TUNKU ABDUL RAHMAN
UNIVERSITY COLLEGE
Centre for Pre-University Studies
A Level
9706 Accounting
Financial Accounting Lecture Workbook
Semester 2
Name of Lecturer
: Chin Nam Keong
Name of student
: …………………………………….
Class
: …………………………………….
*The contents are not for sale and strictly meant for internal circulation only.
1
CORRECTION OF ERRORS
1
Introduction
(a) Errors may arise when recording transactions due to carelessness or for whatever reason. Correction
entries must be made when errors were found
(b) The correction of errors are not corrected using erasers or correction fluids but rather by making
accounting entries to set off the errors and also to show a correct financial state of the business
2
Notes to Double Entry
Debit
Credit
Assets:
Liabilities:
Expenses:
Revenue:
3
Errors not affecting the trial balance
(a) There are errors which do not affect the trial balance. The trial balance still agrees even though such
errors have occurred.
(b) Examples of such errors are as follows:
(i)
Error of omission:
A transaction is not recorded at all in the books
Example: Cash sales $300 was not recorded at all
Cash Account
Sales Account
2
(ii)
Error of commission:
An item is posted to the correct side of the wrong account but of the same type of account.
Example: Cash $200 paid to a creditor, Ali is debited to the account of another creditor, Johnny
Cash Account
200
Johnny
Ali
Note:
(iii)
Error of principle:
An item is posted to the correct side of the wrong type of account.
Example: Cash $100 paid for machine repair is debited to machinery account.
Cash Account
100
Machinery Account
Repairs Account
Note:
3
(iv)
Error of original entry:
An incorrect amount is entered in the records and then posted correctly to the accounts.
Example 1:
Cash $500 for rent expense is recorded as $5000 and then posted to the cash account and rent
expense account.
Cash Account
Rent Expense
Example 2:
Cash $500 for rent expense is recorded as $200 and then posted to the cash account and rent expense
account
Cash Account
200
Rent expense account
200
(v)
Complete reversal of entries:
The amount and the accounts posted are correct, but the account that should have been debited is
credited and vice versa.
Example: A cheque payment of $600 to Sammy was debited in the bank account and credited in
Sammy account.
Bank Account
Sammy
4
(vi)
Error of duplication:
A transaction is recorded and posted correctly to the accounts but more than one time.
Example: Credit sales $30 000 to Ahmad Company was correctly recorded in both sales and Ahmad
Company accounts. However the same transaction was again recorded the next day by a new
accounts clerk.
Sales Account
Ahmad Company
4
Correcting Errors
(a) In accounting, errors are not corrected using erasers or correction fluids but rather by making
other accounting entries that would set off those
(b) Correcting errors are carried out according to the double entry system by means of a journal
entry between the accounts affected
(c) The basic steps for correcting errors are as follows:
5
1
Identify the error and state the entries that should have been made
2
State the wrong entries actually made
3
State the entries to cancel the wrong entries or complete the missing entries
4
Complete the double entry
Worked Example: Correction of the following errors:
(i)
Goods sold on credit to John, $230, was not recorded in the books.
Dr.
1
Entries that should have been made
2
Error:
3
Correction:
5
Cr.
(ii)
Goods bought from Jane $500 was credited to Jenny’s account.
Dr.
(iii)
1
Entries that should have been made
2
Error:
3
Correction:
Repairs to vehicles paid by cheque $650 have been debited to vehicles account.
Dr.
(iv)
1
Entries that should have been made
2
Error:
3
Correction:
Cr.
The purchase of a van for business use by cheque $53 200 was wrongly entered in the
books as $63 200.
Dr.
(v)
Cr.
1
Entries that should have been made
2
Error:
3
Correction:
Cr.
Rent received $5000 was wrongly recorded as rent expense.
Dr.
1
Entries that should have been made
2
Error:
3
Correction:
6
Cr.
(vi)
Purchases returns account and wages account were both overstated by $300
Dr.
(vii)
1
Entries that should have been made
2
Error:
3
Correction:
Purchases returns account and wages account were both understated by $100
Dr.
(viii)
1
Entries that should have been made
2
Error:
3
Correction:
Cr.
Stationery bought in cash $76 was recorded in the books at $70.
Dr.
(ix)
Cr.
1
Entries that should have been made
2
Error:
3
Correction:
Cr.
Stationery bought in cash $76 was recorded in the books at $80.
Dr.
1
Entries that should have been made
2
Error:
3
Correction:
7
Cr.
6
Errors affecting the trial balance
(i) The trial balance does not agree because of these errors.
(ii) The errors affecting the trial balance are listed as follows:
1.
2.
3.
4.
5.
error in total
omission of one entry
posting to the wrong side of the ledger for one entry
enter in wrong amount for one entry
error in calculation
(iii) To ensure that the totals of the trial balance agree, a suspense account is opened.
Illustration:
The bookkeeping system of Turner is not computerised, and at 30 September 2017 the bookkeeper was
unable to balance the accounts.
(a) The trial balance totals were:
Debit - $1500
Credit - $1100
Debit ($)
Credit ($)
Capital
900
Sales
200
Purchases
300
Utilities
500
Salaries
700
Suspense Account
Note: Suspense account balance is the balance of the smaller total of the trial balance
(b) The trial balance totals were:
Debit - $900
Credit - $1100
Debit ($)
Credit ($)
Capital
900
Sales
200
Purchases
300
Utilities
500
Salaries
100
8
Suspense Account
7
Correction of errors which affect the trial balance
(i)
The purchases account had been undercast by $900.
Dr.
1
Entries that should have been made
2
Error:
3
Correction:
Cr.
Note: Creditor accounts are correct.
Do not credit into creditor accounts but credit into suspense account
(ii)
The purchases account had been overcast by $300.
1
Entries that should have been made
2
Error:
3
Correction:
(iii)
Dr.
Cr.
Dr.
Cr.
Dr.
Cr.
The sales account had been overcast by $200.
1
Entries that should have been made
2
Error:
3
Correction:
(iv)
The sales account had been undercast by $100.
1
Entries that should have been made
2
Error:
3
Correction:
9
(v)
$400 received from AmerBotak had been entered in his account as $40.
Dr.
1
Actual (Wrong) Entries:
2
Correction:
(vi)
Cr.
$400 received from AmerBotak had been entered in his account as $500
Dr.
1
Actual (Wrong) Entries:
2
Correction:
(vii)
Cr.
Rent expense paid $600 had been wrongly credited to the rent received account.
Dr.
1
Actual (Wrong) Entries:
2
Correction: Cancel wrong entry
Cr.
Correction: Complete missing entries
(viii)
Interest received $25 had been wrongly debited to the interest expense account.
Dr.
1
Actual (Wrong) Entries:
2
Correction: Cancel wrong entry
Correction: Complete missing entries
10
Cr.
8
Worked Example:
Johnny’s trial balance at 31 May 2018 failed to agree and a suspense account for the difference, $1034
debit, was opened.
The following errors were discovered:
1 Commission received, $120, had been recorded in the account twice.
2 Total trade receivables were understated by $824.
3 A payment for insurance, $650, had been correctly entered in the cash book, but recorded in the
insurance account as $560.
4 The total of the sales returns journal had been overcast by $108.
(a) Show the entries in the general journal to correct items 1 to 4 above. Narratives are not required.
Debit
$
Credit
$
1
2
3
4
(b) Prepare the suspense account at 31 May 2014.
Suspense Account
$
11
$
9
The Effects of Accounting Errors on Profits
(a) If errors affect any items in the income statement, the calculation of the original profit would
not be correct
(b) A statement of corrected net profit would be prepared to determine the correct profit
(c) Errors which affect only balance sheet items (assets, liabilities and capital) would not affect the
calculation of profit
(d) A summary of the effects of accounting errors on profit and the adjustments to correct the
profit is shown as below:
Profit = Revenue - Expenses
Error
Effect on Profit
Adjustment to Profit
Expenses
Revenue:
Assets: \
Liabilities
(e) Exercise:
Luma Khan discovered the following errors had been made in her accounting records.
(i)
Rent of premises $300, had been debited to the rent account as $700
Error
(ii)
Effect on profit
The purchases account had been undercast by $100
Error
Effect on profit
12
(iii)
$400 withdrawn from the bank for personal use had been debited to the salaries account.
Error
(iv)
Effect on profit
Discount received, $60, had been omitted from the trial balance
Error
(v)
Effect on profit
$1500 received from Aminah had been credited to the account of Minah as $1500
Error
(vi)
Effect on profit
The purchases returns account had been undercast by $70
Error
(vii)
Effect on profit
The sales returns account had been undercast by $300
Error
(viii)
Effect on profit
Discount allowed, $50, had been posted to the discount received account
Error
Effect on profit
13
(ix)
No entry had been for goods, $800, taken by Luma Khan for her own use
Error
(x)
Effect on profit
Rent paid, $600, was wrongly recorded as rent received
Error
Effect on profit
14
10 Exercise:
The draft income statement for K Madman showed a profit for the year of $40 000 for the year ended
31 December 2017. The following errors were found after the draft income statement was prepared:
(a)
(b)
(c)
(d)
(e)
(f)
Sales was overstated by $3000
Insurance of $600 was wrongly recorded as $500
$490 cash which was received from cash sales was entered in the sales account only.
Salaries of $800 paid to a worker was not entered in the books at all
Purchases of goods for resale was overstated by $90
An office equipment costing $700 was purchased but had wrongly been recorded as $70 in the
office equipment account.
(g) A purchase of furniture $1000 had been included in the purchases account
Workings:
Error
Expenses
Revenue
Asset/Liability
Effect on
profit
Adjustment to
profit
(a)
(b)
(c)
(d)
(e)
(f)
(g)
Statement to calculate correct profit
$
Profit before correction
$
40 000
Add:
Less:
Corrected profit for the year
15
LIMITED COMPANIES
1
Introduction
(a) A limited company is a form of business organization in which the liability of members is
limited to what they have invested to the company.
(b) In a limited company, the debts of the company are separated from those of the shareholder.
Should the company experience financial distress, the personal assets of shareholders will not
be at risk of being seized by creditors.
(c) Ownership in the limited company can be easily transferred.
(d) Companies are managed by members of the board of directors who are appointed in the
companies’ annual general meeting.
2
Share capital
(a) The capital of a limited company is divided into shares.
(b) Capital is raised by offering for sale of shares to the public in exchange for cash or cash
equivalents.
(c) Share capital can be composed of both
Authorised capital:
Issued and paid up capital:
(d) A company can, at any time, issue new shares up to the full amount of authorized share
capital.
(e) Shares will have a nominal or par value such as $1, $2, $0.50 or even $0.10. The nominal
value is assigned by the company itself. A company wishing to raise $1 000 000may do the
following:
Share Capital
Nominal value
$1 000 000
$1
$1 000 000
$2
$1 000 000
$0.50
$1 000 000
$0.10
Note:
1. Par value
2. Issue price
3. Market price
16
Number of shares issued
3
Authorised and Issued Share Capital
(a) The authorised capital of a company (sometimes referred to as nominal capital) is the maximum
amount of share capital that a company is authorised to issue to shareholders
(b) The part of the authorised capital which has been issued to shareholders is referred to as the
company’s issued share capital
(c) The issued share capital which is also known as the paid-up share capital cannot exceed the
authorised share capital
(d) Example:
Maxim PLC has an authorised share capital of 20 000 000 ordinary shares of $1 each and
6 000 000 7% preference shares of $2 each
8 000 000 of the ordinary shares of $1 each and 5 000 000 7% preference shares of $2 each had
been issued at par and were fully paid.
$
(a) Authorised Share Capital
(b) Issued Fully Paid Share Capital
Note:
17
4
Issuance of Shares
(a) When a company has decided to issue shares, it has to decide a subscription price.
(b) The shares can be issued:
(i)
at par: or
(ii)
above par (premium); or
(iii) below par or at a discount
(c) When shares are issued at par, bank is debited and share capital account is credited.
5
Example:
ABC Limited’s authorized share capital consists of 8 000 000 ordinary shares of $1 each.
6
(i) 3 000 000 ordinary shares of $1 each were issued at par. All the shares were fully subscribed and
paid.
Dr.
Cr.
Bank Account
Ordinary Share Capital Account
(ii) 3 000 000 ordinary shares of $1 each were issued at $1.20 each. All the shares were fully
subscribed and paid.
Dr.
Note: Share capital account is always recorded at nominal value
18
Cr.
Bank Account
Ordinary Share Capital Account
Ordinary Share Premium Account
2
Types of shares
(a) Ordinary shares



Most companies have just ordinary shares.
They carry one vote per share, are entitled to participate equally in dividends.
If the company is wound up, the proceeds of the company's assets would be shared among
the ordinary shareholders after all the debts (liabilities & preference shares) have been paid.
(b) Preference shares

These will usually have a preferential right to a fixed amount of dividend, usually
expressed as a percentage of the nominal (par) value of the share. Example:
(1) A 7% $1 preference share will carry a dividend each year of :
(2) A 7% $2 preference share will carry a dividend each year of :
(3) A 6% $0.50 preference share will carry a dividend each year of :

Preference share dividends may be
Cumulative
19
Non-cumulative.
3

Preference shares may be participating, in which case it participates in profits beyond the
fixed dividend under some formula. Other types of preference shares are convertible,
redeemable, etc.

Preference share are often non-voting.

They may be given a priority on return of capital on a winding up and priority in
dividend payouts but will not be entitled to share in surplus capital
Rights issue of shares
(a) A rights issue is when a company issues rights to existing shareholders to buy additional
shares in the company
(b) A rights issue is a way in which a company can sell new shares in order to raise capital
(c) The shareholders will be offered specific numbers of shares at a specific price which is at
discounted price to encourage existing shareholders to take up the rights issues  rights issue
can still be issued above par / at a premium.
20
(d) Example 1:
A company has issued 600 000 ordinary shares of $1.00 each on 1 Jan 2018 at par and a bank
balance of $30 000.
On 2 Jan 2018 the company makes a rights issue of one share for every two already held at
$1.40 per share. The rights issue was fully taken up
Number of rights issue
Increase in share capital
Share premium
Journal Entries
Date
Debit
Credit
$
$
2 Jan 2018
Bank Account
Ordinary Share Capital Account
Ordinary Share Premium Account
21
(e) Example 2: Beauty Limited’s Statement of Financial Position at 28 February 2018 is as
follows:
$
20 000 000
Net assets
Share capital and reserves
15 000 000 ordinary shares of $1 each
15 000 000
Share premium
2 000 000
Retained earnings (savings from previous profits)
3 000 000
Total equity
20 000 000
The company directors made a rights issue on 1 March 2018 of one new share for every ten
already held.
The shares were offered at $2.30 per share and all the shares were subscribed for by the
shareholders
Beauty Limited’s Statement of Financial Position after the rights issue
$
Net assets
Share capital and reserves
ordinary shares of $1 each
Share premium
Retained earnings
Total equity
22
(f) Example 3: Meno Limited’s Statement of Financial Position at 30 April 2018 is as follows:
$
10 000 000
Net assets
Share capital and reserves
8 000 000 ordinary shares of $0.50 each
4 000 000
Share premium
5 000 000
Retained earnings
1 000 000
10 000 000
The company directors made a rights issue on 1 May 2018 of one new share for every four
already held.
The shares were offered at $0.80 per share and all the shares were subscribed for by the
shareholders
Meno Limited’s Statement of Financial Position after the rights issue
$
4
Bonus issue
(a) An offer of free additional shares to existing shareholders
(b) Bonus shares are distributed in a certain ratio to existing shareholders. The ratio could be:
(i)
a 1 for 5 bonus issue will entitle every existing shareholder to receive 1 bonus share
for every 5 shares the shareholder held, or
(ii) a 5 : 1 ratio which means that if a shareholder holds 1000 shares, he will received 5000
free shares.
(c) Although the total number of shares issued have increased, the bonus issue does not change the
value of the company
(d) Bonus issues are made out of a company from its reserves such as retained earnings or
share premium. Company’s reserves are transferred into paid-up share capital in a bonus issue.
23
(e) The transfer of reserves to the share capital is called capitalization of reserves
(f) Example 1:
Able Limited’s Statement of Financial Position at 1 May 2018 is as follows:
$
3 400 000
Net assets
Share capital and reserves
2 000 000 ordinary shares of $1
2 000 000
Share premium
800 000
Retained earnings
600 000
3 400 000
If the company directors made a bonus issue of shares on the basis of one new share for every
four already held, by capitalizing the share premium
Workings:
1. Number of bonus issue
2. Capital increase from bonus shares
Able Limited’s Statement of Financial Position at after bonus issue
$
24
(g) Example 2: Rocky Limited’s Statement of Financial Position at 1 June 2018 is as follows:
$
Total assets
56 000 000
Less: Liabilities
10 000 000
Net assets
46 000 000
Share capital and reserves
6 000 000 ordinary shares of $2
12 000 000
Share premium
28 000 000
Retained earnings
6 000 000
46 000 000
The company directors made a bonus issue of shares on the basis of one new share for every one
already held, by capitalizing the share premium
Workings:
1. Number of bonus issue
2. Capital increase from bonus shares
Rocky Limited’s Statement of Financial Position at after bonus issue
$
Total assets
Less: Liabilities
Net assets
Share capital and reserves
ordinary shares of $2
Share premium
Retained earnings
25
(h) Example 3:
Sino Limited’s Statement of Financial Position at 1 July 2018 is as follows:
$
Net assets
64 000 000
Share capital and reserves
20 000 000 ordinary shares of $0.50 each
10 000 000
Share premium
28 000 000
Retained earnings
26 000 000
64 000 000
The company directors made a bonus issue of shares on the basis of two new shares for every one
already held, by capitalizing the share premium
Workings:
1. Number of bonus issue
2. Capital increase from bonus shares
Rocky Limited’s Statement of Financial Position at after bonus issue
$
Net assets
Share capital and reserves
ordinary shares of $0.50 each
Share premium
Retained earnings
26
5
Dividends
(a) Dividends are part of a company’s profits, passed to its shareholders
(b) The amount of dividend may vary over time, especially ordinary share dividends as the dividends
depends on the company’s profitability and future plans
(c) Many companies declared their dividends twice a year, the interim dividend and final dividend

Interim dividends / Temporary dividends
A dividend payment made before a company’s annual earnings are computed. Interim
dividends are declared and paid before the company has compiled its final financial
statements for a given year

6
Final dividends / Proposed dividends:
Final dividend is the last dividend declared in a accounting year and is determined after all
financial reports have been made. It would be proposed at companies’ annual general
meeting together with the final financial statements to be passed.
Debentures

Other than issuing shares, a company can raise funds by selling debentures

A debenture is a loan to a company

Debenture carry a fixed rate of interest
Note:
Interest is an expense (salaries, rent) 
Dividends are profit appropriations 
7
Reserves
(a) Reserve is any part of shareholders’ equity, except for basic share capital
(b) Reserves are funds set aside from profits / gains and may be specifically for a certain purpose
or may be a general surplus of funds
(c) There are different types of reserves such as revenue reserves, capital reserves and statutory
reserves:
(i)
Revenue reserves (profits from trading activities)
1
Revenue reserves are created from trading profits.
2
They are the portion of a company’s profits retained by the company (which are
not distributed to shareholders) for investment in future growth.
3
Also known as retained earnings
4
Revenue reserves can be distributed to shareholders in the form of dividends
27
(ii) Capital reserves (gains from non-trading activities)
1
Capital reserves are resources created by the accumulated capital surplus such as by an
upward revaluation of its assets and issuing shares above par value.
2
Capital reserves are not legally available for distribution to shareholders as dividends
3
Share premium, revaluation reserves, capital redemption reserve are examples of
capital reserves
4
Capital reserves can be used for writing off preliminary company setup costs, goodwill
etc. Capital reserves are less flexible compared to revenue reserves (capital reserves
cannot be distributed as dividends to shareholders)
5
Capital reserves can be capitalized by issuing bonus shares. Revenue reserves can
also be capitalized. However revenue reserves are usually retained for dividend
payouts
13 Exercise 1
The financial year of FRA Limited ends on 31 December.
The following information was available on 31 December 2016.
Paid-up share capital
1 400 000 ordinary shares of $0.50 each
500 000 6% preference shares of $1 each
Loan capital
300 000 5% debentures of $1 each
Retained earnings
$75 000
The profit for the year ended 31 December 2017 before interest amounted to $186 000
The directors made the following recommendations for the year ended 31 December 2017:
1 payment of annual preference share dividend
2 payment of ordinary share dividend of 8%
3 transfer of $40 000 to a general reserve
(i) Calculate the following.
Total debenture interest for the year
(a) Preference share dividend to be paid
(b) Ordinary share dividend to be paid
28
(ii) State why the company made a transfer to general reserve.
(iii) Calculate the profit retained in the year 2017
$
$
45
(iv) Prepare the capital and reserves section and the liabilities section of the statement of financial
position of FRA Limited at 31 December 2017.
FRA Limited
Extract from Statement of Financial Positon at 31 December 2017
$
Capital and Reserves
Paid-up share capital
Reserves
Loan capital
29
$
Exercise 2
Doris Ltd was formed some years ago. It raised funds from the issue of preference shares, ordinary
shares and debentures.
(i) Explain two features of each of the following.
(a) Preference shares
(b) Ordinary shares
Doris Ltd has an authorised share capital consisting of 2 000 000 5% preference shares of $1 each
and 8 000 000 ordinary shares of $0.50 each.
Half of the preference shares and 6 000 000 of the ordinary shares have been issued. The company
has also issued $1 000 000 4% debentures.
On 1 April 2016 the balance on the profit and loss account brought forward was $100 000. After the
appropriations the profit retained for the year ended 31 March 2017 was $50 000.
(ii) Prepare a relevant extract from the balance sheet of Doris Ltd at 31 March 2017 to show the
issued capital and reserves.
Doris Ltd
Extract from Statement of financial position at 31 March 2017
$
Capital and Reserves
Issued and paid-up share capital
Reserves
Loan capital
30
$
Exercise 1:
The following is an extract from the statement of financial position of X Limited at 31 December 2016.
Equity
$
Share capital ($1 ordinary shares)
400 000
Share premium
20 000
Retained earnings
190 000
Total equity
610 000
Non-current liabilities
8% debentures (2019 – 20)
80 000
Current liabilities
Trade and other payables
20 000
Cash and cash equivalents
60 000
80 000
Total liabilities
160 000
Total equity and liabilities
770 000
During the year ended 31 December 2017 the following transactions took place.
1 January 2017
30 June 2017
30 September 2017
Issue of 80 000 ordinary shares at $1.25 each.
Rights issue of 3 ordinary shares for every 8 shares held on this date at an
issue price of $1.30. This was fully subscribed.
Bonus issue of 1 ordinary share for every 6 shares held on this date.
(a) Prepare journal entries to record each of these transactions in the books of account. Dates and
narratives are not required.
Debit
1 January 2017
30 June 2017
30 September 2017
31
Credit
(b) Prepare a statement to show the effect that the transactions had on the total equity.
[3]
$
Equity brought forward
(c) State three uses of a share premium account.
[3]
1.
2.
3.
(d) State three reasons why a company may make a bonus issue of shares.
1.
2.
3.
32
[3]
Exercise 2
FIM Limited is a retailer of ladies' winter jackets. The following trial balance has been extracted from the
books of account at 31 December 2017.
Dr
Cr
$
$
Revenue
2 952 000
Purchases
1 440 000
6% debentures (2010 – 2023)
240 000
Administrative expenses
615 000
Cash and cash equivalents
96 000
Distribution costs
591 000
Dividends paid
30 000
General reserve
63 000
Interest paid
39 000
Inventory at 1 January 2017
294 000
Non-current assets at cost / valuation
Land and buildings
555 000
Plant and machinery
612 000
Provision for depreciation
Land and buildings
69 000
Plant and machinery
282 000
Ordinary shares of $0.50 each fully paid
420 000
Trade payables
177 000
Other payables
21 000
Trade receivables
327 000
Other receivables
9 000
Retained earnings
183 000
Share premium
________
9 000
4 512 000
4 512 000
Additional information
1
Inventory at 31 December 2017 is valued at a cost of $315 000.
2
Land is included in the trial balance at a value of $405 000. It is to be revalued to $450 000 at 31
December 2017.
3
Depreciation for the year ended 31 December 2017 is to be provided as follows:
Buildings – 2% per annum using the straight-line method
Plant and machinery – 10% per annum using the reducing balance method.
All annual depreciation is to be charged to administration expenses.
33
4
Trade receivables includes a debt of $27 000 which is to be written off to administrative
expenses at 31 December 2017.
5
The directors wish to make a provision for doubtful debts of 3% of trade receivables. The
adjustment should be charged to administrative expenses.
6
On 31 December 2017, FIM Limited made a bonus issue of shares on the basis of one ordinary
share for every ten ordinary shares held. The company policy is to leave reserves in their most
flexible form.
7
Debenture interest has been paid to 30 October 2017.
Notes & Workings:
1
Depreciation: Buildings
2
Depreciation: P&M
3
Provision for doubtful
debts
4
Administrative expenses
5
Revaluation reserve
6
Bonus issue (no. of
shares)
7
Bonus issue (par value)
8
Accrued debenture
interest
9
Trade receivables
10
Retained earnings
34
(a)
Income statement for FIM Limited for the year ended 31 December 2017
$
Revenue
Less: Cost of sales
Inventory at 1 January 2017
Purchases
Less: Inventory at 31 December 2017
Gross profit
Less:
Administrative expenses
Distribution costs
Profit from operations
Less: Finance costs
Interest
Profit for the year
Notes:
35
$
(b) Statement of financial position for FIM Limited at 31 December 2017
$
Non-current assets
Current assets
Current liabilities
Capital and reserves
Non-current liabilities
36
$
$
Additional information
The 6% debentures are due for repayment in the next three years. The directors of FIM Limited are
considering the following options to raise the necessary finance to repay the $240 000.
1
2
issue 480 000 ordinary shares of $0.50 each.
issue a further 6% debenture of $240 000.
(c) Discuss the impact on future profits of FIM Limited
(i)
Issue 480 000 ordinary shares
Issue of further debentures
(ii)
Advise: To issue the 480 000 ordinary shares of $0.50 each
Additional information
The statement of financial position of a limited company may include capital reserves and also revenue
reserves.
(d) State two differences between a capital reserve and a revenue reserve.
(e) Explain and state one reason why the company wants to leave reserves in their most flexible form.
37
Statement of Changes in Equity
1
The statement of owners equity is the second report of the financial statements. Its full name is the
statement of changes in owner's equity.
2
This accounting report shows all the changes to the owners equity that have occurred during the
period. These changes comprise capital, drawings and the profit for the period.
3
The format of the statement for a limited company is shown below:
Details
Share
capital
$
Retained
earnings
$
General
reserve
$
Revaluatio
n reserve
$
Total
equity
$
Balance at 1 Jan 2017
3 000
600
50
350
4 000
Profit for the year
800
800
Dividend paid
(200)
(200)
Transfer to general reserve
(100)
Issue of shares
100
1 000
1 000
Revaluation
Balance at 31 Dec 2017
4 000
1 100
Notes
Balance at 1 Jan 2017 :
Profit for the year:
Dividend paid:
Transfer to general reserve:
Issue of shares:
Revaluation:
38
150
140
140
490
4 690
Exercise 1:
The following is an extract from the statement of financial position of Chopin Limited at 30 June 2015:
$
Non-current assets
750 000
Ordinary shares of $0.25 each
300 000
Share premium
20 000
Retained earnings
635 210
During the year ended 30 June 2016, the following took place:
1 November 2015 Non-current assets were revalued to $1 000 000.
1 January 2016
A bonus issue of shares was made. The terms of the issue were 1 new share for
every 10 shares in existence. Reserves were maintained in the most flexible form.
1 April 2016
Dividend of $0.02 per share was paid.
Profit for the year ended 30 June 2016 was $230 809.
(a) Prepare a statement of changes in equity for the year ended 30 June 2016.
Opening balance
Ordinary
shares
Share
premium
Revaluation
reserve
Retained
earnings
Total
$
$
$
$
$
300 000
20 000
--
635 210
Workings:
No. of shares already issued =
Bonus issue =
Increase in share capital from bonus issue =
Note: Bonus issue  capitalization of reserves (
Dividends paid =
Note:
Dividends must be paid out from revenue reserves (retained earnings or general reserves)
39
955 210
Exercise 2:
The equity and reserves section of Howard Limited’s statement of financial position at 31 December
2016 was as follows:
$
Ordinary shares of $0.50 each
1 400 000
Share premium
260 000
Retained earnings
195 000
1 855 000
During the year ended 31 December 2017, the following transactions took place:
February 1
May 1
June 1
Issued 200 000 ordinary shares at $0.70 each.
Paid final dividend of $0.04 per ordinary share on all shares in issue at 31 December
2016.
Made a bonus issue of ordinary shares on the basis of two ordinary shares for every
fifteen ordinary shares held at that date.
(a) State the double entry to record each of these transactions. Dates and narratives are not required.
Debit
Credit
$
$
Name of account
Workings:
No. of shares already issued =
Bonus issue =
Increase in share capital from bonus issue =
40
Additional information
On 1 August 2017, Howard Limited also made a rights issue of one ordinary share for every ten ordinary
shares held at a price of $0.60. All shareholders took up their rights.
(b) Prepare a schedule showing the movement in the share premium account during the year ended
31 December 2017.
At
$
1 January 2017:
February 1:
June 1:
August 1:
31 December 2017:
(c) State three reasons why a company may make a bonus issue of shares.
1.
2.
3.
Note: bonus issue will increase share capital
(d) State the reasons why a company may make a rights issue
1.
2.
1. State three differences between ordinary shares and preference shares.
1.
2.
3.
4.
41
INTERPRETATION AND ANALYSIS FINANCIAL RATIOS
1
Introduction
(a) Financial ratios are mathematical comparisons of financial statement accounts or categories.
(b) These relationships between the financial statement accounts help investors, creditors, and
internal company management understand how well a business is performing and areas of
needing improvement.
(c) Ratios can be expressed as a value, such as 0.10, or given as an equivalent percent value, such
as 10%. Some ratios are usually quoted as percentages, especially ratios that are usually or
always less than 1
2
Types of ratios
(a) Financial ratios are categorized according to the financial aspect of the business which the ratio
measures.
(b) Liquidity ratios measure the ability to pay short-term debts.
(c) Activity ratios measure the efficiency of management of company assets such as stocks and
debtors.
(d) Debt ratios measure the firm's ability to repay long-term debt.
(e) Profitability ratios measure the firm's use of its assets and control of its expenses to generate an
acceptable rate of return.
(f) Market ratios measure investor response to owning a company's stock and also the cost of
issuing stock. These are concerned with the return on investment for shareholders, and with the
relationship between return and the value of an investment in company’s shares.
3
Liquidity Ratios
(a) Liquidity ratios analyze the ability of a company to pay off both its current liabilities (near-term
obligations) as they become due.
(b) These ratios show the cash levels of a company and the ability to turn other assets into cash to
pay off liabilities and other current obligations.
(c) Inadequate liquidity can spell doom, even for a profitable company or a company with
significant non-cash assets.
(d) Assets like accounts receivable, trading securities, and inventory are relatively easy for many
companies to convert into cash in the short term.
42
3.1
Current ratio
(a) A liquidity ratio that measures a company's ability to pay short-term obligations.
(b) The higher the current ratio, the more capable the company is of paying its obligations.
(c) A ratio under 1 suggests that the company would be unable to pay off its obligations if they
came due at that point.
(d) Example: On 1 January 2017 Joy Keeper’s and Tan Tan’s financial position was:
Joy Keeper
$
Non-current assets
Current assets
Trade receivables
Stocks
Bank
Tan Tan
$
500 000
150 000
120 000
130 000
$
$
700 000
250 000
100 000
150 000
Current liabilities
Trade payables
Capital
400 000
900 000
500 000
1 200 000
200 000
700 000
300 000
900 000
700 000
900 000
Calculate and explain the current ratio of both businesses at 1 January 2017
Ratio
Current ratio
Formula
Joy Keeper
Tan Tan
𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔
𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
3.2 Acid test ratio / Quick ratio
(a) The acid test ratio measures the liquidity of a company by showing its ability to pay off its
current liabilities with quick assets.
(b) The ratio provides a more stringent test of debt-paying ability with a firm's quick assets
(cash, short-term investments, and trade debtors).
Ratio
Quick ratio
Formula
Joy Keeper
Tan Tan
𝑞𝑢𝑖𝑐𝑘 𝑎𝑠𝑠𝑒𝑡𝑠
𝟒𝟎𝟎 𝟎𝟎𝟎
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝟑𝟎𝟎 𝟎𝟎𝟎
= 1.33 : 1
Note: Quick assets are those assets that can be changed to cash quickly without a substantial drop
in value. Inventories are usually not considered as quick assets
43
Note:
General guide: Current ratio = 2 : 1; Quick ratio = 1 : 1
If liquidity ratio is rather high, e.g current ratio 4 : 1, or quick ratio = 3 : 1

4
Inventory Turnover
(a) A ratio showing how many times a company's inventory is sold and replaced over a period.
(b) The days in the period can then be divided by the inventory turnover formula to calculate the
days it takes to sell the inventory on hand or "inventory turnover days."
(c) A low turnover implies poor sales and, therefore, excess inventory.
(d) A high ratio implies either strong sales or ineffective buying.
(e) Example: Calculate from the information below, the inventory turnover of both companies:
Joy Keeper
$
500 000
40 000
30 000
Cost of sales
Opening inventory
Closing inventory
Ratio
Inventory
turnover
Formula
Joy Keeper
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Note: Assuming both have the same sales
Joy Keeper must have purchase lower quantity of stocks
Note:
High inventory turnover



Low inventory turnover

44
Tan Tan
$
700 000
50 000
60 000
Tan Tan
5
Average Collection Period (Trade Receivables Turnover)
(a) The approximate amount of time that it takes for a business to receive payments owed, from its
customers.
(b) A lower average collection period is seen as optimal, because this means that it does not take a
company very long to turn its receivables into cash.
(c) Example: Calculate and comment, from the information below, the average collection period of
both companies:
Joy Keeper
$
800 000
40 000
Sales
Closing trade receivables
Tan Tan
$
900 000
80 000
Additional information:
All of Joy Keeper's sales are credit sales while 80% of Tan Tan's sales are credit sales.
Ratio
Trade
receivables
turnover
Formula
Joy Keeper
𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
Note: higher trade receivables
Lower trade receivables
45
Tan Tan
6
Trade payables Turnover (Average Payment Period)
Joy Keeper
$
400 000
30 000
Purchases
Closing trade payables
Tan Tan
$
600 000
70 000
Additional information:
Joy Keeper purchases on credit only while 80% of Tan Tan's purchases are on credit.
Ratio
Trade payables
turnover
Formula
Joy Keeper
𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑡𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠
Higher trade payables turnover
Advantages:
Disadvantage:
Lower trade payables turnover
Disadvantages:
Advantage:
46
Tan Tan
7
Non-current Asset Turnover Ratio
(a) The amount of sales or revenues generated per dollar of non-current assets.
(b) The asset turnover ratio is an indicator of the efficiency with which a company is deploying
its non-current assets.
(c) Generally speaking, the higher the ratio, the better it is, since it implies the company is
generating more revenues per dollar of non-current assets.
(d) Example: Calculate and comment, from the information below, the non-current asset
turnover ratio of both companies:
Joy Keeper
$
800 000
100 000
Sales
Closing non-current assets
Ratio
Non-current asset
turnover
Formula
Joy Keeper
𝑠𝑎𝑙𝑒𝑠
𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑛𝑜𝑛−𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡
47
Tan Tan
$
900 000
70 000
Tan Tan
Exercises:
1
Mario is a trader. He provided the following summary of his assets and liabilities on 31 Jan 2018.
$
$
Non-current assets
175 000
Inventory
21 500
Cash
100
Trade receivables
37 400
59 000
234 000
Capital
145 000
Profit for the year
35 000
180 000
Trade payables
36 800
Bank overdraft
12 200
Short term loan
5 000
54 000
234 000
For the year ended 31 January 2018:
Revenue
Cost of sales
Expenses
$450 000
$310 000
$105 000
(a) Complete the table below to compare the performance of his business for the year ended 31
January 2015 with that of the previous financial year. Calculations should be correct to two
decimal places.
Ratio
Gross profit to revenue %
Formula
𝑔𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
𝑟𝑒𝑣𝑒𝑛𝑢𝑒
2017
(given)
40%
x 100
Net profit to revenue %
7.5%
Current ratio
2:1
Quick ratio
1:1
Return on capital
employed
𝑃𝐵𝐼𝑇
𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
x 100
𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
Return on total assets
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
x
100
Note: PBIT  profit before interest & tax
48
Year ended 31 January
2018
Workings
Answer
Capital employed = Equity + non-current liabilities
(b) Suggest three reasons for the change in the percentage of gross profit to revenue.
1.
2.
3.
(c) State the year in which Mario had better control over his expenses. Give a reason for your
answer
(d) Comment on the liquidity of Mario for the year 2018 compared to 2017.
Note:
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
current ratio = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=
𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝑏𝑎𝑛𝑘 + 𝑑𝑒𝑏𝑡𝑜𝑟𝑠
𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 + 𝑏𝑎𝑛𝑘 𝑜𝑣𝑒𝑟𝑑𝑟𝑎𝑓𝑡
49
8
The following balances were extracted from the books of Penny on 31 March 2018.
$
Equipment (net book value)
40 000
Delivery vans (net book value)
22 000
Inventory
10 670
Trade receivables
11 200
Other receivables
4 130
Bank overdraft
4 200
Trade payables
8 800
6% Bank loan (repayable 23 May 2026)
15 000
Capital 31 March 2018
60 000
Additional information:
1.
For the year ended 31 March 2018, the following were reported:
$
480 000
240 000
100 000
Total credit sales
Total credit purchases
Total expenses
2.
At 31 March 2017, the following balances were reported:
$
28 000
15 000
20 000
Inventory
Trade payables
Trade receivables
Workings:
1. Cost of sales
Trading Account
50
2. Gross profit
3. Profit for the year
4. Total assets
51
Calculate the following ratios:
Formula
Current ratio
Quick ratio
Inventory turnover
Workings
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
2:1
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑞𝑢𝑖𝑐𝑘 𝑎𝑠𝑠𝑒𝑡𝑠
1.18 : 1
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
13.31 times
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Inventory turnover
(days)
Trade receivables
turnover
27.42 days
𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
42.86 times
𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
Trade receivables
turnover (days)
Trade payables
turnover
8.52 days
𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
27.27 times
𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑡𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠
Trade payables
turnover (days)
Non-current asset
turnover
Gross profit margin
Net profit margin
Return on capital
employed
31 March 2018
13.38 days
𝑠𝑎𝑙𝑒𝑠
7.74 times
𝑡𝑜𝑡𝑎𝑙 𝑛𝑜𝑛−𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡
𝑔𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
𝑠𝑎𝑙𝑒𝑠
x 100
𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
𝑠𝑎𝑙𝑒𝑠
𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
46.39%
x 100
25.56%
x 100
163.56%
52
The following is an extract of Chikkadea’s financial statements for the year ended 30 April 2018.
Income Statement for the year ended 30 April 2018
$
Revenue
$
375 000
Less cost of sales:
Inventory at 1 May 2017
32 000
Purchases
281 250
313 250
Inventory at 30 April 2018
28 000
285 250
Gross profit
89 750
Less:
Expenses
44 750
Profit for the year
45 000
Statement of financial position at 30 April 2018
Assets
$
Non-current assets
$
428 000
Current assets
Inventory
28 000
Trade receivables
22 500
Bank
1 500
52 000
Total assets
480 000
Equity and liabilities
Equity:
Capital
450 000
Current Liabilities
Trade payables
30 000
480 000
The following have been calculated for Dakeeri, a competitor in the same type of business.
(i)
Gross profit ratio
20.2%
(ii)
Net profit ratio
(iii)
Return on capital employed
9%
(iv)
Return on total assets
8%
(v)
Current ratio
1.5 : 1
(vi)
Acid test ratio
0.7 : 1
(vii)
Trade receivable days
28 days
(viii)
Trade payable days
35 days
(ix)
Inventory turnover
8 times
10%
53
(a)
Calculate the same ratios for Chikkadea’s business.
Formula
Workings
Answer to one
decimal place
(i)
23.9%
(ii)
12.0%
(iii)
10%
(iv)
9.4%
(v)
1.7 : 1
(vi)
0.8 : 1
(vii)
21.9 days
(viii)
38.9 days
(ix)
9.5 times
54
(b)
(i) Name the business which performed better during the year ended 30 April 2018.
(ii) Justify your answer to (b) (i) by comparing four of the ratios which you have calculated with
the same four ratios given for Dakeeri.
55