references to the format of a statement of cash flows pertain to this format.
The “Cash flows from operating activities” section can be disclosed according to either the direct or the indirect method .
188

Read paragraph 7.4 in the prescribed textbook.
Apart from a statement of cash flows, financial statements consist of: x
Statement of profit or loss and other comprehensive income x
Statement of financial position x
Statement of changes in equity x
Notes to the financial statements.
The statement of cash flows is complementary to other statements and can be prepared from information in the various statements and notes. Because statements of cash flows contain only cash flow entries, it is very important to be able to distinguish between cash and noncash entries.
Read paragraph 7.5 in the prescribed textbook.
This paragraph must be read attentively. Attempt to do the table provided on the identification of non-cash transactions before you look at the solution. Carefully work through the explanation and journal entries to understand why the mentioned entries are non-cash entries.
Activity 9.1
Make a list of seven or eight non-cash transactions.
Feedback 9.1
x
Depreciation x
Allowance for credit losses/increases or decreases in the allowance x
Impairment losses or amortisation x
Profit or loss on sale of assets x
Losses with the writing off of inventory x
Revaluation of assets and fair value adjustments x
Credit losses written off x
Certain adjustments such as expenses in arears or income in arrears x
Credit sales and credit purchases.
189

Read paragraph 7.6 in the prescribed textbook.
The “cash flows from operating activities” section of a statement of cash flows can be reported on according to either the direct or the indirect method. You must be able to apply both methods in FAC1601.
Read paragraph 7.6.1 in the prescribed textbook.
Cash generated from or used in operations according to the direct method
Read paragraph 7.6.1.1 in the prescribed textbook and study the layout of the cash flows from operating activities according to the direct method.
Remember that outflows of cash are always indicated in brackets, whereas cash inflows are indicated without brackets.
The calculation of cash receipts from customers and cash paid to suppliers and employees is explained in detail in subparagraphs 7.6.1.1(a) and (b) in the prescribed textbook. Take note that the financial period during which an accrued or prepaid amount was recorded, plays an important role when the cash receipts and cash payments are calculated.
Activity 9.2
Work through examples 7.1 and 7.2 in the prescribed textbook, which illustrate the calculation of cash receipts and cash paid to suppliers and employees, respectively.
The use of t-accounts to establish the cash paid or received is illustrated in example 7.3.
Activity 9.3
Work through example 7.3 in the prescribed textbook.
190

Cash generated from or used in operations according to the indirect method
When the indirect method is used to report on cash generated from or used in operations, the first figure that is needed for disclosure is the profit (or loss) for the financial year (in the case of a sole proprietorship/partnership) or the profit (or loss) before tax (in the case of a close corporation). This figure is then adjusted on the face of the statement of cash flows to omit x any non-cash entries x any items that must be disclosed on the face of the statement of cash flows after the cash generated from or used in operations section has been prepared.
Thereafter, the changes in the working capital (that is the changes in the current assets and current liabilities that pertain to the operating activities of the business entity) are disclosed.
Read paragraph 7.6.1.2 in the prescribed textbook and study the layout of the cash flows from operating activities according to the indirect method.
Activity 9.4
Work through example 7.4 in the prescribed textbook.
Operating activity items disclosed after cash generated from or used in operations
Study paragraph 7.6.1.3 in the prescribed textbook.
Activity 9.5
Work through example 7.5 in the prescribed textbook.
Make sure that you understand when a purchase or disposal of an investment is treated as an operating activity and when it is treated as an investing activity as explained in paragraph
7.6.1.3 and the information in example 7.3 pertaining to investments.
Comment
Cash flows can only be mastered by doing as many examples as you can and doing so on your own before looking at the solution so that you can see where you made a mistake. The use of T-accounts to calculate the cash amount pertaining to a specific account may also be more “user-friendly” than using tables 7.1 and 7.2 in the prescribed textbook and will be particularly useful in the next section.
IAS 7 requires an entity to disclose the classes of gross cash receipts and gross cash payments made to acquire assets and/or investments. This is collectively referred to as the investing activities of an entity.
The cash flows from investing activities are calculated by using information given in the statement of financial position for the current and preceding financial years. If there is a
191

difference between the amounts of an entry from year to year, it is possible that a cash flow took place. The difference must be analysed further to determine whether a cash flow occurred or not and the use of T-accounts is very helpful.
Make sure that you understand the effect of depreciation in the t-account when assets are presented at carrying amount. Take note of the implications of a revaluation surplus in an asset T-account and remember to consider those when you calculate the actual cash flow that occurred in the particular T-account.
Study paragraph 7.6.2 in the prescribed textbook.
Activity 9.6
Work through example 7.6 in the prescribed textbook.
Cash flows from financing activities disclose future claims on cash and how activities and investments were financed.
The cash flows from financing activities can be determined by comparing the statements of financial position of the current year and of the preceding year and/or by using the information given in the statement of the changes in equity (or the statement of changes in net investment of members for CCs).
Study paragraph 7.6.3 in the prescribed textbook.
Activity 9.7
Work through example 7.7 in the prescribed textbook.
Once the cash flows from the operating activities, investing activities and financing activities sections have been prepared, the net cash increase/(decrease) in cash and cash equivalents is calculated by adding/subtracting the net cash flows of the operating, investing and financing activities sections. The cash and cash equivalents at the beginning of the financial period are added to this net increase/(decrease). The answer of this calculation is equal to the cash and cash equivalents at the end of the financial period. This amount must be equal to the cash and cash equivalents as disclosed in the statement of financial position for that period (so you know your statement of cash flows has balanced).
Study paragraph 7.6.4 in the prescribed textbook.
192

Activity 9.8
Work through example 7.8 in the prescribed textbook.
Study paragraph 7.6.5 in the prescribed textbook.
You only need to be able to prepare only the note in respect of a non-cash transaction pertaining to an investing or financing activity. Examples of such a note are supplied in
Example 7.9 and 7.10 in the prescribed textbook.
You are now ready to do the two comprehensive examples in the prescribed textbook.
Example 7.9 deals with the preparation of a statement of cash flows for a partnership prepared according to the direct as well as the indirect method.
Activity 9.9
Work through comprehensive example 7.9 in the prescribed textbook.
Example 7.10 deals with the preparation of a statement of cash flows for a close corporation prepared according to the indirect method only. By now you should be able to prepare the statement of cash flows for a close corporation according to the direct method as well and you can attempt that on your own.
Activity 9.10
Work through comprehensive example 7.10 in the prescribed textbook.
Study paragraph 7.7 in the prescribed textbook which is a summary of the chapter.
193

EXERCISE 9.1 – Preparation of a statement of cash flows in respect of a sole trader
The following information pertains to L Leyds, a general dealer:
EXTRACTED INFORMATION FROM THE STATEMENT OF FINANCIAL POSITION AS AT
28 FEBRUARY
Land and buildings at cost
Equipment at cost
Inventory at cost
Trade receivables control
Bank (Dr)
Trade payables control
Bank overdraft
Capital – L Leyds
Long-term loan
Accumulated depreciation: Equipment
20.15
R
100 000
72 000
20 000
17 000
2 000
19 000
–
84 200
80 000
12 000
20.14
R
90 000
60 000
16 000
19 000
–
20 000
6 000
58 400
75 000
9 800
Additional information:
1.
The total comprehensive income for the year amounted to R26 000 and has already been closed off against the capital account of L Leyds. There were no items pertaining to other comprehensive income.
2.
No property, plant and equipment were sold or scrapped during the year ended
28 February 20.15. Equipment with a cost price of R7 000 was purchased on credit during the year. This amount is included in the trade payables control figure. By the end of the year, no payments in respect of the equipment were made. Assume the amount of this purchase to be significant. All of the other additions to property, plant and equipment were obtained from third parties and paid for in cash.
3.
The interest expense on the long-term loan during the year amounted to R12 000.
Interest is not capitalised.
4.
The creditors in respect of 28 February 20.15 pertain to trade payables control and the creditor referred to in additional information 2.
5.
Cash withdrawals (closed off against the capital account) by L Leyds during the year ended 28 February 20.15 amounted to R10 200.
6.
Capital contributions by L Leyds are made in cash.
REQUIRED
Prepare the statement of cash flows of L Leyds for the year ended 28 February 20.15 to comply with the requirements of International Financial Reporting Standards (IFRS) appropriate to the business of the sole trader. Comparative figures are not required. The cash generated from/(used in) operations must be disclosed according to the indirect method. Only the note in respect of the non-cash transaction pertaining to the investing activity must be disclosed.
194

SOLUTION 9.1
L LEYDS
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 28 FEBRUARY 20.15
R
Cash flows from operating activities
Profit for the year
Adjustments for:
Interest on long-term loan
Depreciation R(12 000 – 9 800)
26 000
12 000
2 200
40 200
(4 000)
2 000
Increase in inventories R(20 000 – 16 000)
Decrease in trade receivables(19 000 – 17 000)
Decrease in trade payables
R[20 000 – (19 000 – 7 000 * )]
Cash generated from operations
Interest paid
Drawings
Net cash from operating activities
(8 000)
30 200
(12 000)
(10 200)
R
8 000
Cash flows from investing activities
Investments in property, plant and equipment to expand operating
Capacity
Additions to land and buildings
Additions to equipment d
Net cash used in investing activities
Cash flows from financing activities
Proceeds from capital contribution e
Proceeds from long-term borrowing
Net cash increase from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
(15 000)
(10 000)
(5 000)
10 000
5 000
(15 000)
15 000
8 000
(6 000)
2 000
L LEYDS
NOTE FOR THE YEAR ENDED 28 FEBRUARY 20.15
1.
Non-cash transaction pertaining to the investing activity
Equipment with a cost price of R7 000 was purchased on credit during the year. No payments were made in this regard.
Comment
Since the above credit purchase is regarded as significant (refer to additional information 2), the transaction is disclosed in a note to the statement of cash flows.
Take special note of the: x
Calculation of a decrease in the trade payables control when trade creditors include a creditor pertaining to purchases of assets.
x
Disclosure of the purchase of equipment on credit, in respect of which no payment was made.
195

SOLUTION 9.1 (continued)
Calculations
ᬅ
Additions to land and buildings
Step 1: Determine the difference between the opening and closing balances of the land and buildings at cost account.
Land and buildings at cost (closing balance)
Subtract: Land and buildings at cost (opening balance)
Increase in (purchase of) land and buildings
R
100 000
(90 000)
10 000
Step 2: Determine whether the increase pertains to a cash flow.
Additional information 2 states that all property, plant and equipment with the exception of the purchase of equipment from a creditor, were purchased from third parties and paid for. Therefore, we know that the additions to the land and buildings were paid for in cash.
ᬆ
Additions to equipment
Step 1: Determine the difference between the opening and closing balances of equipment at cost account.
Equipment at cost (closing balance)
Subtract: Equipment at cost (opening balance)
Increase in (purchase of) equipment
R
72 000
(60 000)
12 000
Step 2: Determine whether the increase pertains to a cash flow.
Additional information 2 states that all property, plant and equipment, with the exception of the purchase of equipment with a cost price of R7 000 from a creditor, were paid for.
Therefore, for calculation purposes, the accounting entry that pertains to this transaction must be “reversed” (added back). (That is, the creditor’s account is “debited” and the equipment at cost account is “credited”. In other words, the closing balances of these accounts must each be reduced by this amount. Note that this reversal is not an actual accounting entry. It pertains solely to a calculation to prepare the statement of cash flows.)
The effect of the reversal is that the increase in the equipment is reduced to
R5 000 (R12 000 – R7 000), which is the value of the equipment that was purchased for cash.
ᬇ
Proceeds from capital contribution
Step 1: Determine the difference between the opening and closing balances of the capital account.
Capital (closing balance)
Add: Drawings (Additional information 5)
Subtract: Capital (Opening balance)
Total comprehensive income for the year (Additional information 1)
Increase in capital
R
84 200
10 200
(58 400)
(26 000)
10 000
196

SOLUTION 9.1 (continued)
Step 2: Determine whether the increase pertains to a cash flow.
Additional information 6 states that all capital contributions by Leyds are made in cash.
Reconstructing the capital account of Leyds will result in the same calculated amount of
R10 000
Capital: L Leyds
Dr (reconstructed for calculation purposes) Cr
20.15
R 20.14
R
Feb 28 Drawings 10 200 Mar 1 Balance b/d 58 400
Balance c/d 84 200 Profit or loss account 26 000
Bank * 10 000
94 400 94 400
20.15
Mar 1 Balance b/d 84 200
* Balancing entry
ᬈ
Proceeds from capital contribution
Step 1: Determine the difference between the opening and closing balances of the long-term loan (shown as long-term borrowing in the statement of financial position).
Long-term loan (closing balance)
Subtract: Long-term loan (Opening balance)
Increase in long-term loan
R
80 000
(75 000)
5 000
Step 2: Determine whether the increase pertains to a cash flow.
Since there was an increase of R5 000 and the interest expense on the borrowing is not capitalised, the R5 000 must have been received by the business in cash.
197

EXERCISE 9.2 – Preparation of a statement of cash flows in respect of a partnership
The following information pertains to the partnership, Bluemax:
BLUEMAX
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.15
Revenue
Cost of sales
Inventory (1 March 20.14)
Purchases
Inventory (28 February 20.15)
R
500 600
(196 360)
100 400
191 960
292 360
(96 000)
Gross profit
Other income
Profit on sale of non-current asset (Land and buildings)
Rental income
Distribution, administrative and other expenses
Administrative expenses (Salaries and wages included)
Depreciation
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
304 240
14 800
10 000
4 800
319 040
(71 200)
70 000
1 200
247 840
–
247 840
BLUEMAX
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.15
Capital
B Blue M Max
R R
Current accounts
B Blue M Max
R R
Appropriation
R
Total equity
R
Balances at 1 March 20.14
193 800 193 800
Capital contributions
Total comprehensive income for the year
26 200 26 200
Interest on capital
Interest on current accounts
Interest on drawings
Partners’ share of total comprehensive income
Drawings
Balances at 28 Feb 20.15
220 000 220 000
50 400 (400) –
13 200 13 200
5 040 (40)
(13 440) (11 720)
247 840
(26 400)
(5 000)
25 160
120 800 120 800 (241 600)
(134 400) (117 200)
41 600 4 640 –
437 600
52 400
247 840
(251 600)
486 240
198

BLUEMAX
EXTRACTED INFORMATION FROM THE STATEMENT OF FINANCIAL POSITION AS AT
28 FEBRUARY
Capital: B Blue
Capital: M Max
Current account: B Blue
Current account: M Max
Land and buildings at cost
Furniture and equipment at cost
Accumulated depreciation: Furniture and equipment
Inventory
Bank
Trade receivables control
Trade payables control
Accrued income (Rent receivable)
Accrued expenses (Salaries and wages)
Fixed deposit
20.15
20.14
R R
220 000 193 800
220 000 193 800
41 600 Cr 50 400 Cr
4 640 Cr 400 Dr
240 000
12 800
360 000
12 000
3 200
96 000
67 240 Dr
146 600
112 400
400
1 200
2 000
100 400
10 000 Cr
74 000
97 200
800
400
40 000 –
Additional information:
1.
The fixed deposit was made on 28 February 20.15.
2.
No land and buildings were purchased during the year. Fifty percent of the selling price of the land and buildings was received in cash, whereas the outstanding amount was on credit.
3.
No furniture or equipment was sold or scrapped during the year. All purchases were paid for in cash.
4.
All purchases of inventory were on credit. All of the other expenses, except the accrued expenses, were paid in full.
5.
The drawings of the partners were made in cash.
6.
Inventory is disclosed at cost.
7.
There were only trade debtors at 28 February 20.14. The debtors at 28 February 20.15 pertain to trade debtors and the debtor in respect of the sale of land and buildings.
8.
All capital contributions were made in cash.
REQUIRED
Prepare the statement of cash flows of Bluemax for the year ended 28 February 20.15 to comply with the requirements of IFRS appropriate to the business of the partnership. The cash generated from/(use in) operations must be disclosed according to the direct method.
Comparative figures are not required. Disclose only the note in respect of the non-cash transaction pertaining to the investing activity.
199

SOLUTION 9.2
BLUEMAX
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 28 FEBRUARY 20.15
Note R R
Cash flows from operating activities
Cash receipts from customers c
Cash paid to suppliers and employees
Cash generated from operations
Drawings R(134 400 + 117 200)
498 200
(245 960)
252 240
(251 600)
Net cash from operating activities 640
Cash flows from investing activities
Investments in property, plant and equipment to expand operating capacity
Additions to furniture and equipment R(12 800 – 12 000)
Proceeds from the sale of land and buildings
Acquisition: Fixed deposit R(40 000 – 0)
Net cash from investing activities
1
(800)
(800)
65 000
(40 000)
24 200
Cash flows from financing activities
Proceeds from capital contribution R[(220 000 – 193 800) x 2]
Net cash from financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
52 400
52 400
77 240
(10 000)
67 240
BLUEMAX
NOTE FOR THE YEAR ENDED 28 FEBRUARY 20.15
1.
Non-cash transaction pertaining to the investing activity
Land and buildings with a cost price of R120 000 were sold for R130 000. An amount of
R65 000 is receivable in the next financial year.
Comment
Take note of how to calculate and disclose a non-cash transaction in respect of an investing activity.
200

SOLUTION 9.2 (continued)
Calculations
ᬅ
Cash receipts from customers
Items in statement of profit or loss and other comprehensive income
Revenue
Rental income n Trade receivables (closing balance)
R
500 600
4 800
20.14
+ Accrued income – income received in advance
R
+ 74 000
+ 800
20.15
- Accrued income +
Income received in advance
R
- 81 600 n
- 400
Cash received from customers during 20.15
R
= 493 000
= 5 200
498 200
A debtor included in the amount of R146 600 does not pertain to trade receivables , but to a debtor who purchased land and buildings from the entity (refer to additional information
7). The closing balance of this debtor’s account must be excluded from the R146 600.
The closing balance is calculated as follows: x
The selling price of the sold land and buildings:
Carrying amount + Profit on sale
R(360 000 – 240 000) + R10 000
= R130 000 x
According to additional information 2, 50% of R130 000 is still outstanding at the end of 20.15:
?
R130 000 ÷ 2 = R65 000 = Closing balance.
Therefore, R65 000 must be excluded from R146 600:
R(146 600 – 65 000) = R81 600 = Closing balance of trade receivables
ᬆ
Cash paid to suppliers and employees
Items in statement of profit or loss and other comprehensive income
Purchases
Administrative expenses
R
191 960
70 000
20.14
+ Accrued expenses –
Prepayments
R
+ 97 200
+ 400
20.15
- Accrued expenses +
Prepayments
R
- 112 400
- 1 200
Cash to suppliers and employees during 20.15
R
= 176 760
= 69 200
245 960
201

EXERCISE 9.3 – Preparation of a statement of cash flows in respect of a close corporation
The following information pertains to Cash CC:
CASH CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20.15
Revenue
Cost of sales
Inventory (1 January 20.15)
Purchases
Inventory (31 December 20.15)
Gross profit
Other income
Dividend income: Listed investment
Fair value adjustment: Held for trading: Listed investment
Distribution, administrative and other expenses
Depreciation
Salaries to members
Administrative expenses
Wages
Finance costs
Interest on long-term loan
Profit before tax
Income tax expense
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
R
490 000
(282 500)
31 000
301 500
332 500
(50 000)
207 500
28 000
13 000
15 000
235 500
(99 000)
19 000
24 000
20 000
36 000
(14 000)
14 000
122 500
(36 000)
86 500
–
86 500
CASH CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 31 DECEMBER 20.15
Balances at 1 January 20.15
Members’ contributions
Total comprehensive income for the year
Distribution to members
Balances at 31 December 20.15
Members’ contributions
R
355 000
20 000
375 000
Retained earnings
R
8 000
86 500
(47 500)
47 000
Total
R
363 000
20 000
86 500
(47 500)
422 000
202

CASH CC
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.15
Note 20.15
R
ASSETS
Non-current assets
Property, plant and equipment
Current assets
Inventories
Trade receivables
Prepayments
Listed investment
Cash and cash equivalents
1
20.14
R
448 500
448 500
151 000
50 000
35 000
394 000
394 000
103 000
31 000
30 000
2 000 –
50 000 35 000
14 000 7 000
Total assets
EQUITY AND LIABILITIES
Total equity
Members' contributions
Retained earnings
Total liabilities
Non-current liabilities
Long-term borrowings
Current liabilities
Trade payables
Distribution to members payable
Current tax payable
599 500
422 000
375 000
47 000
177 500
100 000
100 000
77 500
31 000
37 500
9 000
497 000
363 000
355 000
8 000
134 000
70 000
70 000
64 000
38 000
15 000
11 000
Total equity and liabilities 599 500 497 000
CASH CC
ABSTRACT FROM THE NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR
ENDED 31 DECEMBER 20.15
1.
Property, plant and equipment
Carrying amount at 1 January 20.15
Cost
Accumulated depreciation
Additions
Disposals
Depreciation for the year
Carrying amount at 31 December 20.15
Cost
Accumulated depreciation
Land and buildings
R
260 000
260 000
–
–
–
–
260 000
260 000
–
Machinery and equipment
R
134 000
177 000
(43 000)
77 500
(4 000)
(19 000)
188 500
237 500
(49 000)
Total
R
394 000
437 000
(43 000)
77 500
(4 000)
(19 000)
448 500
497 500
(49 000)
203

Additional information:
1.
During the year machinery with a cost price of R17 000 was sold for cash at its carrying amount and replaced with new machinery. Depreciation to the amount of R13 000 was recorded in respect of the sold machinery, as from the date of purchase to the date of sale.
2.
An additional machine was purchased for R40 000 to expand the operating capacity of the business.
3.
Machinery was purchased for cash.
4.
No equipment was purchased or sold during the financial year ended
31 December 20.15.
5.
Listed investment pertains to shares purchased on 31 December 20.15 from Doc
Limited. The shares are held for trading. No shares from the listed investment were sold during the current financial year.
6.
All inventories are purchased and sold on credit.
7.
Inventory is recorded at cost.
8.
Trade and other payables include:
Trade payables control
Accrued wages
20.15
R
25 000
6 000
20.14
R
33 000
5 000
9.
The close corporation will be renting additional premises as from 1 January 20.16.
10 The trade receivables control pertains to the trade debtors to whom trading inventory was sold on credit.
11.
The prepayment was in respect of a rental expense which is included in administrative expenses.
12.
The long-term borrowings pertain to a long-term loan. The interest on the loan is not capitalised.
REQUIRED
Prepare the statement of cash flows of Cash CC for the year ended 31 December 20.15 to comply with the requirements of IFRS appropriate to the business of the close corporation.
The cash generated from/(used in) operations must be disclosed according to the direct method. Comparative figures and notes are not required.
204

SOLUTION 9.3
CASH CC
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20.15
Note R
Cash flows from operating activities
Cash receipts from customers c
Cash paid to suppliers and employees
Cash generated from operations
Dividends received
Interest paid f e
Income tax paid
Distributions to members paid
485 000
(390 500)
94 500
13 000
(14 000)
(38 000)
(25 000)
Net cash from operating activities
R
30 500
Cash flows from investing activities
Investments in property, plant and equipment to maintain operating capacity
Replacement of machinery
Investment in property, plant and equipment to expand operating
Capacity
Addition to machinery
Proceeds from sale of machinery
Net cash from in investing activities
Cash flows from financing activities
Proceeds from members’ contributions
Proceeds from long-term borrowings ᬎ
Net cash from financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
(37 500)
(37 500)
(40 000)
(40 000)
4 000
20 000
30 000
(73 500)
50 000
7 000
7 000
14 000
Comment
Take note of the following: x
How to disclose an investment in property, plant and equipment to maintain operating capacity.
x
How to calculate the cash receipts from the sale of machinery.
x
The non-cash entry pertaining to the revaluation of the financial asset at fair value through profit or loss: Held for trading: Listed investment. The fair value adjustment of R15 000
R(50 000 – 35 000) pertains to a revaluation of the listed investment. The increase in the statement of financial position is therefore a non-cash entry.
205

SOLUTION 9.3 (continued)
Calculations
ᬅ
Cash receipts from customers
Revenue (Sales)
Add: Trade receivables control (opening balance)
Less: Trade receivables control (closing balance)
Cash receipts from customers
R
490 000
30 000
(35 000)
485 000
ᬆ
Cash paid to suppliers and employees
Items
R
20.14
+ Accrued expenses –
Prepayments
R
20.15
- Accrued expenses +
Prepayments
R
Cash to suppliers and employees during 20.15
R
Statement of profit or loss and other comprehensive income:
Purchases (for payments made to trade payables control)
Salaries to members
Administrative expenses
Wages
301 500 + 33 000 - 25 000
24 000 – –
20 000 – + 2 000
36 000 + 5 000 - 6 000
309 500
24 000
22 000
35 000
390 500
ᬇ
Dividends received
No dividends are indicated as receivable at the beginning or end of the financial year under review. It can therefore be concluded that the dividend income of R13 000 for the year ended 31 December 20.15 was received in cash.
ᬈ
Interest paid
No accrued or prepaid amounts were indicated in respect of an interest expense. It can therefore be concluded that the interest of R14 000 in the statement of profit or loss and other comprehensive income for the year ended 31 December 20.15 was paid in cash.
ᬉ
Income tax paid
Income tax expense
Add: Current tax payable (opening balance)
Less: Current tax payable (closing balance)
Income tax paid
ᬊ
Distribution to members
R
36 000
11 000
(9 000)
38 000
Distribution to members
Add: Distribution to members payable (opening balance)
Less: Distribution to members payable (closing balance)
Distribution to members paid
R
47 500
15 000
(37 500)
25 000
206

SOLUTION 9.3 (continued)
ᬋ
Replacement and addition to machinery
Step 1: Determine the difference between the opening and closing balances of the machinery and equipment at cost account:
The note in respect of property, plant and equipment show that there were additions to the amount of R77 500. In additional information 2, it was mentioned that machinery to the amount of R40 000 was purchased to expand the operating capacity of the business.
It can therefore be concluded that machinery to the amount of R37 500 was purchased to replace machinery sold.
Step 2: Determine whether the additions pertain to a cash flow:
Additional information 3 states that the purchases of machinery were paid for in cash.
ᬌ
Proceeds from the sale of machinery
Cost – Accumulated depreciation = Carrying amount
R(17 000 – 13 000) = R4 000
Additional information 1 states that machinery was sold for cash at its carrying amount. The selling price of the machinery is therefore R4 000.
ᬍ
Proceeds from members’ contributions
Step 1: Determine the difference between the opening and closing balances of the members’ contributions account:
Members’ contributions (Statement of financial position as at 31 December 20.15)
Less: Members’ contributions (Statement of financial position as at
31 December 20.14)
Increase in members’ contributions*
R
375 000
(355 000)
20 000
* Also refer to the statement of changes in net investment of members for the year ended
31 December 20.15.
Step 2: Determine whether the increase pertains to a cash flow:
No further information was given in respect of members’ contributions. It can therefore be concluded that the increase in the members’ contributions was a cash contribution.
ᬎ
Proceeds from long-term borrowing
Step 1: Determine the difference between the opening and closing balances of the long-term borrowing:
Long-term borrowings (Statement of financial position as at 31 December 20.15)
Less: Long-term borrowings (Statement of financial position as at
31 December 20.14)
Increase in long-term borrowings
R
100 000
(70 000)
30 000
Step 2: Determine whether the increase pertains to a cash flow:
Since there was an increase in the long-term borrowing and the interest charged on the borrowing is not capitalised, the R30 000 must have been received in cash.
207

EXERCISE 9.4 – Preparation of a statement of cash flows in respect of a close corporation
The following information pertains to Greengrow CC:
EXTRACTED INFORMATION FROM THE STATEMENT OF FINANCIAL POSITION AS AT
31 DECEMBER
20.15
20.14
Members’ contributions
Retained earnings
Long-term loan
Land and buildings at cost
Machinery and equipment at cost
Accumulated depreciation: Machinery
Fixed deposit
Inventory
Trade receivables control
Bank (Dr)
Prepaid rental expense
Trade payables control
Bank overdraft
Current tax payable
Distribution to members payable
Interest payable
R R
375 000 375 000
48 000
70 000
260 000
177 000
43 000
15 000
100 000
260 000
220 500
49 000
35 000
31 000
30 000
50 000
50 000
35 000
47 000 –
– 3 000
13 000
–
25 000
2 000
11 000
15 000
5 000
9 000
37 500
6 000
EXTRACTED INFORMATION FROM THE STATEMENT OF PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.15
Interest income (Fixed deposit)
Depreciation
Loss on sale of machinery and equipment
Interest on long-term loan
Income tax expense
Profit for the year
R
13 000
19 000
500
14 000
43 000
70 500
EXTRACTED INFORMATION FROM THE STATEMENT OF CHANGES IN NET INVESTMENT
OF MEMBERS FOR THE YEAR ENDED 31 DECEMBER 20.15
Distributions to members
R
37 500
Additional information:
1.
No machinery and equipment were purchased during the financial year. Machinery and equipment were sold for cash
2.
Inventory is disclosed at cost.
3.
A fixed deposit was redeemed in cash during the financial year.
4.
The interest on the long-term loan is not capitalised.
5.
The were no other comprehensive income for the year.
REQUIRED
Prepare the statement of cash flows of Greengrow CC for the year ended 31 December 20.15 to comply with the requirements of International Financial Reporting Standards (IFRS) appropriate to the business of the close corporation. The cash generated from/(used in) operations must be disclosed according to the indirect method. Comparative figures and notes are not required.
208

SOLUTION 9.4
GREENGROW CC
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20.15
R
Cash flows from operating activities
Profit before tax c
Adjustments for:
Interest on long-term loan
Loss on sale of machinery and equipment
Depreciation
Interest income (Fixed deposit)
Decrease in inventories R(50 000 – 31 000)
Decrease in trade receivables R(35 000 – 30 000)
Decrease in prepaid rent R(3 000 – Nil)
Decrease in trade payables R(25 000 – 13 000)
Cash generated from operations
Interest received
Interest paid e d
Income tax paid
Distribution to members paid
Net cash from operating activities
113 500
14 000
500
19 000
(13 000)
134 000
19 000
5 000
3 000
(12 000)
149 000
13 000
(15 000)
(41 000)
(60 000)
R
46 000
Cash flows from investing activities
Proceeds from the sale of machinery and equipment
Proceeds from the maturity of fixed deposit i
Net cash used in investing activities
Cash flows from financing activities
Repayment of long-term borrowing j
Net cash from financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
18 000
15 000
(30 000)
33 000
(30 000)
49 000
(2 000)
47 000
Comment
Take note of the calculation of profit before tax and the adjustments necessary.
Calculations
ᬅ
Profit before tax
Profit for the year
Add: Income tax expense
Profit before tax
ᬆ
Interest received
R
70 500
43 000
113 500
No interest income is indicated as receivable at the beginning or end of the financial year.
It can therefore be concluded that the interest of R13 000 earned for the year ended
31 December 20.15, was received in cash.
209

SOLUTION 9.4 (continued)
ᬇ
Interest paid
Interest on long-term loan
Add: Interest payable (opening balance)
Less: Interest payable (closing balance)
Interest paid
ᬈ
Income tax paid
R
14 000
6 000
(5 000)
15 000
Income tax expense
Add: Current tax payable (opening balance)
Less: Current tax payable (closing balance)
Income tax paid
ᬉ
Distribution to members paid
R
43 000
9 000
(11 000)
41 000
Distribution to members
Add: Distribution to members payable (opening balance)
Less: Distribution to members payable (closing balance)
Distribution paid
ᬊ
Proceeds from the sale of machinery
R
37 500
37 500
(15 000)
60 000
Step 1: Determine the difference between the opening and closing balances of the machinery and equipment at cost account:
Machinery and equipment at cost (opening balance)
Less: Machinery and equipment at cost (closing balance)
Decrease in machinery and equipment at cost
R
220 500
(177 000)
43 500
Step 2: Determine whether the decrease pertains to a cash flow:
Additional information 1 states that no machinery and equipment were purchased during the year and that machinery and equipment were sold for cash. The decrease in the machinery and equipment was caused by a cash sale of machinery and equipment with a cost price of R43 500.The cash inflow is equal to the proceeds (selling price) of the sales transaction.
Carrying amount of machinery and equipment sold (unknown) minus Loss on sale of machinery and equipment = Selling price (unknown)
The carrying amount = Cost price of the machinery and equipment sold minus
Accumulated depreciation of the machinery and equipment sold
210

SOLUTION 9.4 (continued)
The calculation of the accumulated depreciation is best illustrated by the reconstruction of the accumulated depreciation account:
Accumulated depreciation
Dr (reconstructed for calculation purposes)
20.14
Dec 31 Realisation account *
Balance (given) c/d
R 20.14
25 000 Jan 1 Balance (given)
43 000 Dec 31 Depreciation
68 000
b/d
(given)
R
Cr
49 000
19 000
68 000
20.15
Jan 1 Balance b/d 43 000
* Balancing entry: Pertain to the accumulated depreciation in respect of the sold machinery and
equipment.
Carrying amount of the machinery and equipment sold = R(43 500 – 25 000) = R18 500
Selling price = R(18 500 – 500) = R18 000
ᬋ
Proceeds from the maturity of fixed deposit
Step 1: Determine the difference between the opening and closing balances of the fixed deposits:
Fixed deposits (opening balance)
Less: Fixed deposits (closing balance)
Realisation of fixed deposit
R
50 000
(35 000)
15 000
Step 2: Determine whether the increase pertains to a cash flow:
Additional information 3 states that a fixed deposit was redeemed in cash during the financial year.
ᬌ
Repayment of long-term borrowing
Step 1: Determine the difference between the opening and closing balances of the long-term loan disclosed as long-term borrowings in the statement of financial position:
Long-term (opening balance)
Less: Long-term loan (closing balance)
Decrease in long-term loan
R
100 000
(70 000)
30 000
Step 2: Determine whether the increase pertains to a cash flow:
Since there was a decrease in the long-term loan to the amount of R30 000 and the interest charged on the borrowing is not capitalised the R30 000 must have been repaid in cash.
211

After having worked through this learning unit, are you able to do the following?
Yes No
Briefly discuss the purpose and importance of a statement of cash flows.
Briefly explain the relationship between a statement of cash flows and the other financial statements that were prepared on the accrual basis of accounting, and describe how this relationship impacts on the preparation of a statement of cash flows.
Prepare a statement of cash flows and the notes in respect of noncash transactions pertaining to investing and financing activities according to the requirements of IAS 7 by utilising information which is mainly obtained from the other financial statements and any relevant notes thereto, for each of the following business entities:
Sole proprietor
Partnership
Close corporation
If you answered "yes" to all of the above assessment criteria, you have complete the learning unit on cash flows and can now focus on revision of the study material for the exams. If your answer was "no" to any of the above criteria, revise those sections concerned before commencing with the revision of the study material.
212