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answers to selected questions in the textbook AS Unit 1 Introduction to Financial Accounting 1 What is financial accounting? 1 3 Double-entry book-keeping: further transactions 3 2 4 5 AS Accounting for AQA second edition TUTOR SUPPORT MATERIAL: ANSWERS TO SELECTED QUESTIONS 6 7 8 9 10 11 12 Double-entry book-keeping: first principles Business documents Balancing accounts – the trial balance Division of the ledger – the use of subsidiary books The main cash book 1 5 7 9 11 Bank reconciliation statements 12 The general journal and correction of errors 15 Introduction to final accounts Control accounts Adjustments to final accounts 14 18 19 AS Unit 2 Financial and Management Accounting 13 Business organisations 21 15 Further aspects of final accounts 23 14 © Osborne Books Limited 2012 All answers are the responsibility of the publisher. Published by Osborne Books Limited Tel 01905 748071 Email books@osbornebooks.co.uk www.osbornebooks.co.uk 16 17 18 19 20 Accounting concepts and inventory valuation Preparing sole trader final accounts Financial statements of limited companies Ratio analysis Budgeting and budgetary control The impact of computer technology in accounting 22 25 28 31 34 36 1.7 CHAPTER 1 What is financial accounting? 1.2 1.3 Purposes of accounting: To quantify items such as sales, expenses and profit 1. 2. To present the accounts in a meaningful way so as to measure the success of the business 3. To provide information to the owner of the business and to other stakeholders • • • • • • 1.4 trial balance extraction of figures from all the double-entry accounts to check their accuracy • overheads and expenses to date • • 2.1 assets owned trade receivables – total amount owed to the business, and individual trade receivables liabilities owed profit during a particular period trade payables – total amount owed by the business, and individual trade payables providers of finance, eg the bank manager if the business wants to borrow from the bank • suppliers, who wish to assess the likelihood of receiving payment from the business • employees and trade unions, who wish to check on the financial prospects of the business • • • • (a) (b) • • • • asset of bank increases by £3,000 liability of loan increases by £3,000 asset £11,000 – liability £3,000 = capital £8,000 asset of van increases by £6,000 asset of bank decreases by £6,000 asset £11,000 – liability £3,000 = capital £8,000 Dr Capital Account Dr Computer Account Cr Rent Paid Account Cr Wages Account Cr Dr Bank Loan Account Bank Cr £ 2,500 Dr Commission Income Account Cr Dr Drawings Account Dr 20-1 8 Feb customers, who wish to ensure that the business has the financial strength to continue selling the goods and services that they buy the tax authorities, who will wish to see that tax due by the business on profits and for Value Added Tax has been paid Dr 20-1 12 Feb 25 Feb competitors, who wish to assess the profitability of the business potential investors in the business the local community and national interest groups, who may be seeking to influence business policy government and official bodies, eg Companies House who need to see the final accounts of limited companies £ Bank Bank Bank Bank 20-1 Business entity – the accounts record and report on the financial transactions of a particular business, and not the owner's personal financial transactions. Money measurement – the accounting system uses money as the common denominator in recording and reporting all business transactions; thus the loyalty of a firm's workforce or the quality of a product cannot be recorded because these cannot be reported in money terms. assets – items owned by a business; liabilities – items owed by a business purchases – goods bought, whether on credit or for cash, which are intended to be resold later; sales – the sale of goods, whether on credit or for cash, in which the business trades 20-1 23 Feb 1 £ 2,000 £ 750 £ 425 380 £ 20-1 trade receivables – individuals or businesses who owe money in respect of goods or services supplied by the business; trade payables – individuals or businesses to whom money is owed by the business credit purchases – goods bought, with payment to be made at a later date; cash purchases – goods bought, with immediate payment made in cash, by cheque, debit card, credit card, or bank transfer asset of computer increases by £4,000 asset of bank decreases by £4,000 asset £8,000 – liability £0 = capital £8,000 20-1 20-1 6 Feb Other stakeholders – any four from • • 1.6 purchases of goods for resale to date asset of bank increases by £8,000 capital increases by £8,000 asset £8,000 – liability £0 = capital £8,000 CHAPTER 2 Double-entry book-keeping: first principles final accounts production of an income statement and a balance sheet • • 1.5 • double-entry accounts system transfer from subsidiary books into the double-entry book-keeping system of accounts in the ledger turnover (cash and credit sales) to date • • initial recording of transactions recording accounting transactions in subsidiary books (or books of prime entry) • • • documents processing of source documents relating to accounting transactions Information from the accounting system includes: • £ Bank £ 200 20-1 1 Feb Bank 20-1 £ 20-1 20-1 20 Feb 20-1 £ 7,500 £ 20-1 20-1 14 Feb Cr £ Bank £ 145 Cr £ Dr 20-1 28 Feb 2.3 Dr 20-5 1 Aug 15 Aug 20 Aug 25 Aug Bank Van Account £ 20-1 6,000 Cr £ Capital S Orton: loan Office fittings Commission received Bank Account £ 20-5 5,000 3 Aug 1,000 7 Aug 250 12 Aug 150 27 Aug Computer Rent paid Office fittings S Orton: loan Cr £ 1,800 100 2,000 150 Bank Cr £ 5,000 Capital Account £ 20-5 1 Aug Dr 20-5 Dr 20-5 3 Aug Dr 20-5 7 Aug Dr 20-5 12 Aug Dr 20-5 27 Aug Dr 20-5 17 Aug Dr 20-7 1 Nov 7 Nov 23 Nov 25 Nov 28 Nov Dr 20-7 3 Nov Dr Bank Bank Rent Paid Account £ 20-5 100 Cr £ 20-7 10 Nov Cr £ 200 150 20-7 12 Nov Commission received Cash Account £ 20-5 200 17 Aug Drawings Bank Cr £ 250 Bank Sally Orton: Loan Account £ 20-5 150 15 Aug Bank Cr £ 1,000 Cash Dr 20-7 14 Nov Cr £ 100 Office Fittings Account £ 20-5 2,000 20 Aug Bank Drawings Account £ 20-5 100 Dr Dr 20-7 15 Nov Bank Bank Bank Bank Commission received 20-7 1 Nov Photocopier Office premises Business rates Office fittings Wages Bank Bank £ 75,000 Cr £ 20-7 7 Nov Bank £ £ 70,000 Office Premises Account Cr Rates Account Cr Office Fittings Account Cr £ 130,000 20-7 £ 3,000 20-7 £ 1,500 20-7 25 Nov Bank £ 200 £ 300 20-7 18 Nov 23 Nov Drawings Bank £ 125 100 20-7 15 Nov 28 Nov Cash Bank £ 300 200 Cash Account £ 125 20-7 £ 250 20-7 Wages Account £ £ Drawings Account Dr Cr Bank Loan Account 20-7 Dr 20-7 20 Nov £ 2,500 130,000 3,000 1,500 250 Cr £ 2,500 £ Cash Cr Photocopier Account Commission Income Account 20-7 18 Nov 2 20-7 3 Nov 10 Nov 12 Nov 14 Nov 20 Nov Dr 20-7 Cr £ £ 75,000 70,000 100 200 200 £ 20-7 Dr Bank Account Capital Account Dr Cr £ Commission Income Account £ 20-5 10 Aug Cash 25 Aug Bank Capital Bank loan Cash Office fittings Commission received 20-7 Computer Account £ 20-5 1,800 Dr 20-5 Dr 20-5 10 Aug 2.5 Cr Cr Cr £ Cr £ 2.6 2.7 20-7 1 Nov 3 Nov 7 Nov 10 Nov 12 Nov 14 Nov 20 Nov 23 Nov 25 Nov 28 Nov Bank Account Capital Photocopier Bank loan Office premises Rates Office fittings Wages Cash Office fittings Commission received Debit £ 75,000 70,000 100 200 200 2,500 130,000 3,000 1,500 250 Balance £ 75,000 72,500 142,500 12,500 9,500 8,000 7,750 7,850 8,050 8,250 Dr 20-2 1 Oct 4 Oct 8 Oct 12 Oct 18 Oct 30 Oct Dr 20-2 Dr 20-2 2 Oct 6 Oct 14 Oct Dr 20-2 Capital Sales Sales K Smithson: loan Sales Sales Bank Bank Bank Bank Account £ 20-2 2,500 2 Oct 150 6 Oct 125 14 Oct 2,000 22 Oct 155 25 Oct 110 Dr Dr Dr Dr Dr Dr Dr Dr Dr Dr Capital Account £ 20-2 1 Oct Purchases Account £ 20-2 200 90 250 Sales Account £ 20-2 4 Oct 8 Oct 18 Oct 30 Oct Purchases Purchases Purchases Delivery van Wages Cr £ 200 90 250 4,000 375 Bank Cr £ 2,500 Dr 20-2 22 Oct Dr 20-2 25 Oct Bank Bank Bank Bank 3.5 Dr 20-2 2 Apr 4 Apr Dr 20-2 9 Apr 20 Apr Dr 20-2 26 Apr Dr 20-2 5 Apr Dr 20-2 7 Apr 12 Apr 22 Apr Dr 20-2 3 Cr £ 2,000 Bank Delivery Van Account £ 20-2 4,000 Bank Wages Account £ 20-2 375 Cr £ Purchases Account £ 20-2 200 250 Cr £ Wyvern Producers Ltd A Larsen Purchases returns Bank Purchases returns Wyvern Producers Ltd £ 20-2 50 2 Apr Purchases 150 £ 45 A Larsen 20-2 4 Apr Sales Account £ 20-2 5 Apr 7 Apr 12 Apr 28 Apr Dr 20-2 Cr £ Cr £ 150 125 155 110 J Smithson: Loan Account £ 20-2 12 Oct Bank Dr 20-2 Guidance to the trainee to include: • the use of accounts to record different types of transactions • the principles of double-entry book-keeping whereby one account is debited and one account is credited for every business transaction • the debit entry is made in the account which gains value, or records an asset, or an expense • the credit entry is made in the account which gives value, or records a liability, or an income item • examples can be given using bank account where money in is recorded on the debit side, and money out is recorded on the credit side • an explanation of various accounts including – capital – the amount of money invested in the business by the owner – non-current assets – items purchased by a business for use on a long-term basis (noting the distinction between capital expenditure and revenue expenditure) – expenses – the day-to-day running expenses (revenue expenditure) of the business – income – amounts of income received by the business – owner’s drawings – where the owner takes money in cash or by cheque (or sometimes goods) from the business for personal use – loans – where a business receives a loan, eg from a relative or the bank CHAPTER 3 Double-entry book-keeping: further transactions 3.1 Credit £ Sales Sales Sales Pershore Patisserie Cr £ 200 Purchases Cr £ 250 Pershore Patisserie Bank Bank Cash Cr £ 150 175 110 100 Pershore Patisserie £ 20-2 150 15 Apr Sales returns 22 Apr Bank Bank Account £ 20-2 175 20 Apr 110 30 Apr 125 Cr £ Cr £ 25 125 Wyvern Producers Ltd Amery Scales Ltd Cr £ 150 250 Purchases Returns Account £ 20-2 9 Apr Wyvern Producers Ltd 26 Apr A Larsen Cr £ 50 45 Dr 20-2 15 Apr Dr 20-2 17 Apr Dr 20-2 30 Apr Dr 20-2 28 Apr Dr 20-2 29 Apr 3.6 Dr 20-3 2 Jun 7 Jun 23 Jun Dr 20-3 6 Jun 18 Jun Pershore Patisserie Amery Scales Ltd Dr 20-3 5 Jun 20 Jun Cr £ Weighing Machine Account £ 20-2 250 Cr £ Bank Amery Scales Ltd £ 20-2 250 17 Apr Weighing machine Sales Cash Account £ 20-2 100 29 Apr Cash Wages Account £ 20-2 90 Cr £ Purchases Account £ 20-3 350 400 285 Cr £ Designs Ltd Mercia Knitwear Ltd Designs Ltd Purchases returns Bank Designs Ltd £ 20-3 100 2 Jun 250 23 Jun Sales Account £ 20-3 4 Jun 5 Jun 10 Jun 12 Jun 20 Jun Dr 20-3 Dr 20-3 4 Jun 12 Jun 28 Jun Sales Returns Account £ 20-2 25 Sales Sales Wyvern Trade Supplies Sales Sales Bank Account £ 20-3 220 18 Jun 175 300 Cash Account £ 20-3 115 26 Jun 180 Wages Dr 20-3 17 Jun Cr £ 250 Dr 20-3 10 Jun Cr £ 90 Purchases Purchases Cr £ 350 285 Bank Cash Wyvern Trade Supplies Bank Cash Cr £ 220 115 350 175 180 Designs Ltd Cr £ 250 Rent paid Cr £ 125 Purchases Returns Account £ 20-3 6 Jun Designs Ltd 17 Jun Mercia Knitwear Ltd Dr 20-3 Dr 20-3 15 Jun Dr 20-3 26 Jun 3.7 3.8 Sales Wyvern Trade Supplies Cash Transaction (a) (b) (c) (d) (e) (f) (g) (h) Mercia Knitwear Ltd £ 20-3 80 7 Jun Purchases Cr £ 400 Wyvern Trade Supplies £ 20-3 350 15 Jun Sales returns 28 Jun Bank Cr £ 50 300 Sales Returns Account £ 20-3 50 Cr £ Rent Paid Account £ 20-3 125 Cr £ Account debited purchases bank purchases L Harris Teme Traders sales returns bank cash Account credited bank sales Teme Traders sales purchases returns L Harris D Perkins: loan bank Answers to the trainee: • Separate accounts for purchases and sales enable the business to know the amount of goods bought and sold. A combined account for ‘goods’ would not provide this information so readily. • The purchase of a new delivery van for use in the business is the purchase of a non-current asset, which will be used on a long-term basis. As such the purchase of the van – which is an example of capital expenditure – is entered on the debit side of van account. • • • 4 Purchases returns Cr £ 100 80 Purchases and sales accounts follow the principles of book-keeping in that the debit side of purchases account gains value when the business buys goods for resale, while the credit side of sales account gives value when the business sells goods. Purchases returns (or returns out) is where we return goods to a trade payable (supplier). The returns transaction is recorded the opposite way round to a purchases transaction. Sales returns (or returns in) is where a trade receivable (customer) returns goods to us. The transaction is recorded the opposite way round to a sales transaction. Carriage inwards and carriage outwards are kept in separate accounts because they represent different transactions. Carriage inwards is where we pay the carriage cost of goods purchased to have them delivered to us. Carriage outwards is where we pay the carriage charge for goods we have sold, that is we have sold the goods to our customers as ‘delivery free’. 4.3 CHAPTER 4 Business documents 4.2 INVOICE INVOICE DEANSWAY TRADING COMPANY JANE SMITH, FASHION WHOLESALER The Model Office, Deansway, Rowcester, RW1 2EJ Unit 21, Eastern Industrial Estate, Wyvern, Wyvernshire, WY1 3XJ invoice to Excel Fashions 49 Highland Street Longton Mercia LT3 2XL deliver to as above product code description Dresses Suits Coats quantity 5 3 4 terms 2.5% cash discount for full settlement within 14 days Net 30 days invoice no account your reference 2451 date today unit price £ 30.00 45.50 51.50 unit total each each each £ 150.00 136.50 206.00 TOTAL trade discount % invoice to The Card Shop 126 The Cornbow Teamington Spa Wyvernshire WY33 0EG deliver to as above product code net £ Assorted rubbers Shorthand notebooks Ring Binders 0.00 150.00 0.00 136.50 0.00 206.00 quantity 5 100 250 terms 2.5% cash discount for full settlement within 14 days Net 30 days 492.50 Excel Fashions will pay £480.18 (£492.50 x 97.5%, rounded down) for settlement in full within 14 days. description 5 invoice no account your reference 8234 date today unit price £ 5.00 4.00 0.50 unit box 10 each total trade discount % net 25.00 40.00 125.00 0.00 0.00 0.00 25.00 40.00 125.00 £ TOTAL The Card Shop will pay £185.25 (£190.00 x 97.5%) for settlement in full within 14 days. 190.00 £ 4.4 Dr 20-4 2 Feb 16 Feb G Lewis G Lewis Sales Account £ 20-4 4 Feb 7 Feb Dr 20-4 Dr 20-4 10 Feb 10 Feb 24 Feb 24 Feb Dr 20-4 4 Feb Dr 20-4 7 Feb Dr 20-4 12 Feb 20 Feb Bank Discount received Bank Discount received Sales Sales L Jarvis G Patel 20-4 12 Feb 20 Feb £ 190 10 152 8 360 £ 150 150 £ 240 240 G Lewis 20-4 2 Feb 16 Feb L Jarvis G Patel Purchases Purchases £ L Jarvis G Patel L Jarvis 20-4 12 Feb 12 Feb G Patel 20-4 20 Feb 20 Feb 20-4 10 Feb 24 Feb Bank Discount allowed Bank Discount allowed G Lewis G Lewis 20-4 10 Feb 24 Feb G Lewis G Lewis Discount Allowed Account £ 3 6 Cr £ 150 240 20-4 (a) product code description quantity 45B Trend tops (black) 30 35W Cr £ 200 160 360 Bank Account £ 147 234 4.5 Cr £ Discount Received Account Dr 20-4 Dr Purchases Account £ 20-4 200 160 Trend trousers (white) 20 unit price unit 12.50 each £ 25.00 terms 5% cash discount for full settlement within 7 days Net 30 days Cr £ 147 3 150 (b) £ 234 6 240 trade net discount % 375.00 10 £ each 500.00 TOTAL £ 10 337.50 450.00 787.50 Trade discount is given, if prearranged: – to businesses, often in the same trade (but not to the general public) – by wholesalers, as a discount off list price to retailers – Cr total for buying in bulk (this discount is also known as bulk discount) Cash discount (also known as settlement discount) is given, for prompt payment, if prearranged, and indicated on the invoice Cr £ 190 152 4.7 Cr (c) Fashion Shop will pay £748.12 (£787.50 x 95%, rounded down) for settlement in full within 7 days. (a) A source document is used to update the book-keeping records. (b) (i) (ii) £ 10 8 An invoice is a source document prepared by the seller and states the value of goods sold and, hence, the amount to be paid by the buyer. A credit note is a source document which shows that the buyer is entitled to a reduction in the amount charged by the seller; it is used if: – – Cr (c) £ the price charged on the invoice was too high Any three from: – cheque counterfoils – cash receipts – – 6 some of the goods delivered were faulty, or incorrectly supplied – paying-in slip counterfoils till rolls information from bank statements, such as standing orders, direct debits, BACS, credit transfers, bank charges 4.8 (a) • • • • • • 5 computer desks were ordered (not 10 as shown on the invoice) CHAPTER 5 Balancing accounts – the trial balance 10 office chairs were ordered (not 5 as shown on the invoice) 5.1 (a) and (c) the unit price of the computer desks is £65.00 each (not £70.00 as shown on the invoice) Dr 20-9 1 Jan 11 Jan 12 Jan 22 Jan the net amount for computer desks is £292.50 (not £350.00 as shown on the invoice) the net amount for office chairs is £180.00 (not £20.00 as shown on the invoice) the invoice total is £472.50 (not £370.00 as shown on the invoice) (b) 1 Feb 4 Feb 10 Feb 12 Feb 19 Feb 25 Feb 1 Mar Capital Sales Sales Sales Balance b/d Sales Sales Rowcester College Sales Sales Balance b/d Capital Account £ 20-9 1 Jan Dr 20-9 Dr 20-9 4 Jan 2 Feb 1 Mar Dr 20-9 5 Jan 15 Feb 1 Mar (c) Wyvern Products Limited will pay £448.87 (£472.50 x 95%) for settlement in full within 14 days. 7 Rent paid Shop fittings Comp Supplies Ltd Balance c/d Rent paid Shop fittings Comp Supplies Ltd Balance c/d Cr £ 500 1,500 5,000 6,700 13,700 500 850 6,350 5,300 13,000 Bank Cr £ 10,000 Bank Bank Rent Paid Account £ 20-9 500 28 Feb Balance c/d 500 1,000 1,000 Cr £ 1,000 Bank Bank Shop Fittings Account £ 20-9 1,500 28 Feb Balance c/d 850 2,350 2,350 Cr £ 2,350 Purchases Account £ 20-9 5,000 31 Jan Balance c/d 6,500 11,500 Cr £ 11,500 Balance b/d Balance b/d Dr 20-9 7 Jan 25 Jan Comp Supplies Ltd Comp Supplies Ltd 1 Feb 24 Feb Balance b/d Comp Supplies Ltd 1 Mar Bank Account £ 20-9 10,000 4 Jan 1,000 5 Jan 1,250 20 Jan 1,450 31 Jan 13,700 6,700 2 Feb 1,550 15 Feb 1,300 27 Feb 750 28 Feb 1,600 1,100 13,000 5,300 Balance b/d 11,500 5,500 17,000 17,000 28 Feb Balance c/d 1,000 2,350 11,500 17,000 17,000 Dr 20-9 20 Jan 31 Jan 5 Feb 27 Feb 28 Feb Dr 20-9 31 Jan 28 Feb Bank Balance c/d Purchases returns Bank Balance c/d Balance c/d Balance c/d Dr 20-9 16 Jan Sales 1 Feb 26 Feb Balance b/d Sales 1 Mar Dr 20-9 27 Jan Dr 20-9 Balance b/d Rowcester College Comp Supplies Limited £ 20-9 5,000 7 Jan Purchases 6,500 25 Jan Purchases 11,500 150 1 Feb Balance b/d 6,350 24 Feb Purchases 5,500 12,000 1 Mar Balance b/d Sales Account £ 20-9 4,550 11 Jan 12 Jan 16 Jan 22 Jan 4,550 11,150 1 Feb 4 Feb 10 Feb 19 Feb 25 Feb 26 Feb 11,150 1 Mar Bank Bank Rowcester College Bank Balance b/d Bank Bank Bank Bank Rowcester College Balance b/d Rowcester College £ 20-9 850 27 Jan Sales returns 31 Jan Balance c/d 850 750 1,050 1,800 1,050 12 Feb 28 Feb Bank Balance c/d Sales Returns Account £ 20-9 100 Purchases Returns Account £ 20-9 5 Feb Comp Supplies Ltd Cr £ 5,000 6,500 11,500 6,500 5,500 (b) 12,000 5,500 Cr £ 1,000 1,250 850 1,450 4,550 4,550 1,550 1,300 1,600 1,100 1,050 11,150 11,150 (d) Cr £ 100 750 850 5.2 Name of Account Bank Capital Rent paid Shop fittings Purchases Comp Supplies Limited Sales Rowcester College Sales returns Name of Account Bank Capital Rent paid Shop fittings Purchases Comp Supplies Limited Sales Rowcester College Sales returns Purchases returns Cr £ Cr £ 150 8 Dr £ 6,700 500 1,500 11,500 750 100 Trial balance as at 28 February 20-9 Cr £ 10,000 6,500 4,550 21,050 21,050 Dr £ 5,300 Cr £ 1,000 2,350 17,000 1,050 100 26,800 Trial balance of Jane Greenwell as at 28 February 20-1 Dr £ Name of account Bank Purchases Cash Sales Purchases returns Trade payables Equipment Van Sales returns Trade receivables Wages Capital (missing figure) 750 1,050 1,800 Trial balance as at 31 January 20-9 850 48 2,704 3,200 90 1,174 1,500 9,566 10,000 5,500 11,150 150 26,800 Cr £ 1,250 730 144 1,442 6,000 9,566 5.5 Four from: • • • • • • Error of omission (a) Date 20-2 1 Feb 2 Feb 15 Feb 19 Feb 28 Feb Date 20-2 8 Feb 14 Feb 18 Feb Softseat Ltd Dr Business transaction completely omitted from the accounting records. For example, cash sale omitted from both cash account and sales account. 20-2 Reversal of entries £ Debit and credit entries on the wrong side of the two accounts concerned. For example, cash sale entered wrongly as debit sales account, credit cash account. Mispost/error of commission Transaction entered to the wrong person's account. For example, a sale of goods on credit to A T Hughes has been entered as debit A J Hughes' account, credit sales account. Dr Error of principle 20-2 Transaction entered in the wrong type of account. For example, cost of petrol for vehicles has been entered as debit motor vehicles account, credit bank account. Error of original entry (or transcription) Amount entered incorrectly in both accounts. For example, sale of £45 entered in both sales account and the trade receivable's account as £54. Two errors cancel each other out. For example, balance of purchases account calculated wrongly at £10 too much, compensated by the same error in sales account. Details Invoice Softseat Ltd PRK Ltd Softseat Ltd High Street Stores Peter Lounds Ltd Carpminster College 25 Feb High Street Stores 28 Feb Total for month £ 320 529 160 80 984 Total for month Amount 961 068 Quality Furnishings Details Reference £ Sales Sales Dr 160 20-2 14 Feb 720 Sales Dr Sales Day Book Invoice 001 002 003 004 Reference 20-2 18 Feb Amount Sales £ 440 120 20-2 28 Feb 200 1,080 Dr 9 20-2 Purchases Purchases PRK Ltd 20-2 2 Feb 20-2 15 Feb Purchases Day Book £ 320 160 Cr Purchases £ 80 Cr Purchases £ 160 High Street Stores Cr Peter Lounds Ltd Cr Carpminster College Cr £ 440 200 £ 120 £ 320 20-2 £ 20-2 £ 20-2 GENERAL LEDGER Dr 320 Cr SALES LEDGER Dr 20-2 8 Feb 25 Feb 20-2 1 Feb 19 Feb Quality Furnishings 20-2 Compensating error Purchases Day Book £ Dr CHAPTER 6 Division of the ledger – the use of subsidiary books 6.2 PURCHASES LEDGER £ Purchases Account Cr Sales Account Cr £ 720 £ 20-2 20-2 28 Feb £ Sales Day Book £ 1,080 6.3 (a) Date 20-2 2 May 4 May 10 May 18 May 21 May 25 May 31 May Date 20-2 18 May 23 May 28 May 31 May Details Purchases Day Book Invoice Reference Amount 562 PL 302 190 M Roper & Sons Wyper Ltd 82 Wyper Ltd M Roper & Sons 580 M Roper & Sons 589 Wyper Ltd PL 301 PL 302 91 Total for month Details PL 301 86 Purchases Returns Day Book PL 301 PL 302 200 180 PL 302 30 M Roper & Sons 84 (b) and (c) Dr 20-2 23 May 31 May PURCHASES LEDGER Purchases Returns Balance c/d Wyper Ltd (account no 301) £ 20-2 40 1 May Balance b/d 710 4 May Purchases 10 May Purchases 21 May Purchases 750 1 Jun Dr 20-2 18 May 28 May 31 May Purchases Returns Purchases Returns Balance c/d 40 38 Cr Purchases Returns Account Cr £ 1,118.00 £ Purchases Day Book quantity details unit price unit X24 96 Trend tops £8.50 each each 20 Jeans £15 each Cr £ 100 200 210 240 750 Cr £ 85 190 180 98 553 20-2 31 May £ product Y36 M Roper & Sons (account no 302) £ 20-2 30 1 May Balance b/d 38 2 May Purchases 485 18 May Purchases 25 May Purchases 553 20-2 each trade discount 20% total terms 5% cash discount for full settlement within 7 days Net 30 days 485 10 £ 108.00 (a) code 108 710 Balance b/d 6.5 £ Balance b/d 1 Jun Purchases Account 1,118.00 82 Total for month 20-2 98 M Roper & Sons PL 301 Purchases Day Book Dr 240 Amount PL 302 20-2 31 May 210 Reference 6 Dr £ Credit Note Wyper Ltd GENERAL LEDGER total amount 816.00 300.00 1,116.00 223.20 892.80 (b) (c) (i) CHAPTER 7 The main cash book Purchases day book (ii) Sales day book (i) Trade discount: 7.3 Dr – given for bulk buying (also known as bulk discount), or for being in the trade, or for regular customers – deducted from the invoice before entry in the books – usually a larger percentage than cash discount (ii) Cash discount (also known as settlement discount): – given for prompt payment – not deducted until account is paid – can be disallowed if terms are not met – usually a smaller percentage than trade discount Date Details 20-7 1 Aug 1 Aug 11 Aug 12 Aug 21 Aug 29 Aug 29 Aug Balances b/d Wild & Sons Ltd Bank A Lewis Ltd Harvey & Sons Ltd Wild & Sons Ltd Bank Ref C C Disc allwd £ 20 15 Cash Cash Book Bank Date £ £ 276 4,928 398 500 1,755 261 595 275 6.8 Source Document Invoice for goods sold on credit to V Singh (a) Invoice received for Book Subsidiary be debited Account to Account to Sales day book V Singh Sales Purchases day Purchases Okaro Limited (b) Credit note issued to Sales returns Sales returns S Johnson (c) Credit note received Purchases returns Roper & Purchases from Okara Limited S Johnson from Roper & Company book day book day book Company 1 Sep Balances b/d be credited goods bought on credit 35 1,051 7,937 361 3,217 7.4 Dr Date 20-5 1 Mar 3 Mar 8 Mar 11 Mar 13 Mar 22 Mar 25 Mar 29 Mar 31 Mar 31 Mar returns * 11 Details Balances b/d Sales* Sales Bank Sales Bank Sales Sales* Hobbs Ltd Pratley & Co 1 Apr Balances b/d Ref Discount allowed £ C C 30 50 80 Cash 20-7 5 Aug 8 Aug 11 Aug 18 Aug 22 Aug 25 Aug 27 Aug 28 Aug 29 Aug 31 Aug Cash Book Bank Date £ £ 106 3,214 100 950 1,680 150 1,800 150 2,108 200 2,000 720 1,160 706 13,632 423 8,259 20-5 2 Mar 5 Mar 9 Mar 11 Mar 16 Mar 18 Mar 20 Mar 22 Mar 26 Mar 27 Mar 30 Mar 31 Mar 31 Mar 31 Mar Details T Hall Ltd Wages Cash F Jarvis Wages J Jones Salaries Telephone Cash Balances c/d Ref Disc recd £ 24 C 33 C 57 Cr Cash Bank £ £ 541 254 436 361 1,051 500 457 628 2,043 276 275 3,217 7,937 Cr Ref Discount Cash Bank received £ £ £ Rent 10674 250 Cleaning expenses 35 Purchases 10675 1,200 Cash 10676 C 150 Postages 50 Telephone 10677 168 Stationery 128 Cash 10678 C 150 Misc expenses 70 Wages 10679 2,000 Electricity 10680 106 Evans & Co 10681 45 855 A Bennett 10682 26 494 Balances c/d 423 8,259 71 706 13,632 Details An alternative way of showing the transactions of 3 March and 29 March is to record the full amount of sales in the debit cash column, and then to show the amount banked as a separate transfer, ie debit bank, credit cash. 7.6 Standing order Money paid out of the bank directly, at regular intervals, on the business’s order. Usually for the same fixed amount for goods and services supplied (i) DR Supplier/Trade payable DR Bank Dr CR Bank CR Customer/Trade receivable (a) and (b) Date 20-6 8.2 Credit transfer for payment by a customer Amounts paid directly into the bank by a trade receivable, who has the necessary bank code information. (ii) 7.8 CHAPTER 8 Bank reconciliation statements Details Disc £ 1 Jan Balance b/d 6 Jan R Reed 13 Jan B Brown 4 14 Jan Sales 28 Jan Sales 50 752 642 24 Jan C Denton & Co Ltd C/T 31 Jan Cash Cash £ C Bank £ 567 366 248 1,319 4 1 Feb Balance b/d Cash Book 1,444 50 2,500 Date 20-6 Details Disc £ 1 Jan Balance b/d 2 Jan Bilton Office Supplies 11 Jan Rent 27 Jan Wages 20 Jan British Gas S/O 31 Jan Bank C 21 Jan Bank interest 31 Jan Balances c/d Cash £ 3 1,319 3 50 1,444 Bank £ 20-6 31 Jan Dr 20-6 Cash book £ 4 20-6 Discounts Received Account £ 20-6 31 Jan Cash book P GERRARD BANK RECONCILIATION STATEMENT AS AT 31 JANUARY 20-7 £ Balance at bank as per cash book Add: unpresented cheques 1,236 Bryant & Sons P Reid 450 cheque no. 001354 176.50 422 8.3 Cr £ (a) Dr 20-7 1 May 7 May 16 May 23 May 30 May Balance b/d Cash C Brewster Cash Cash 1 Jun Balance b/d 1,076.45 Cash Book (bank columns) £ 300 162 89 60 40 651 20-7 2 May 14 May 29 May 16 May 31 May 31 May P Stone 867714 Alpha Ltd 867715 E Deakin 867716 Standing order: A-Z Insurance Bank charges Balance c/d 428 JANE DOYLE (b) BANK RECONCILIATION STATEMENT AS AT 31 MAY 20-7 Balance at bank as per cash book Add: Cr £ 3 Less: 12 488.50 335.75 Balance at bank as per cash book 2,500 £ 923.70 1,412.20 G Shotton Limited 28 Cr £ p 207.95 923.70 1,131.65 312.00 cheque no. 001355 Less: outstanding lodgement 200 422 Discounts Allowed Account Cash Book (bank columns) £ p 20-7 Balance b/d 415.15 23 Jan Direct debit: Omni Finance BACS credit: T K Supplies 716.50 31 Jan Balance c/d 1,131.65 Balance b/d 923.70 (b) Cr (c) Dr Dr 20-7 1 Jan 13 Jan 1 Feb 164 75 (a) unpresented cheque E Deakin cheque no. 867716 outstanding lodgement cash banked Balance at bank as per bank statement £ 428 110 538 40 498 Cr £ 28 50 110 25 10 428 651 8.5 (a) (i) (ii) (iii) 8.7 Standing orders Credit Regular payments of the same amount made directly from the bank on behalf of the company on the order of the company. Dr Date 2003 Direct debits Credit Payments made from the bank for the customer collected by the payee on the order of the customer usually for changing amounts. Debit or Credit Credit transfer Balance c/d Cash Book – Bank Account £ 540 Balance b/d 534 Standing order Direct debit Bank charges 1,074 Balance b/d 2,459.35 5 Nov B J Patel 3,219.00 √ 234.00 √ 1,142.00 √ 560.00 √ 26 Nov Cash banked 340.00 7,954.35 30 Nov Balance b/d 9 Nov J Black Ltd C/T 534 2,027.23 246.98 2,274.21 1 Dec Balance b/d (c) Date 2003 1 Nov Balance b/d 23 Nov J A Smith Ltd Cr £ 378 230 420 46 1,074 Cash Book Bank £ p 5 Nov Dolls and Things Receipts from customers paid directly into the bank of the payee. Payments to suppliers or wages into the bank of the payee. Dr Details 3 Nov Toys for You Credit transfers (b) (a) 1 Nov 1 Nov 10 Nov 12 Nov 23 Nov 25 Nov 25 Nov 30 Nov 12 Nov 18 Nov 23 Nov 30 Nov Details Cheque number Banks Ltd 11346 Books & Paints Wages Jones and Son HGF Finance Business rates Bank charges 11349 3,781.95 11351 11352 Balance c/d Proper Ins Co 276.89 11350 Toy Designs 134.37 11347 11348 Smith and Son Bank £ p 92.50 139.43 256.00 Cr √ √ √ √ √ 1,245.98 2,027.23 7,954.35 S/O 547.90 S/O 145.65 45.89 Balance c/d 1,534.77 2,274.21 1,534.77 A SMITH AND CO BANK RECONCILIATION STATEMENT AS AT 31 MARCH 2001 Balance at bank as per cash book Add: Less: £ unpresented cheques outstanding lodgement (uncleared bankings) cheque query Balance at bank as per bank statement Tutorial note: brackets indicate an overdraft £ (534) (b) 469 270 265 (65) JAMES JOLLY AND CO BANK RECONCILIATION STATEMENT AS AT 30 NOVEMBER 2003 £ Balance at bank as per cash book Add: 535 (600) unpresented cheques HGF Finance Toy Designs Less: 11351 11352 outstanding lodgement cash banked Balance at bank as per bank statement 13 £ 1,534.77 256.00 1,245.98 1,501.98 3,036.75 340.00 2,696.75 CHAPTER 9 Introduction to final accounts 9.2 TRIAL BALANCE (a) Salaries √ (b) Purchases √ (d) Sales returns √ (f) Vehicle √ (c) Trade receivables (e) Discount received 9.5 Debit (g) Capital Credit INCOME FINAL ACCOUNTS STATEMENT Debit √ Credit √ √ √ √ 9.7 Debit Credit √ √ BALANCE SHEET AS AT 31 DECEMBER 20-4 £ £ Current Assets Inventory Trade receivables Less Current Liabilities Trade payables Bank overdraft Net Current Assets or Working Capital NET ASSETS FINANCED BY Capital Opening capital Add Profit for the year Less Drawings 13,735 32,335 5,820 √ (ii) (b) 9.9 9,820 5,500 15,320 (a) Dr 2002 31 Mar 31 Mar Dr 2001 Details Balance b/d Monthly total 2001 1 Dec 31 Dec Details Balance b/d Monthly total Dr 2001 14 Details 2001 1 Dec 31 Dec Dr 14,375 29,695 Capital Account £ 2002 12,500 31 Mar 48,341 31 Mar 60,841 1 Apr Two from: – increased by profit – more capital introduced – reduced by losses – reduced by drawings Dr 18,600 Details Drawings Balance c/d Details £ 56,231 350 56,581 23,980 3,600 4,500 450 Profit for the year £ 25,250 17,756 43,006 13,311 29,695 £ Less expenses: Wages Carriage outwards Motor expenses Bank charges 12,140 17,960 INCOME STATEMENT FOR THE YEAR ENDED 31 MARCH 2002 Gross profit Add Discount received √ √ R MASTERS (i) BALANCE SHEET CLARE LEWIS INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20-4 £ £ Revenue 144,810 Opening inventory 16,010 Purchases 96,318 112,328 Less Closing inventory 13,735 Cost of sales 98,593 Gross profit 46,217 Less expenses: Salaries 18,465 Heating and lighting 1,820 Rent and rates 5,647 Sundry expenses 845 Vehicle expenses 1,684 28,461 Profit for the year 17,756 Non-current Assets Vehicles Office equipment (a) Sales Account £ p 2001 1 Dec 31 Dec Returns Inwards Account £ p 1,269.43 236.91 2001 £ p 10,276.41 2,769.56 2001 Purchases Account Returns Outwards Account £ p 2001 1 Dec 31 Dec 32,530 24,051 Details Balance b/d Profit for the year Balance b/d Details Balance b/d Monthly total Cr £ 36,790 24,051 60,841 48,341 Cr £ p 16,493.27 4,560.30 Details £ Details £ Details Balance b/d Monthly total Cr p Cr p Cr £ p 1,039.41 127.50 AMARYLLIS TRADING (b) INCOME STATEMENT FOR THE THREE MONTHS ENDED 31 DECEMBER 2001 £ Revenue Less Returns inwards Less Cost of sales: Opening inventory Add Purchases Less Returns out 13,045.97 1,166.91 Add Carriage in Less Closing inventory Gross profit (c) 9.10 (i) (ii) (iii) Cost of sales Goods available for sale Net revenue Date Today £ 2,560.87 11,879.06 871.26 15,311.19 2,640.96 Subject Balance sheet queries 1. Reason: 4. 12,670.23 6,877.00 Date Details 31 Dec Inventory 20-8 Capital/Financed by/Represented by It is cash or goods taken out of the business by the owner, therefore it reduces the capital invested in the business. Income statement Inventory valuation at 31 December 20-8 transferred to income statement Financial Accounting Student Reference GL GL Dr £ 22,600 Cr £ 22,600 (b) Non-current assets Date Details 31 Dec Income statement 20-8 An asset purchased for use in the business – not for resale Telephone expenses Transfer to income statement of expenditure for the year – is a tangible asset Reference GL GL Dr £ 890 Cr £ 890 (c) Inventory of dolls for resale Current assets Date Details 31 Dec Drawings 20-8 An asset remaining in the business for the short-term – less than one year – the business is expected to sell them shortly Section: (a) – will help generate profits Reason: – an amount owed by the business CHAPTER 10 The general journal and correction of errors 10.2 – will depreciate with use Section: Short-term liability Drawings for the year Reason: – used over a long period/more than one year 2. Current liabilities Tutorial note: the accounting treatment for a bill which has not been paid at the balance sheet date – called an accrual of expenses – is covered in detail in Chapter 12 Cost of new delivery van Section: Section: – which needs to be paid within the next 12 months MEMORANDUM Mary Arbuthnot, proprietor of Mary’s Doll Shop Telephone bill due to be paid in one month’s time Reason: £12,670.23 £15,311.19 £19,547.23 To From 3. £ 21,053.57 1,506.34 19,547.23 Motoring expenses Transfer of private motoring to drawings account continued 15 Reference GL GL Dr £ 200 Cr £ 200 (d) (c) Date Details 31 Dec Drawings 20-8 Purchases Goods taken for own use by the owner Reference GL GL Dr £ 175 Cr Date £ Date 31 Dec Details Bad debts written off N Marshall Account of N Marshall written off as a 175 Vehicle expenses Correction of error – vehicle no ............ (a) Date Reference GL SL Dr £ 125 Cr (d) £ Date 125 J Rigby Sales Sales invoice no ............. omitted from Date H Price Limited H Prince Correction of mispost – cheque no .....: GL £ 10,000 Reference SL GL Dr £ 150 (e) Cr £ Date 150 £ GL 55 Postages GL 55 GL GL on ................... Reference Dr Postages Correction of reversal of entries Cr £ 10,000 Cr £ 55 55 110 110 Dr Cr compensating error Details Purchases Purchases returns Correction of under-cast on purchases Reference GL GL £ 100 £ 100 account and purchases returns account on .......(date)....... (f) mispost/error of commission Details Details Bank the accounts. (b) GL Dr reversal of entries Bank error of omission Details Reference invoice no ............... bad debt - see memo dated ................... 10.4 Details Delivery van (e) 20-8 error of principle Reference PL PL Dr £ 125 Date Cr £ error of original entry Details L Johnson 125 16 GL 89 L Johnson SL received on ....(date).... £ 98 GL Correction of error – cheque for £89 Dr SL Bank Bank to H Price Limited Reference 187 Cr £ 98 89 187 10.6 (a) (b) Two from: trial balance – – bank reconciliation statement control accounts (see Chapter 11) – (c) An error of principle has occurred. JOURNAL Account Dr £ (1) Sales 270 (2) Returns inwards 500 Returns inwards 300 Suspense 400 Suspense Suspense Suspense (3) (4) Yes Error Discount received J Jones 350 A Jones The sales account has been totalled incorrectly. Cr 3 An invoice has been completely omitted from the books. £ A cheque has been debited in the cash book as £150 but credited in the customer’s account as £105. 270 500 10.10 300 (a) Dr Date 2004 30 Apr 400 Details Balance per T/B Suspense Account £ 450 450 Date 2004 30 Apr 30 Apr No 3 3 3 Details Sales Rent paid Cr £ 200 250 450 350 Tutorial note: The mispost between J Jones and A Jones needs to be corrected in the sales ledger, 10.8 (a) and (b) but has no effect on suspense account. Account H G PATEL: TRIAL BALANCE AS AT 30 APRIL 2003 Wages Administration costs Capital Property Motor vehicles Motor expenses Purchases Revenue (Sales) Returns outwards Carriage inwards Carriage outwards Discount received Drawings Suspense TOTAL Dr £ 23,890 6,000 65,000 5,000 1,650 38,900 367 450 6,900 15,676 163,833 Tutorial notes: • Cr £ • Error (2) is an error of original entry which affects both the debit and credit side of the trial balance by the same amount, and will not be revealed by the trial balance. Such an error is not entered in the suspense account. Error (3) has been entered in the suspense account, above, as the net amount of £250 (ie £650 – £400); as an alternative, it could have been entered as – 60,000 – (b) 98,000 3,698 (c) 163,833 17 credit £650 (to enter the correct amount in rent paid account) Error of commission (or mispost): • • 2,135 debit £400 (to take out the old amount in rent paid account) example – payment to A Brown entered to B Brown’s account explanation – although the entry has been misposted to the wrong person’s account, the trial balance will still balance because the entry has been made on the correct side of the account. Sales ledger control account (see Chapter 11) 10.11 Jonathon Smith Corrected Profit for the year ended 30 November 2004 1. Profit calculated by Jonathon Sales undercast 2. Discount allowed (2 x £140) 4. Non-current asset 6. Closing inventory (reduction in cost of sales) 3. 5. Wages Error of commission – no effect on profit Corrected profit CHAPTER 11 Control accounts 11.3 (a) Dr 20-8 1 Feb 3 Feb Balance b/d Sales 1 Mar Balance b/d Dr 20-8 1 Feb Dr 20-8 1 Feb 3 Feb Balance b/d Balance b/d Sales Dr 20-8 1 Feb 17 Feb Balance b/d Sales 1 Mar Balance b/d Dr 20-8 1 Feb 17 Feb Balance b/d Sales 1 Mar Balance b/d add 20-8 £ 1 Feb 26,790 28 Feb 450 less 280 less Balances b/d Credit sales £ p 2,012.43 1,288.76 3,301.19 34,060 338.59 1 Mar B Brick (Builders) Limited £ p 20-8 59.28 28 Feb Bad debts written off Cr £ p 59.28 Mereford Manufacturing Company £ p 20-8 293.49 24 Feb Sales returns 127.48 28 Feb Set-off: purchases ledger 420.97 Cr £ p 56.29 364.68 420.97 Redgrove Restorations £ p 20-8 724.86 7 Feb Sales returns 394.78 28 Feb Balance c/d 1,119.64 954.26 Wyvern Warehouse Limited £ p 20-8 108.40 15 Feb Bank 427.91 15 Feb Discount allowed 28 Feb Balance c/d 536.31 (c) Cr £ p 805.74 20.66 338.59 1,164.99 Balances b/d Sales returns 28 Feb Cash discount allowed 28 Feb Cr £ p 165.38 954.26 1,119.64 Dr 2001 1 Mar 31 Mar Set-off: purchases ledger Bad debts written off Balances c/d 221.67 911.43 23.37 364.68 59.28 1,720.76 3,301.19 Reconciliation of sales ledger control account with trade receivable balances Balance b/d Returns Set-off: sales ledger Discounts Cash paid Balance c/d Balance b/d Cr £ p 105.69 2.71 427.91 536.31 28 Feb Cheques received from trade receivables 1,720.76 1 February 20-8 £ p 826.40 59.28 293.49 724.86 108.40 2,012.43 Arrow Valley Retailers B Brick (Builders) Limited Mereford Manufacturing Company Redgrove Restorations Wyvern Warehouse Limited Sales ledger control account 11.5 Cr £ p 28 Feb 28 Feb 100 Arrow Valley Retailers £ p 20-8 826.40 20 Feb Bank 338.59 20 Feb Discount allowed 28 Feb Balance c/d 1,164.99 20-8 28 Feb 9,500 SALES LEDGER 427.91 Sales Ledger Control Account 2,500 add add (b) Dr Purchase Ledger Control Account £ 465 4,679 475 3,674 236,498 24,742 270,533 749 2001 1 Mar 31 Mar Balance b/d Purchases Cash refunds Balance c/d Balance b/d 28 February 20-8 £ p 338.59 – – 954.26 427.91 1,720.76 Cr £ 23,437 245,897 450 749 270,533 24,742 Tutorial note: The cash purchases figure of £25,679 is not shown in the control account because it does not involve the accounts of trade payables – it is a cash purchase (ie debit purchases; credit bank/cash) 18 11.6 Dr 20-5 1 Jan 31 Jan 31 Jan Balance b/d Sales Returned cheque 1 Feb Balance b/d Sales Ledger Control Account £ 44,359 27,632 275 72,266 20-5 31 Jan 31 Jan 31 Jan 31 Jan 31 Jan Bank Discount allowed Sales returns Set-off: purchases ledger Balance c/d 44,884 CHAPTER 12 Adjustments to final accounts Cr £ 23,045 1,126 2,964 247 44,884 72,266 12.1 12.2 Tutorial note: The mispost of £685 between J Hampton and Hampton Limited needs to be corrected in the sales ledger, but has no effect on the control account. 11.7 (a) Dr 2003 1 Nov 30 Nov 1 Dec Dr 2003 30 Nov 30 Nov 30 Nov 30 Nov (b) (c) • • Details Balance b/d Sales Balance b/d Details Returns outwards Bank (payments to suppliers) Set-off: sales ledger Balance c/d Sales Ledger Control Account £ 5,476 26,500 31,976 2003 Details 30 30 30 30 Nov Nov Nov Nov Returns inwards Bank (receipts from customers) Set-off: purchases ledger Balance c/d 12,086 Purchases Ledger Control Account £ 450 16,300 400 5,410 22,560 2003 Details 1 Nov Balance b/d 30 Nov Purchases 1 Dec Balance b/d £ £ • 12.7 2,960 19,600 The balances of the individual accounts of trade receivables in the sales ledger are totalled. Less expenses: Insurances Vehicle expenses Wages and salaries 86,060 + 3,180 Discount allowed Rates and insurance 6,070 – 450 General expenses Depreciation: vehicles 12,000 x 20% furniture and fittings 25,000 x 10% The balances of the individual accounts of trade payables in the purchases ledger are totalled. 19 70,000 280,000 350,000 60,000 9,700 3,100 1,820 36,050 13,750 HAZEL HARRIS INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20-4 £ Less Closing inventory Cost of sales Gross profit Add Discount received 5,410 A control account may indicate that there is an error within a ledger section but it will not pinpoint where the error has occurred. SOUTHTOWN SUPPLIES INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20-9 £ Revenue Opening inventory Purchases 22,560 Some types of errors (such as a mispost/error of commission) will not be revealed by the control account. Thus the accounts will be thought to be correct when they are not. Expense in income statement of £1,800; balance sheet shows computer rental prepaid (current asset) of £150. Expense in income statement of £2,852; balance sheet shows rates prepaid (current asset) of £713. Profit for the year Cr • (c) (b) Less Closing inventory Cost of sales Gross profit Less expenses: Rent and rates 10,250 – 550 Electricity Telephone Salaries 35,600 + 450 Vehicle expenses 590 18,900 400 12,086 31,976 These totals should agree with the balances of sales ledger control account and purchases ledger control account respectively. Expense in income statement of £56,760; balance sheet shows wages and salaries accrued (current liability) of £1,120. Revenue Opening inventory Purchases Cr • (a) Profit for the year 63,000 465,000 528,000 88,000 8,480 2,680 89,240 10,610 5,620 15,860 2,400 2,500 £ 420,000 290,000 130,000 64,420 65,580 £ 614,000 440,000 174,000 8,140 182,140 137,390 44,750 Non-current Assets Freehold land Vehicles Furniture and fittings Current Assets Inventory Trade receivables Prepayment of expenses BALANCE SHEET AS AT 31 DECEMBER 20-4 £ £ Cost Prov for dep'n 100,000 – 12,000 4,800 25,000 5,000 137,000 9,800 Less Current Liabilities Trade payables Accrual of expenses Bank 41,850 3,180 2,000 Net Current Assets or Working Capital 47,030 Less Current Liabilities Trade payables Bank Accrual of expenses 12.10 Dr Date BETH DAVIS Profit for the year (a) 2007 55,217 1,864 4,963 2,246 395 868 2,400 28,176 3,641 163 310 32,290 13,459 31 May 31 May 1 Jun 67,953 27,421 20 Details Cash/bank Balance c/d Balance b/d £ 12,000 4,800 7,200 18,831 26,031 20,806 27,421 48,227 22,196 26,031 Less Drawings INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20-8 £ £ 95,374 Gross profit Less expenses: Wages and salaries Heating and lighting Rent and rates 5,273 – 310 Advertising Bad debts written off General expenses 783 + 85 Depreciation of shop fittings 12,000 x 20% £ FINANCED BY Capital Add Profit for the year 125,000 44,750 169,750 24,000 145,750 Less Drawings 10,290 3,084 85 Net Current Assets or Working Capital NET ASSETS 93,550 220,750 75,000 145,750 FINANCED BY Capital Opening capital Add Profit for the year £ Non-current Assets Shop fittings at cost Less provision for depreciation 2,400 + 2,400 Net book value Current Assets Inventory Trade receivables Cash Prepayment of expenses 88,000 52,130 450 140,580 Less non-current Liabilities Bank loan NET ASSETS 12.9 BALANCE SHEET AS AT 31 DECEMBER 20-8 £ Net book value 100,000 7,200 20,000 127,200 Telephone Account £ 2,400 130 2,530 210 Date Details 2007 31 May Income statement 31 May Balance c/d 1 Jun Balance b/d Cr £ 2,320 210 2,530 130 (b) CHAPTER 13 Business organisations 13.2 MEMORANDUM • • The final accounts of a sole trader comprise: – – income statement balance sheet The income statement shows: income minus expenses equals profit (or loss) To: The Owner, Beta Batteries • The balance sheet shows: Date: Today • Assets are items owned by the business; liabilities are amounts owed by the business; capital is the amount of the owner’s investment. (a) The Partnership Act 1890 defines a partnership as “the relation which subsists between persons carrying on a business in common with a view of profit”. From: Subject: Student Accountant Account of J Booth 13.3 I note that a customer of Beta Batteries, J Booth, has been declared bankrupt whilst owing you £350. You are of the opinion that none of the debt will be recovered. (b) The accounting treatment is that the amount of £350 should be treated as a bad debt written off. To do this you will need to: assets minus liabilities equals capital Where no partnership agreement exists, then the following accounting rules from the Partnership Act 1890 must be followed: • profits and losses are to be shared equally between the partners • partners are not entitled to receive interest on their capital • – debit bad debts written off account – credit J Booth’s account in your sales ledger • If you use a sales ledger control account you should also credit this memorandum account with the amount. • For the year end accounts, you will need to transfer the amount of the bad debt to income statement as an expense: no partner is entitled to a salary interest is not to be charged on partners’ drawings when a partner contributes more capital than agreed, he or she is entitled to receive interest at five per cent per annum on the excess Note: the question asks for any three provisions. – debit income statement 13.5 – credit bad debts written off account The effect of writing off this bad debt will be to reduce your profit for the year by £350 and, at the same time, the trade receivables’ figure in your balance sheet will be reduced by the amount, so reducing the net assets of the business. Points to cover include: * Definition of a limited company – separate legal entity – managed by directors – • Types of companies – public limited company – company limited by guarantee – • private limited company Advantages of forming a limited company – limited liability – ability to raise finance – – – 21 owned by shareholders separate legal entity membership other factors (d) CHAPTER 14 Accounting concepts and inventory valuation 14.1 • • • Going concern concept • 14.2 Accruals concept 14.5 Examples: The accrual of an expense in income statement which has been used in the accounting period but not yet paid for. The prepayment of an expense for the next accounting period. The recording of opening and closing inventories. The use of trade receivables' and trade payables' accounts to record amounts owing to the business, or owed by the business. Materiality concept This means that some items in accounts have such a low monetary (money) value that it is not worthwhile recording them separately. Examples include: 14.8 small expense items which may not justify their own separate expense account and are, instead, grouped together in a sundry expenses account end-of-year quantities of office stationery are often not valued for the purpose of final accounts because the amount is not material and does not justify the time and effort involved low-cost non-current assets are often charged as an expense in income statement because, while strictly these should be treated as non-current assets and depreciated each year, in practice they are treated as income statement expenses as the amounts involved are not material – such as a calculator, a stapler Materiality depends very much on the size of the business – what is material and what is not becomes a matter of judgement. Business entity concept This refers to the fact that final accounts record and report on the activities of a particular business. For example, the personal assets and liabilities of those who play a part in owning or running the business are not included on the business balance sheet. (a) The concept of prudence means – – – (b) – – – (c) not anticipating profit until it is reasonably certain that it will be realised – provision for doubtful debts (see Chapter 15) (a) The kettle should be valued at £16. (b) Inventory should be valued at the lower of cost or net realisable value whichever is the lower. Workings: £31 – £15 = £16 net realisable value (which is lower than the cost of £18) This is an example of using the prudence concept. Gross Profit Profit for the year Current Assets Current Liabilities Capital increase £4,000 decrease £4,000 1. Accruals 2. Consistency no change decrease £15,000 no change no change decrease £15,000 3. Prudence or Consistency decrease £18,000 decrease £18,000 decrease £18,000 no change decrease £18,000 4. Business entity no change increase £13,000 no change no change no change 14.10 providing for all known liabilities (a) no change decrease £4,000 no change jacket, £40 (note: replacement cost is not applicable here) shirt, £25 suit, £80 not giving an over-optimistic presentation of the business trousers, £25 – £10 = £15 not overstating the value of assets electric trouser press, £80 valuation of inventory, at the lower of cost and net realisable value (b) depreciation of non-current assets, to measure the amount of the fall in value of non-current assets over time • • bad debts written off, to reduce the trade receivables’ figure to give a realistic view of the amount that the business can expect to receive provision for doubtful debts (see Chapter 15), to reduce the trade receivables’ figure The concept of consistency means that, when a business adopts particular accounting policies, it should continue to use such policies consistently bad debts written off depreciation of non-current assets Concept Examples (question asks for one example): – – By applying the consistency concept, direct comparison between the final accounts of different years can be made. This means that expenses and income for goods and services are matched to the same time period. – valuation of inventory – Example: As a going concern, non-current assets are valued at cost, less accumulated depreciation to date; inventory is valued at cost (unless net realisable value is lower). – – – This presumes that the business to which the final accounts relate will continue to trade in the foreseeable future. The income statement and balance sheet are prepared on the basis that there is no intention to reduce significantly the size of the business or to liquidate the business. If the business was not a going concern, assets would have very different values, and the balance sheet would be affected considerably. – Examples (question asks for one example) • 22 The prudence concept says that final accounts should always, where there is any doubt, report a conservative figure for profit or the valuation of assets. In inventory valuation it is applied by using the lower of cost and net realisable value. (Note that net realisable value is the selling price of the goods, less further costs to get the inventory into a saleable condition.) A lower closing inventory figure means that profits are not overstated – thus the amount drawn by the owner(s) will be reduced, so helping to ensure the continued financial viability of the business. (b) CHAPTER 15 Further aspects of final accounts 15.2 Dr 20-7 31 Dec 31 Dec Dr 20-7 31 Dec 31 Dec 20-8 1 Jan Dr 20-7 31 Dec 20-8 1 Jan 15.4 Balance b/d (accrual of income) Income statement Balance b/d (accrual of income) Income statement Balance b/d (accrual of income) Income statement Balance b/d (accrual of income) Advertising Income Account £ 20-7 150 31 Dec Bank/Cash (receipts for year) 2,820 31 Dec Balance c/d (accrual of income) 2,970 250 20-8 Rent Income Account £ 20-7 19,260 31 Dec Balance b/d (prepayment of income) 31 Dec Bank/Cash (receipts for year) 31 Dec Balance c/d (accrual of income) 19,260 120 20-8 Cr £ 1,250 20-0 1,250 • (c) Provision for Doubtful Debts Account £ 20-9 1,000 31 Dec Income statement Balance c/d 20-0 1 Jan Cr £ 1,000 Balance b/d 1,000 Income statement (expenses) debit bad debts written off £420 debit provision for doubtful debts £1,000 Explanation: profit for the year is reduced by £1,420 Cr £ 2,720 • 250 Balance sheet Trade receivables £39,000 Workings: £40,420 – £420 bad debts = £40,000 – £1,000 provision for doubtful debts = £39,000 net trade receivables 2,970 Explanation: current assets are reduced by £420 + £1,000 = £1,420 15.6 Year Cr £ 850 Income statement Bad debts written off 18,290 120 19,260 £ 20-5 1,800 20-7 1,400 20-6 2,400 Expense Increase in provision for doubtful debts £ Income Bad debts recovered 2,585 245 £ 150 Decrease in provision for doubtful debts £ 110 Trade receivables (after bad debts written off) Balance sheet Less prov for doubtful debts £ £ Webster Limited T Smith Khan and Company Bad Debts Written Off Account £ 20-9 110 31 Dec Income statement 210 100 420 Cr £ 420 420 23 £ 2,585 100,815 108,800 2,720 106,080 113,200 2,830 20-5 (£105,200 – £1,800) x 2.5% = £2,585 creation of provision 20-7 (£110,200 – £1,400) x 2.5% = £2,720 – £2,830 = £110 decrease in provision 20-6 Net trade receivables 103,400 Workings for doubtful debts provision: (a) Dr 20-9 31 Dec 31 Dec 31 Dec Commission Income Account £ 20-7 100 31 Dec Bank/Cash (receipts for year) 1,150 1,250 Dr 20-9 31 Dec (£115,600 – £2,400) x 2.5% = £2,830 – £2,585 = £245 increase in provision 110,370 15.8 (a) Straight-line method £ 3,000 Year 1 Year 2 (b) 20-8 1 Jan 1 Oct 1 Oct 20-9 1 Jan 3,000 Depreciation is not a method of providing a fund of cash which can be used to replace the asset at the end of its life Profits are lower after depreciation has been deducted – this may discourage drawings from the business Balance b/d Disposals (part-exchange allowance) Bank (balance paid by cheque) 27,000 Disposals Balance c/d £ 7,200 3,000 10,200 £ £ 12,000 15,000 Disposals Balance c/d 20-9 1 Jan Balance b/d Income statement Balance b/d Vehicles Income statement (profit on sale) (d) Non-current assets Vehicles £ 12,000 700 20-8 1 Oct 1 Oct 12,700 £ Cost 15,000 £ Prov for dep’n 3,000 Net book value 21,875 £ 7,200 3,000 10,200 £ Workings £ Trade-in value 8,000 Profit on disposal 2,000 Non-current Assets Machinery at cost Less prov for depreciation Net book value 6,000 GORG HAMMAN BALANCE SHEET AS AT 31 DECEMBER 2003 Current Liabilities Trade payable – instalment due on machine £ 5,500 £ 176,000 123,500 52,500 (£170,000 – £24,000 + £30,000) (£105,000 – £18,000 + £36,500) (11,000) Tutorial notes: • depreciation for 2003 is calculated at 25% straight-line method (being the rate applied to the old machine) • therefore depreciation on remaining machinery is £170,000 – £24,000 = £146,000 x 25% = £36,500 7,200 12,700 £ Net book value 12,000 3,125 Profit on disposal of old machine = £2,000 (b) Cr Cr BALANCE SHEET EXTRACT AS AT 31 DECEMBER 20-8 25,000 Net book value at date of trade-in 3,000 Vehicles (part-exchange allowance) Prov for depreciation £ Vehicle at cost £24,000 – £18,000 depreciation = £6,000 net book value £ Disposals Account – Vehicles Dr (a) 27,000 20-9 20-8 1 Jan 31 Dec 15.13 Cr Provision for Depreciation Account – Vehicles (c) 20-8 1 Oct 31 Dec 9,500 20-8 1 Oct 31 Dec £ 15,000 Balance b/d Dr 20-9 £ 12,000 5,500 BALANCE SHEET EXTRACT AS AT 31 DECEMBER 20-9 Non-current Assets Tutorial note: Do not deduct the trade in allowance from the cost price of the new vehicle – the cost price is £25,000. It is an accounting adjustment Vehicles Account £20,000 – £12,500 – £4,000 = loss of £3,500 Less provision for depreciation • (b) 20-8 1 Oct 31 Dec 1,440 (60%) or 2,400 (to disposal) Depreciation is a non-cash expense • (a) (b) • • 15.11 (a) Dr 15.12 Reducing balance method £ 3,600 24 15.16 16.4 THOMAS SALMON INCOME STATEMENT FOR THE YEAR ENDED 30 NOVEMBER 2004 Gross profit £ Discount received 119 Rent receivable Wages Bad debts Rent and rates Other expenses Discount allowed Income in provision for doubtful debts Depreciation of fixed assets Loss on sale of van 720 69,611 26,320 340 4,630 21,435 286 *230 ** *** ***100 7,270 (b) (a) £27,000 provision for depreciation at start of year – £6,000 depreciation on van sold = £21,000, which is deducted from £30,000 provision for depreciation at end of year = £9,000 depreciation for year (as shown in income statement) Capital expenditure cost of van air conditioning fitted shelving total (b) Revenue expenditure tax disc 16.5 £ 2,000 1,900 100 11,650 550 350 165 450 total • Depreciation, using the straight-line method, at present is £15,000 (see above) • Therefore reducing balance depreciation is £3,000 less this year than straight-line method, so profit will increase from £8,100 (see above) to £11,100. Reducing balance depreciation will be 20% (£150,000 – £90,000) = 20% x £60,000 = £12,000 JOHN HENSON INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20-8 Less expenses: Vehicle running expenses 1,480 + 230 Rent and rates Office expenses 2,220 – 120 Wages and salaries Depreciation: office equipment vehicle 12,550 insurance premium tank of fuel • Rent £2,500 – £220 prepaid Workings: Less Closing inventory Cost of sales Gross profit Add income: Discounts received £ 220 40 875 117,800 8,100 • Wages £74,750 + £650 owing Revenue Opening inventory Purchases cost of extended warranty 152,500 125,900 New profit: £11,100 • CHAPTER 16 Preparing sole trader final accounts 16.1 £ 278,400 • Depreciation £150,000 x 10% 62,341 £1,120 – £890 = £230 Net book value (£8,000 – £6,000) Sale price Loss on sale ABEL BROWN INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2001 £ Revenue Less Cost of sales: Opening inventory 12,700 Purchases 153,900 166,600 Less Closing inventory 14,100 Gross profit Less expenses: Wages 75,400 Rent 2,280 Other expenses 25,120 Depreciation 15,000 Profit for the year Workings: **9,000 Profit for the year * £ 68,772 Add income: Less expenses: (a) 25 Profit for the year £ 6,250 71,600 77,850 8,500 1,710 5,650 2,100 18,950 1,000 3,000 £ 122,000 69,350 52,650 285 52,935 32,410 20,525 BALANCE SHEET AS AT 31 DECEMBER 20-8 Non-current Assets Office equipment Vehicle £ Net book value 12,000 3,000 9,000 10,000 22,000 9,000 Net revenue 18,000 Opening inventory Purchases 280,797 – 2,170 goods for own use Less Closing inventory Cost of sales Less expenses: 725 Wages 128,528 + 1,383 Motor expenses 47,870 – 18,500 Rates Insurances 7,780 – 286 4,910 5,140 Bad debts written off General expenses Provision for depreciation: 9,430 property 27,430 equipment motor vehicles FINANCED BY Capital Opening capital Add Profit for the year Less Drawings 39,771 586,624 278,627 318,398 40,135 278,263 308,361 129,911 29,370 7,810 7,494 1,368 33,713 2,900 1,140 13,448 Profit for the year 20,000 £ 587,461 837 Gross profit 14,570 230 £ Less Returns inwards 120 Bank NET ASSETS Revenue 5,225 Prepayment of expenses Net Current Assets or Working Capital 4,000 INCOME STATEMENT FOR THE YEAR ENDED 31 MARCH 2006 8,500 Trade receivables Accrual of expenses 1,000 KEN TUCKY (a) £ Prov for dep'n Current Assets Trade payables £ Cost Inventory Less Current Liabilities 16.6 227,154 81,207 Depreciation calculations 20,525 40,525 • Property: £145,000 x 2% = £2,900 • Motor vehicles £42,000 + £18,500 acquisition = £60,500 – £26,880 depreciation to date = £33,620 x 40% = £13,448 • 13,095 27,430 (b) Additional information 4 • This is a prepayment of expenses. • The amount will be shown as a current asset in the balance sheet. • • • 26 Equipment: £11,400 x 10% = £1,140 The amount is deducted from the expense to be shown in income statement, ie £7,780 expense – £286 prepayment = £7,494 to income statement. The £286 will be included in the cost for insurances charged to next year’s income statement. The accounting concept is accruals (or matching) – expenses and revenues for goods and services are matched to the same time period, here the year ended 31 March 2006. (b) Additional information 5 • • • • (c) • • • • 16.8 (a) Workings: The owner has taken some of the goods in which the business trades for his own use. The amount, here £2,170, is deducted from purchases and added to the owner’s drawings (which will be deducted from capital in the balance sheet). The accounting concept is prudence. SIOBHAN HUGGETT Cost of sales Reduction in provision for doubtful debts Wages and general expenses Business rates Bad debts written off Provision for depreciation: fixtures and fittings vehicles Loss for the year 16.9 122,500 170,600 Add income: Less expenses: 293,100 131,200 Gross profit (b) Example of capital expenditure: purchase of fixtures (c) Capital expenditure is expenditure incurred on the purchase, alteration or improvement of fixed assets. Example of revenue expenditure: wages and general expenses WULLIE McDUFF (a) INCOME STATEMENT FOR THE YEAR ENDED 30 SEPTEMBER 2005 Gross profit £ Add income: Bad debts recovered 40 Less expenses: 117,800 Wages 13,330 Rent and rates 750 General expenses Bad debts written off 10,800 Loss on sale of vehicle Provision for depreciation: property 174,520 vehicles 3,880 27 Loss for the year £ 807,850 100 Reduction in provision for doubtful debts 170,640 31,840 Provision for depreciation of vehicles: £160,000 – £80,400 depreciation to date = £79,600 x 40% = £31,840 Capital expenditure is shown on the balance sheet (subject to the accounting concept of materiality), while revenue expenditure is an expense in the income statement. It is important to classify these items of expenditure correctly in the accounting system so that the final accounts report reliably on the financial state of the business – profit is stated accurately and the balance sheet shows the assets owned by the business. £ 123,400 8,700 Provision for depreciation of fixtures and fittings: £85,000 + £23,000 acquisition = £108,000 x 10% = £10,800 Revenue expenditure is expenditure incurred on running expenses. INCOME STATEMENT FOR THE YEAR ENDED 30 APRIL 2004 Less Closing inventory Business rates: £13,510 – £180 prepayment = £13,330 • If a provision is not made, then profits will be overstated by the amount of doubtful debts. Purchases Wages and general expenses: £116,200 + £1,600 accrual = £117,800 • Creation of a provision for doubtful debts is shown as an expense in income statement, and deducted from trade receivables in the balance sheet. 7,800 Provision for doubtful debts: £9,000 trade receivables x 3% provision = £270, which is deducted from £310 existing provision = £40 reduction in provision for doubtful debts Closing inventory: valued at the lower of cost, £8,700, and net realisable value, £11,500 • A provision for doubtful debts should be created so that the balance sheet figure of net trade receivables is a reliable estimate of the amount that will be received. Revenue • • The accounting concept is business entity which keeps separate from the business the personal assets and liabilities of the owner. Opening inventory Purchases: £149,400 – £3,000 goods for own use – £23,000 fixtures = £123,400 • The reason for reducing purchases is to ensure that only those purchases used in the business are recorded, which are then matched to the sales derived from them. £ • 65 808,015 748,432 12,140 37,898 760 200 2,400 7,500 809,330 1,315 Workings: • • • • • • (b) CHAPTER 17 Financial statements of limited companies Provision for doubtful debts: £35,000 trade receivables x 2.5% provision = £875, which is deducted from £940 existing provision = £65 reduction in provision for doubtfut debts. 17.1 Rent and rates: £12,460 – £320 prepayment = £12,140 (a) General expenses: £36,980 + £918 accrual = £37,898 • Loss on sale of vehicle: £20,000 cost – £15,000 depreciation to date = £5,000 net book value at date of sale – £4,800 sale proceeds = £200 loss on sale. Provision for depreciation of property: £120,000 x 2% = £2,400 Provision for depreciation of vehicles: £60,000 – £30,000 depreciation to date = £30,000 x 25% = £7,500 The private limited company is the most common form of limited company and is defined as ‘any company that is not a public company’ (Companies Act 2006). Many private limited companies are small companies, often in family ownership and it would seem appropriate for Wullie McDuff to consider this form of business organisation. (b) • (c) • (d) Advantages include: • • • • limited liability – the shareholders of the company can only lose the amount of their investment (together with any money unpaid on their shares); the personal assets of the shareholders are not available to the company’s trade payables 17.2 separate legal entity – a limited company is separate from the owners ability to raise finance – the smaller company can raise funds from venture capital companies, relatives and friends; debentures can be issued to raise long-term finance from lenders and investors • 17.4 documentation – there is more documentation – eg the preparation of formal annual accounts – for a company to produce than for a sole trader business; the costs of administering a company are higher than for a sole trader • Market value is the price at which issued shares are traded, ie bought and sold. Capital reserves are created as a result of a non-trading profit; examples include revaluation reserve, share premium account. Revenue reserves are retained profits from the income statement; examples include retained earnings, general reserve. A bonus issue is the capitalisation of reserves – either capital or revenue – in the form of free shares issued to existing shareholders in proportion to their holdings; no cash flows into the company. A rights issue is the raising of cash by offering shares to existing shareholders, in proportion to their holdings, at a favourable price. corporation tax is shown in the income statement, and any amount not yet paid is shown as a current liability on the balance sheet (a) directors' remuneration is shown as an expense in the income statement dividends paid are shown in the statement of changes in equity revaluation reserve is shown as a capital reserve as a part of the equity section of the balance sheet goodwill is shown as an intangible asset in the non-current assets section of the balance sheet; it is amortised in the same way as tangible non-current assets are depreciated MASON MOTORS LTD INCOME STATEMENT (EXTRACT) FOR THE YEAR ENDED 31 DECEMBER 20-1 Profit from operations Finance costs Profit before tax Conclusion • • Nominal value is the face value of a share which is entered in the accounts, eg 5p, 10p, 25p, 50p or £1. (c) (f) membership – all ordinary shareholders have voting rights, so Wullie may lose some control of the business • Preference shares usually carry a fixed rate of dividend which is paid in preference to that of ordinary shareholders. In the event of the company ceasing to trade, the preference shareholders will also receive repayment of capital before the ordinary shareholders. debenture interest is shown as an expense in the income statement (b) (e) a limited company may have a higher standing and status in the business community, allowing it to benefit from economies of scale, and making it of sufficient size to employ specialists • Ordinary shares are the most commonly issued class of share. They take a share of the profits which remain after all other expenses of the business. The main risk of ordinary shares is that part or all of the value of the shares will be lost if the company loses money or becomes insolvent. (a) (d) Disadvantages include • • Tax Profit for the year Wullie must consider the advantages and disadvantages of changing his business into a private limited company. If he is seeking to expand the business and raise finance, it would be sensible to consider this option. At the same time he would gain the benefit of limited liability. 28 £ 75,000 (5,500) 69,500 (20,050) 49,450 STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20-1 (b) Retained earnings Balance at 1 January 20-1 49,450 Dividends paid (10,000) Balance at 31 December 20-1 119,450 Balance at 1 June 20-2 Profit for the year Dividends paid Transfer to general reserve Balance at 31 May 20-3 (b) (20,000) Debt Equity £20,000,000 £55,000,000* £50,000,000* £25,000,000 – – – – – – – – – (2,000,000) 4,600,000 Conclusion It seems to be preferable for Srian to finance its expansion scheme with an issue of ordinary shares. This has a much lower gearing ratio than the issue of debentures – the company may have difficulty in the future meeting the extra annual interest cost of £1,800,000. the new shareholders will have voting rights the power of the existing shareholders will be diluted because there will be more shares in issue the company’s gearing ratio will be improved a different type of financing based on loans and interest, rather than shares and dividends the interest charge will rise by £1,800,000 from £1,200,000 to £3,000,000 interest must be paid whether or not profits are made a failure to pay interest could lead the company into insolvency no voting rights, so no dilution of shareholders’ power debentures must be repaid at an agreed date in future interest rate is fixed, whatever may happen to the level of interest rates debenture holders likely to require security for their loan in the form of a mortgage over company assets; this may restrict the use the company can make of the assets = 2:1 or 200% This is an extremely high gearing ratio, well above the ‘normal’ maximum of 1:1 or 100% acceptable to investors. It may be that Srian plc will have difficulty in meeting the annual interest costs of this option. (2,800,000) Issue of debentures – 0.36:1 or 36% * 6% debentures £20,000,000 + £30,000,000 9,400,000 not essential to pay dividends every year, although a failure to do so might cause difficulties with future share issues = If debentures are issued, the gearing ratio becomes: Issue of ordinary shares – = 0.8:1 or 80% This is a much improved gearing ratio. 6,000,000 – £25,000,000 * ordinary shares £25,000,000 + £20,000,000 and share premium account £10,000,000 3,400,000 ordinary shares are not normally repayable, so the company will have the finance for the foreseeable future £20,000,000 If ordinary shares are issued to raise the money for expansion, the gearing ratio (including share premium account) becomes: £ – = This is already a high gearing ratio which investors will not wish to see going above 1:1 or 100%. SRIAN PLC STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MAY 20-3 Retained earnings the company’s gearing ratio will be worsened Without having information on the company’s revenue reserves (retained earnings and general reserve), the gearing ratio is currently: General reserve is created from profit which has been kept in the company. It belongs to the shareholders, but is represented by assets in the balance sheet and is not a bank balance available to rebuild the garage forecourt. (a) if repayment not made at due date, debenture holders can realise assets to obtain repayment Gearing ratio 149,450 Transfer to general reserve 17.7 – 100,000 Profit for the year (c) – 29 17.9 (a) STOULBY LIMITED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2006 Retained earnings £ Balance at 1 January 2006 Inventories 1,060,000 Transfer to general reserve 877,000 TOTAL EQUITY AT 31 DECEMBER 2006 £ Issued share capital 4,000,000 ordinary shares of 50p each Share premium account General reserve £ 877,000 TOTAL EQUITY (d) (e) 17.10 (37,000) Net Assets 840,000 700,000 ordinary shares of 50p each, fully paid Share premium account Revenue Reserves Retained earnings 1,297,000 General reserve TOTAL EQUITY * Cash and cash equivalents: Revenue reserves are profits from trading activities which have been retained in the company to help build the company for the future balance at start share issue Retained earnings or general reserve dividend paid Revenue reserves can be used to fund dividend payments or to provide bonus shares to shareholders closing balance (a) DAVID MARK LIMITED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20-2 Balances at 1 January 20-2 Profit for the year Dividend paid Transfer to general reserve Issue of shares Balances at 31 December 20-2 250,000 Share premium £ – – – – – 100,000 350,000 – General reserve £ £ – **(35,000) (35,000) – – 150,000 45,000 50,000 120,000 * £400,000 – £150,000 profit for the year Total *250,000 – 50,000 Retained earnings £ (c) 75,000 – 350,000 Capital Reserve 3,797,000 Issued share capital £ 240,000 EQUITY * general reserve: £300,000 + £120,000 transfer (c) Trade and other payables Issued Share Capital *420,000 Retained earnings 277,000 Net Current Assets 500,000 Revenue Reserves *132,000 Current liabilities 2,000,000 Capital Reserve 60,000 Cash and cash equivalents (120,000) £ 600,000 85,000 Trade and other receivables (63,000) Balance at 31 December 2006 £ Current assets 650,000 Dividend paid DAVID MARK LIMITED SUMMARISED BALANCE SHEET AS AT 31 DECEMBER 20-2 Non-current assets 410,000 Profit for the year (b) (b) 150,000 (45,000) 320,000 ** 500,000 shares x 7p 575,000 150,000 – 840,000 30 50,000 320,000 120,000 440,000 840,000 £ 17,000 150,000 (35,000) 132,000 • Limited company, or • Private Limited Company (d) • The term ‘Ltd” means that the shareholders of David Mark Limited have limited liability. • Thus the risk taken by shareholders is limited. • This means that they could lose their investment but cannot be asked to contribute further in the case of liquidation (unless the shares are not fully paid). CHAPTER 18 Ratio analysis 18.3 Exton gross profit margin 13.4% gross profit mark-up 15.5% overheads in relation to revenue 12.0% net profit margin (profit in relation to revenue) 1.4% rate of inventory turnover 33 days or 10.9 times per year net current asset (current) ratio 1.3:1 liquid capital (acid test) ratio 0.05:1 trade receivable days 1 day* return on capital employed 11% (a) (b) (c) (d) (e) (f) (g) (h) (i) profit Frimley 44.0% 78.7% 39.8% 4.2% 95 days or 3.8 times per year 2.4:1 1.3:1 60 days 8.1% (d) Frimley 18.4 (a) Return on capital employed (ROCE) expresses the profit of a business in relation to the amount of capital in the business by the owner. gearing Debt (loan capital + preference shares, if any) Equity (ordinary shares + reserves) Gearing is concerned with the long-term financial stability of a business. It measures how much of the business is financed by debt (including preference shares) against capital – gearing is often referred to as the debt/equity ratio. The higher the gearing, the less secure will be the ordinary share capital of the business and, therefore, the future of the business. This is because debt is costly in terms of interest payments. low overheads/revenue and net profit margin; high inventory turnover; quick trade receivable days, low net current asset and liquid capital ratios; few trade receivables higher overheads/revenue and net profit margin and low inventory turnover; slow trade receivable days; good net current asset and liquid capital ratios; high figures for non-current assets and trade receivables 18.6 gross profit margin Gross profit Revenue This ratio expresses, as a percentage, the gross profit in relation to revenue. (c) (d) net current assets Current assets – Current liabilities Net current assets or working capital, are needed by all businesses in order to finance day-to-day trading activities. Sufficient net current assets enable a business to hold adequate inventories, allow a measure of credit to its customers (trade receivables) and to pay its suppliers (trade payables) as payments fall due. (e) liquid capital Liquid capital is calculated in the same way as net current assets, except that inventories are omitted. This is because inventories are the most illiquid current asset. Liquid capital provides a direct comparison between the short-term assets of trade receivables and cash and short-term liabilities. cash Trade receivables x 365 days Revenues Trade payables Purchases x 365 days trade receivable days This is the actual amount of money held in the bank or as cash. trade payable days 20-1 20-2 £43,000 x 365 days £680,000 £32,550 x 365 days £660,000 20-1 20-2 = 23.08 days £28,500 x 365 days £520,000 = 20 days = 18 days £38,500 x 365 days £540,000 = 26.02 days 20-1 Trade payables are paid more quickly than trade receivables are paying, which will cause cash management problems. 20-2 Trade payables are paid more slowly than trade receivables are paying, which aids cash management. (Current assets – Inventories) – Current liabilities (c) In general terms, investors and lenders would not wish to see debt exceeding equity; thus a gearing ratio of greater than 1:1 is undesirable. x 100 1 This ratio expresses, as a percentage, the gross profit in relation to cost of sales; often used by businesses to establish selling price. (b) (a) (b) x 100 1 gross profit mark-up Gross profit Cost of sales Profit for the year x 100 Capital employed* 1 sole traders: the amount of the owner’s capital in the business Exton is the supermarket; Frimley is the engineering company Exton return on capital employed * limited companies: ordinary share capital + reserves + preference share capital + loan capital * revenue figure used for this calculation; this is unrealistic because most supermarket sales will be for cash rather than on credit Reasons: This is a calculated figure which shows the surplus of income over expenditure for the year. It takes note of adjustments for accruals and prepayments and non-cash items such as depreciation and provision for doubtful debts. 31 Note: The figure for trade receivables has fallen during the period, while the figure for trade payables has increased. The reasons for the changes need to be investigated to include: – has revenue reduced, or is collection from trade receivables more efficient? – does the company have the money to pay trade payables, or have generous credit terms been offered by a supplier? 18.7 (a) (b) • Net current assets (current) ratio = • Net profit margin (profit in relation to revenue) = • Liquid capital (acid test) ratio = • Rate of inventory turnover = • Return on capital employed = or Proposal 2 Current assets Current liabilities £30,000 **£540,000 (Current assets – inventories) Current liabilities Average inventories x 365 days Cost of sales Profit for the year Capital employed Tutorial note: bank overdraft is a current liability and is not included in the figure of capital employed. = number of times per year (c) x 100 1 To: From: Date: Subject: Green Ltd is the supermarket, while Hawke Ltd is the furniture store. Green Ltd has a low net profit margin and a high inventory turnover. This is a characteristic of the way in which supermarkets operate – low profit margins, but a high level of revenue. Liquidity ratios are lower than the norms as supermarkets usually have few trade receivables. • • • • • • 18.10 • • • If expenses could be reduced, the net profit margin would improve, and also return on capital employed. • A review of buying prices and selling prices may reveal opportunities for increasing profits and return on capital employed. Advertising could increase sales, but only if the extra revenue generated covers the cost of advertising. • Any surplus non-current assets could be sold to improve liquidity ratios. (b) Ratio calculation Return on capital employed Proposal 1 £30,000 *£600,000 x 100 1 = Profit for the year Capital employed Ordinary shareholder Student Accountant Today Proposals to raise finance This proposal to issue more ordinary shares means that ownership of the company will be diluted. Unless the amount paid out by the company in dividends is increased, then your dividend per share will fall. Return on capital employed will be reduced from 7.89% (£30,000 ÷ £380,000) to 5%. The company’s gearing ratio is lowered (because equity has increased from £380,000 to £600,000); no interest to pay on the share issue. Reserves will increase to £300,000, ie £160,000 share premium and £140,000 retained earnings. the company may decide to make a bonus issue of shares in the future. Proposal 2 Inventory levels could be reduced, so improving the net current asset ratio. Formula * • If inventory turnover could be increased above 20 times per year, this would generate more cash and improve the liquidity ratios of the business (provided that selling prices do not have to be cut to encourage sales). (a) Report Proposal 1 Hawke Ltd has a higher net profit margin with a lower inventory turnover. This indicates a business that sells higher value items which are not purchased on a regular basis. The liquidity ratios are close to the norms indicating a business with higher inventories and trade receivables than a supermarket. (c) = 5.56% ** £380,000 equity (ordinary shares + capital and revenue reserves) £160,000 long-term bank loan Profit for the year x 100 Revenue 1 Cost of sales Average inventories x 100 1 • • x 100 1 • • = 5% • £300,000 ordinary shares (£200,000 + £100,000) £160,000 share premium (£140,000 + £120,000) £140,000 retained earnings 32 The proposal is to fund the expansion entirely from external borrowing – your ownership of the company will not be diluted. Your dividend per share should remain the same and, if profits are increased after paying interest on the loans, will increase. The company’s gearing ratio is increased by the borrowing, and the company must pay interest on the borrowing. The overdraft is a current liability which will have the effect of reducing the company’s net current asset (current) ratio and liquid capital (acid test) ratio. Return on capital employed will be reduced from 7.89% to 5.56% (a smaller reduction than proposal 1). The company will need a repayment scheme for the external borrowing – this could cause liquidity and cash flow problems in the future. 18.11 (a) FALCON LIMITED BALANCE SHEET AS AT 31 MARCH 2007 Non-Current Assets (b) £ £ Net book value 200,000 Property Fixtures and fittings 217,500 Inventories 14,560 Cash and cash equivalents 31,058 Trade receivables 51,074 Trade payables (c) (7,842) Tax liabilities (7,900) (15,742) Net Current Assets 252,832 Debentures (2011-2013) = 12.45% Issued Share Capital 75,000 ordinary shares of £1 each 18.12 75,000 Capital Reserves 10,000 120,000 Revenue Reserve Retained earnings TOTAL EQUITY 130,000 • £28,000 *£224,832 • The level of debt has remained at £28,000. • 224,832 • 33 profit is a calculated figure which shows the surplus of income over expenditure for the year. Example of how a business can make a good profit during a year when the bank balance reduces or the bank overdraft increases (the question asks for two examples): • share premium £5,000 + £5,000 premium on rights issue = £10,000 A lower gearing ratio reduces the level of risk to the company and enables it to borrow further funds in the future if required. (b) • • revaluation reserve £200,000 revaluation – £80,000 net book value = £120,000 The impact of the rights issue and the revaluation of the property has been to reduce considerably the gearing ratio from 37.42% to 12.45%. Even before the adjustments, the company was relatively low-geared; the ratio is much lower after the adjustments. • • bank £1,058 + £30,000 (£25,000 + £5,000 premium) rights issue = £31,058 Revaluation of the property has added £120,000 (£200,000 – £80,000) to total equity. (a) • 19,832 Tutorial notes: • = The rights issue has added £30,000 (£25,000 + £5,000 premium) to total equity. • • Debt Equity • 224,832 EQUITY Share premium account After adjustments • (28,000) NET ASSETS = 37.42% • 35,332 Non-Current Liabilities Before adjustments = £28,000 *£74,832 or * total equity from balance sheet 5,456 Current Liabilities Debt (loan capital + preference shares, if any) Equity (ordinary shares + reserves) * £50,000 + £19,832 + £5,000 17,500 Current Assets Revaluation reserve Gearing ratio = cash is the actual amount of money held in the bank or as cash purchase of non-current assets – cash decreases; no effect on profit (but there is likely to be an amount for provision for depreciation in the income statement repayment of a loan – cash decreases; no effect on profit payment of drawings/dividends – cash decreases; no effect on profit an increase in trade receivables – cash decreases; no effect on profit a decrease in trade payables – cash decreases; no effect on profit an increase in inventory – cash decreases; profit increases 19.3 CHAPTER 19 Budgeting and budgetary control 19.1 (a) Benefits of budgetary control • • • • • • • (b) Cash budget for four months ending 31 October 2002 Sales co-ordination – when a budget is being set, any anticipated problems should be resolved decision-making – by planning ahead through budgets, a business can make decisions on how much output can be achieved Net inflow/outflow sales (revenue) budget • labour budget • trade payable budget • (b) (i) trade receivable budget cash budget (c) • • • • 12.0 15.6 16.8 14.4 20.4 25.2 26.8 24.0 8.0 8.0 8.0 4.0 5.2 5.6 3.2 (10.8) costs and benefits – benefits must exceed the cost accuracy – of information used (ii) demotivation – of staff may occur if they have not been involved in planning the budget and/or where budgets are set at too high a level 5.2 18.0 14.0 4.0 5.6 12.0 26.0 22.0 16.0 (10.8) (11.6) (6.8) (0.8) 4.8 (11.6) (6.8) 8.0 1.2 • At 31 October 2002, the bank balance is budgeted to be £1,200. • The company sells beach buckets and spades, so the seasonal effect is over quickly. • Thus, over the four-month period there is expected to be a change from an overdraft of £7,200 at the start, through a maximum overdraft of £11,600 in August, to £1,200 money in the bank at the end of October. Expected amounts due from trade receivables in November are: £ 12,000 4,800 16,800 • It is likely that the company will go into overdraft again quite quickly, from November onwards. • The company needs to make arrangements for an overdraft facility for July, August and September, with a limit of approximately £12,000. • disfunctional management – ensure that the budgets co-ordinate 4.8 4.0 1 month £20,000 x 60% 2 months £24,000 x 20% Relevant factors when implementing budgetary control • £000 (7.2) • The most likely three budgets for a small business such as Classic Furniture would be cash, sales and production £000 (3.6) Closing balance Oct £000 24.0 Opening balance Sept £000 16.0 Overheads motivation – a budget can be part of the techniques for motivating managers and other staff to achieve the objectives of the business production budget – 1 month Purchases control – action can be taken to modify the operation of the business • – cash – 2 months monitoring – management is able to monitor and compare the actual results against the budget purchases budget Aug July communication – because a budget is agreed by the business, all the relevant managers and staff will be working towards the same end • • Sunshine Ltd planning – by formalising objectives through a budget, a business can ensure that its plans are achievable Any three budgets • (a) Other measures to improve the company’s cash position include: – offering discounts to encourage increased sales – allowing one month’s credit only, so receiving payment from sales quicker set too easy – ensure that budgets are set at realistic levels to enable the business to use its resources to best advantage – encouraging cash sales – reducing purchases as the summer season draws to a close 34 – reducing overheads 19.5 (a) July £ Income Cash from trade receivables Expenditure Payments to trade payables Operating expenses Purchase of non-current assets Repayment of loan August £ September £ October £ November £ December 24,000 28,500 32,500 38,500 *47,760 10,000 11,000 14,000 18,000 24,500 12,500 12,000 12,000 8,500 12,000 12,000 30,000 36,500 64,010 Net cash flow (2,000) (7,500) 2,500 2,500 2,000 (16,250) Closing balance (1,020) (1,520) (17,770) Opening balance 980 (1,020) (8,520) cash from December sales: £60,000 x 20% x 98% cash from November sales: £50,000 x 60% cash from October sales: £30,000 x 20% (b) (8,520) (6,020) = = = (6,020) (3,520) (3,520) (d) (1,520) 19.7 £11,760 • in December, the company plans to buy new non-current assets at a cost of £19,510 in December, the company plans to make a repayment on the loan of £20,000 See Chaper 20. • Automatic updating – as amendments are made, the entire budget is changed easily. What-if calculations – the effect of possible changes can be considered, eg a reduction in the period of credit allowed to customers. (a) JIM SMITH £47,760 Jan Receipts Memorandum May Jun 1,250 3,000 4,000 4,000 4,500 – 4,500 4,500 3,500 3,500 3,500 6,750 5,100 5,100 4,150 4,150 4,200 10,000 Trade payables Expenses Total payments for month Net cash flow Add bank balance (overdraft) at beginning of month Bank balance (overdraft) at end of month 35 Apr Total receipts for month Van purchase of non-current assets Mar 10,000 Payments the application of the realisation concept – timing of receipts and payments Feb £ Capital introduced Trade receivables The Directors of Hawk Limited Student Accountant Today Making profits whilst having a bank overdraft repayment of loans • the sales of £60,000 forecast to be made in December are higher than each of October and November; the cash received from December’s sales will be £11,760 in December, £24,000 in January and £12,000 in February – thus, at the end of December, £36,000 is outstanding CASH BUDGET FOR THE SIX MONTHS ENDING 30 JUNE 20... a company can make a profit but have a bank overdraft for a number of reasons, including: • 20% of cash from sales is received in the month of sale; then 60% is paid in the next month, with 20% two months after sale £6,000 Reasons • • £30,000 = £18,750 total net cash outflow To: From: Date: Subject: the purchase of non-current assets affects cash but has no effect on profit • £980 (opening balance 1 July) + £17,770 overdraft (closing balance 31 December) (c) repayment of loans affects cash but has no effect on profits • 20,000 26,000 • • 19,510 31,500 receipts from trade receivables and payments to trade payables are likely to occur some weeks after the sales and purchases have been recorded in the income statement Hawk Limited 12,000 22,000 • • £ 20,000 12,000 Explanation – 6,000 750 £ 1,250 600 £ 3,000 600 £ 4,000 650 4,000 650 4,500 700 (3,850) (2,100) (600) (2,700) (2,850) (3,000) 3,250 (600) (2,700) (2,850) (3,000) (2,700) 3,250 (150) £ 3,250 – (150) £ 300 Notes: • no depreciation – a non-cash expense – is shown in the cash budget • customers pay one month after sale, ie trade receivables from January settle in February • suppliers are paid one month after purchase, ie trade payables from January are paid in February (b) The cash budget shows the maximum bank overdraft to be £3,000 in May. Jim Smith could avoid the need for a bank overdraft in one or more of the following ways (the question asks for two ways): • by commencing his business with a higher initial capital, eg £13,000 • by buying the van on hire purchase or leasing instead of outright purchase • by reducing his purchases to £3,000 for each of January and February • by asking his suppliers for two months’ credit for the initial purchases of £4,500 made in January • by asking his customers to pay more quickly CHAPTER 20 The impact of computer technology in accounting 20.6 Two from each of: (a) (b) (c) - single entry system which automatically makes entries in all relevant accounts - all arithmetic in account entries is performed automatically - - - - - - - accounts are normally already set up in the system provided that the original figure entered is correct, all account entries will be correct all calculations are automatic and therefore accurate error of omission (entries which have been left out in error) error of original entry (the wrong figure entered in error) error of principle (entry in the wrong type of account) mispost (entry in the wrong person’s account) 36
