CHAPTER 1
Companies
Concepts, unique ledger accounts and bookkeeping
Progression
▪ Grade 10: Concepts, unique ledger accounts and bookkeeping
of sole traders
▪ Grade 11: Concepts, unique ledger accounts and bookkeeping
of partnerships and clubs
▪ Grade 12: Concepts, unique ledger accounts and bookkeeping
of companies
_____________________________________________________
Introduction
❖
Up until now in accounting, we have dealt with two types of business:
Sole proprietor (in Grade 10)
Partnerships (in Grade 11)
❖
Companies originated as a result of the shortcomings of these other types of business.
❖
The main differences between companies and sole proprietors or partnerships are as follows:
Sole proprietor
Partnership
Company
One owner
Two or more partners
Shareholders
Not a separate legal entity
Not a separate legal entity
Separate legal entity
No legal regulations
A few legal regulations
Bound by Companies Act
Profits belong to owner
Profits are distributed in specific
ratios to partners
Profits belong to the company and are paid out to
shareholders by way of dividends
Owner has unlimited liability
(liable for all debts/losses)
Partners have unlimited liability
(liable for all debts/losses)
Shareholders’ liability is limited
(the company as a legal entity is liable for debts/losses)
Managed by owner
Managed by partners
Managed by board of directors
No foundation documents
Partnership agreement
Memorandum of Incorporation (MOI) and Notice of
Incorporation
_______________________________________________________________________________
Legal entity
❖
❖
According to the business dictionary, a legal entity has legal capacity to:
•
enter into agreements or contracts,
•
assume obligations,
•
incur and pay debts,
•
sue and be sued in its own right, and
•
to be held responsible for its actions.
In other words, a company as a legal entity implies the following:
•
A company has its own rights and responsibilities.
•
The company operates independent from its shareholders.
•
The company owns the assets in its own right.
•
The income generated belongs to the company.
•
The company as an entity is liable for tax.
•
The company is liable for the its obligations.
Company
independent from its
Shareholders
_______________________________________________________________________________
Advantages of a company
❖
❖
❖
Separate legal entity
•
A company has a legal existence separate from its management and shareholders.
•
A company may own assets in its own right, may incur debt and perform jural acts.
Limited liability to shareholders
•
Should a company fail, a shareholder’s only loss is the value of their shares.
•
The personal assets of the shareholder are protected.
•
This is not the case with a sole proprietor and partnership, where the personal
assets of the proprietor or partners may be confiscated should the business fail.
Continuity
•
Directors, managers and employees only act as agents of the company.
•
If they leave, retire or die, the company remains in existence.
________________________________________________________________________________
Disadvantages of a company
❖
Companies are costly and complex to administer.
❖
Companies are regulated by the Companies Act, which protect the shareholders.
❖
Statutory audit of financial statements for companies with public liability are required.
________________________________________________________________________________
Companies Act
❖
South Africa has a well-developed and formally regulated Companies Law.
❖
The Companies Act 61 of 1973 used to regulate all matters relating to companies.
❖
In April 2011, a new Companies Act 71 of 2008 became law.
❖
The aims of the new Companies Act are:
•
to simplify the procedure for forming companies, and
•
to reduce the cost of forming and running a company.
❖
The new Act brings relief to smaller companies that could not afford high audit fees.
❖
The Companies Act covers aspects such as:
❖
•
the procedures for forming a company,
•
how capital may be raised,
•
how companies should be run and
•
what information should be disclosed in financial statements.
The Companies Act is administered by the Registrar of Companies, who issues
registration certificates to registered companies as evidence of incorporation.
CIPC – Companies and Intellectual Properties Commission (Department of Trade and Industry)
_______________________________________________________________________________
Types of companies
❖
The following is a summary of the various types of companies that may be formed:
Profit
companies
❖
Non-profit
companies
Private
company (Pty) Ltd
Personal liabilities
company Inc.
State-owned
company SOC Ltd
Public
company Ltd
Non-profit
company
Its Memorandum of
Incorporation (MOI)
prevents it from
offering securities to
the public and
restricts the
transferability of
securities.
MOI states that the
directors and past
directors are jointly
liable, together with
the company, for any
debts and liabilities
that were contracted
during their periods of
office.
They are defined in
terms of the Public
Finance
Management Act or
are owned by a
municipality.
The public is invited
to buy shares and
these shares can be
transferred freely.
Certain aspects of
the Companies Act
do not apply to
these companies.
In Grade 12 we will limit our discussions to:
•
the difference between public and private companies, and
•
the bookkeeping process of public companies.
_______________________________________________________________________________
https://www.listcorp.com/jse
Public and private companies
The following table compares the differences between these two types of companies:
Aspect
Public company
Private company
May be incorporated by …
one person
one person
Company name ends in …
“Limited”
(abbreviation: Ltd.)
“Proprietary Limited”
(abbreviation: (Pty) Ltd.)
Three
One
Shares offered to public
Public is invited to buy shares.
Public is not invited to buy shares.
Transferability of shares
Shares can be transferred freely.
Shares can only be transferred after approval
by the Board of Directors.
Public companies must appoint an auditor,
audit committee and company secretary.
Private companies appoint an audit committee
only to the extent provided for in the MOI.
Audit requirements
Must have audited financial statements that
should be presented to shareholders at the
AGM within six months after financial year-end.
Only need to be audited if certain requirements
are met (mainly for larger private companies)
Appointment of a Social and
Ethics Committee
Must appoint a Social and Ethics Committee.
Only need to appoint a Social and Ethics
Committee if certain requirements are met
(mainly for larger private companies).
issuing shares to the public
issuing shares to the owners
Minimum number of directors
Appointment of an auditor, audit
committee and company secretary
Capital raised by …
Formation of a company
When registering and founding a company, the Companies Act stipulates the following:
The founding company must first draw up the following:
Memorandum of Incorporation (MOI)
Memorandum of Incorporation (MOI):
a document that sets out rights, duties and
responsibilities of shareholders, directors and
others within and relation to a company
Notice of Incorporation
these must then be submitted to the …
Notice of Incorporation:
a formal announcement to the public,
indicating the formation of a new legal entity
Registrar of Companies
(Companies and Intellectual Property Commission or CIPC)
The Registrar will then:
• approve the name of the company
• enter information about the company in the Companies Register
• endorse the Notice of Incorporation and Memorandum of Incorporation.
A registration certificate will then be issued to the
company so that it can commence business.
The company must then compile a prospectus.
The prospectus should contain, among others:
• the name of the company,
• the address of the company,
• the detail of the directors,
• the particulars of share capital, etc.
Prospectus:
a document describing the main features of a
business for prospective buyers
HOMEWORK (CLASS DISCUSSION)
➢ https://www.youtube.com/watch?v=GnJC
Oof2HJk
➢ https://www.youtube.com/watch?v=Y0JQo
qdh7oM
➢ https://www.youtube.com/watch?v=k1PtFs
xs7W4
Board of Directors
❖
The shareholders, as the “owners” of a company, elect a Board of Directors (“board”)
to act as the coordinating and policy-making body of the company.
❖
The board must consist of at least three directors.
❖
Most boards of public companies have between eight and twelve directors.
❖
A director of a company must exercise his powers and perform his functions:
❖
❖
•
in good faith and for a proper purpose
•
in the best interest of the company
•
with a high degree of skill, care and diligence.
A director of a company may be held personally liable for any loss, damage or costs
sustained by the company as a result of a breach of the director’s:
•
fiduciary duty (duty to act in good faith and in the best interest of the company); or
•
the duty to act with care, skill and diligence.
Directors can be executive, non-executive or independent.
_______________________________________________________________________________
Board of Directors (continued)
❖
❖
Executive directors
•
are involved in the day-to-day management of the company, and/or
•
are in full-time salaried employment of the company.
Non-executive directors
•
❖
❖
are independent of management on all issues including strategy, performance,
sustainability resources, transformation, employment equity etc.
Independent directors
•
should not have been employed by the company during the previous three years,
•
should be totally independent from the company, and
•
should provide independent judgment and broad business experience to the board.
Some of the board’s roles and functions are to:
•
provide strategic direction to the company and approve strategic plans
•
retain effective control of the company and ensure that it complies with all laws and regulations
•
delegate appropriate powers to management and to monitor them on an ongoing basis
•
identify and monitor key risks and ensure that the company has effective internal control
measures to manage all risks
•
identify and monitor key performance areas for the board and management.
_______________________________________________________________________________
Management of the company
❖
Not all board members are involved in daily routine activities.
❖
A management team is usually appointed to do this.
❖
Management consists of a managing director and other officials, who are responsible for
controlling and managing the company’s activities.
❖
There may be a manager for each department of the company (e.g. a sales manager,
purchases manager, human resources manager, marketing manager etc.).
❖
The main role of management is to ensure that the company meets its objectives.
❖
A good manager will be able to:
•
define strategies and goals for the company
•
apply financial, budgetary, personnel, policy and security judgments
•
do strategic planning by setting targets and making sure benchmarks are achieved
•
lead, motivate, do teambuilding and have good relationships with employees
•
have good communication skills externally and internally in their organisation.
_______________________________________________________________________________
Independent auditors and the audit committee
Independent auditors
❖
All public companies must appoint a registered independent auditor at every AGM.
❖
The independent auditors perform an audit of the company’s financial statements.
❖
The independent auditors then provide an independent opinion on the accuracy and
reliability of the company’s financial statements.
Audit committee
❖
The shareholders of all public companies must appoint an audit committee at every AGM.
❖
Some of the duties of the audit committee include:
•
nominating an independent auditor and determining the audit fee
•
ensuring the appointment of the auditor complies with all regulations
•
evaluating the company’s exposure and responses to significant risks
•
ensuring effective communication between directors, management,
internal auditors and external auditors
•
reviewing compliance with JSE listing requirements and King III.
_______________________________________________________________________________
Social and ethics committee
❖
The new Companies Act requires all public companies and state owned companies
(as well as many other larger companies) to appoint a social and ethics committee.
❖
The committee must comprise at least three directors, of whom at least one should be
an independent non-executive director.
❖
The social and ethics committee is required to report to the shareholders at the AGM.
❖
The primary function of the social and ethics committee is to monitor the company’s
activities relating to, amongst other:
❖
•
social and economic development;
•
good corporate citizenship;
•
the environment;
•
consumer relationships; and
•
certain employment-related matters.
This is very much in line with the policies of King III, which states that the board
should ensure that the company’s ethics are managed effectively.
_______________________________________________________________________________
Shareholders
❖
A shareholder has the following rights:
•
❖
Voting power on major issues
(e.g. electing directors and fundamental changes)
•
An entitlement to dividends
•
Ownership in a portion of the company
•
Opportunity to inspect the company’s records
usually one vote for
every share they own
they share in the profits
of the company
they will share in the final distribution
of net assets upon liquidation
The following should be transacted during the AGM:
•
Presentation of the directors’ report, audited financial statements
and report of the audit committee
•
Election of directors
•
Appointment of an auditor and an audit committee
•
Any matters raised by shareholders.
_______________________________________________________________________________
Johannesburg Stock Exchange Limited (JSE)
❖
The Johannesburg Stock Exchange Limited (JSE) is the largest stock exchange in Africa.
❖
The JSE provides a market where shares can be traded freely under a regulated procedure.
❖
The JSE is bound by the provisions of the Stock Exchange Control Act 1 of 1985 (SECA).
❖
The JSE is required by SECA to look after the interests of both:
•
the investing public, and
•
its member companies.
❖
The JSE’s “Listing Requirements” are the rules and regulations that need to be complied with
by all its member companies.
❖
The “Listing Requirements” set regulations for, amongst others:
•
the preparation of financial statements
•
audit requirements
•
corporate governance, etc.
_______________________________________________________________________________
Shares
❖
A company needs funds to start and run a business, it can get these funds in the following ways:
Selling shares
❖
Generating profit
Borrowing through loans
There are two basic classes of shares that a company may issue:
Ordinary shares
Preference shares
Usually outperform preference shares on the stock markets,
but are riskier from an investor’s point of view.
Preference shareholders have preference over ordinary
shareholders if the company is liquidated
Dividends on ordinary shares are not guaranteed –
depends on the profitability and cash flow of the company.
Generally a fixed percentage dividend is paid annually
on preference shares
❖
In Grade 12, we will only deal with ordinary shares, not preference shares.
❖
Authorised and issued share capital
•
Authorised shares are the maximum number of shares a company’s MOI permits it to issue.
•
Issued shares are the number of shares the company has actually sold.
•
Issue price is the price at which the shares are sold.
•
The difference between the authorised share capital and the issued share capital is known
as the reserve or unissued share capital.
_______________________________________________________________________________
Example: Issuing ordinary shares
Information:
According to the Memorandum of Incorporation (MOI) of Danjo Traders Ltd, they are authorised to
issue 100 000 ordinary shares.
On 1 March 2018, Danjo Traders Ltd issued 60 000 shares to the public at R16,50 per share.
On 31 March 2018, applications for all 60 000 shares together with their payments were received.
Required:
1. Show the entries in the journals
2. Post to the General Ledger
3. Show the effect on the accounting equation and how it will be reflected in the notes to the
financial statements.
Solution:
Entry in the Cash Receipts Journal:
Cash Receipts Journal of Danjo Traders Ltd for March 2018
Doc
no.
65
Day
31
Details
Shareholders
Fol.
B1
Analysis of
receipts
990 000 00
CRJ
Sundry accounts
Bank
Details
Amount
990 000 00
990 000
00
Ordinary share capital
Example: Issuing ordinary shares (continued)
Posting to the General Ledger:
General Ledger of Danjo Traders Ltd
Balance Sheet accounts
Dr
Ordinary Share Capital
2018
Mar
Dr
B1
31 Bank
CRJ
Bank
2018
Mar 31 Ordinary share capital
CRJ
990 000
B6
00
The effect on the accounting equation:
Owner’s equity
Assets
Effect
+ 990 000
Reason
Cash increase
Effect
+ 990 000
Reason
Increase in ordinary share
capital
Liabilities
Effect
Reason
Cr
990 000 00
Cr
Example: Issuing ordinary shares (continued)
Notes to the financial statements:
Danjo Traders Ltd
NOTES TO THE FINANCIAL STATEMENTS
7. ORDINARY SHARE CAPITAL
AUTHORISED
Number of ordinary authorised shares: 100 000 shares
ISSUED
60 000 ordinary shares in issue at 1 March 2018
60 000 additional shares issued during the financial year at issue price R16,50 each
990 000
60 000 ordinary shares in issue at 31 March 2018
990 000
Income tax
❖
In a sole proprietor or partnership, the net profit belongs to the owner or partners and
therefore the owner or partners must pay tax in their personal capacities.
❖
Since a company is a legal entity, the net profit belongs to the company and the
company has to pay income tax.
❖
Income tax is paid to the South African Revenue Services (SARS).
❖
Provisional tax
❖
•
Companies are obliged to pay provisional tax during the tax period.
•
The first provisional tax payment is due six months into the financial year.
•
The second provisional tax payment is due at the end of the financial year.
At the end of the financial year, companies are required to:
•
calculate their income tax for the year,
•
submit this information to SARS by completing a tax return form, and
•
submit their financial statements to SARS.
❖
SARS will then perform an independent tax calculations and issue the company with
a final tax assessment, which states the amount of income tax due for the year.
❖
Any outstanding income tax needs to be paid within seven months of the year end.
_______________________________________________________________________________
Income tax (continued)
❖
Provisional tax payments are recorded in the company’s Cash Payments Journal and
debited against the SARS (Income Tax) account.
Debit: SARS (Income Tax)
Credit: Bank
❖
As this is an advance payment, the SARS (Income Tax) account is considered an asset
until the company calculates its final tax at the end of the financial year.
❖
The income tax calculated at the end of the year is considered a year-end adjustment
and is recorded in the General Journal.
Debit: Income Tax
❖
Should the provisional tax paid be less than the total income tax due, then:
•
❖
Credit: SARS (Income Tax)
the SARS (Income Tax) account will have a credit balance and be considered a liability.
Should the provisional tax paid exceed the total income tax due, then:
•
the SARS (Income Tax) account will have a debit balance and be considered an asset.
_______________________________________________________________________________
Income tax (continued)
Diagram illustrating the timing of the various income tax payments:
Beginning of
financial year
1 Mar 2017
6 months after beginning
of financial year
31 Aug 2017
Last day of
financial year
7 months after end
of financial year
28 Feb 2018
30 Sep 2018
Submit tax return form
First provisional
tax payment
Second provisional
tax payment
Third (final)
tax payment
Receive tax assessment
Example: Income tax
The financial year of Danjo Traders Ltd ends on 28/29 February. On 1 March 2018, the balance of the
SARS (Income Tax) account was nil.
Provisional payments for income tax made during the year ended 28 February 2019 were as follows:
• First provisional payment on 31 August 2018
R75 000
• Second provisional payment on 28 February 2019
R80 000
Danjo Traders Ltd calculated the profit before tax for the year ended 28 February 2019 to be R540 000.
Tax should be provided for at 30% for the 2019 tax year.
Required:
1. Show the journal entries for the year 1 March 2018 to 28 February 2019.
2. Show the entries in the General Ledger for the period 1 March 2018 to 28 February 2019.
3. Show the effect of the transactions from 1 March 2018 to 28 February 2019 on the accounting equation.
4. Show the entry for SARS (Income Tax) on 28 February 2019 in the notes to the Financial Statements.
Entries in the journals:
Cash Payments Journal of Danjo Traders Ltd
CPJ
Sundry accounts
Date
Details
Fol.
Bank
Amount
Details
31 Aug 2018
SARS
75 000 00
75 000 00
SARS (income tax)
28 Feb 2019
SARS
80 000 00
80 000 00
SARS (income tax)
General Journal of Danjo Traders Ltd for February 2019
Day
28
Details
Income tax (540 000  30%)
SARS (income tax)
Fol.
GJ
Debit
Credit
162 000 00
162 000 00
Example: Income tax (continued)
Posting to the General Ledger:
General Ledger of Danjo Traders Ltd
Balance Sheet accounts
Dr
SARS (Income Tax)
2018
Aug 31 Bank
CPJ
75 000
00
2019
Feb 28 Bank
CPJ
80 000
00
c/d
7 000
00
162 000
00
Balance
2019
Feb
B12
28 Income tax (540 000  30%)
GJ
Cr
162 000 00
162 000 00
2019
Mar
1
Balance
b/d
7 000 00
Nominal accounts
Dr
2019
Feb 28 SARS (income tax)
Income Tax
GJ
162 000
00
162 000
00
2019
Feb
N22
28 Appropriation account
GJ
Cr
162 000 00
162 000 00
Example: Income tax (continued)
The effect on the accounting equation:
Owner’s equity
Assets
Date
Effect
Reason
31 Aug 2018
– 75 000
Cash decreases
– 75 000
Debt to SARS decreases
28 Feb 2019
– 80 000
Cash decreases
– 80 000
Debt to SARS decreases
+ 162 000
Debt to SARS increases
28 Feb 2019
Effect
Liabilities
– 162 000
Reason
Effect
Income tax – decreases
remaining profit
Notes to the financial statements:
Danjo Traders Ltd
NOTES TO THE FINANCIAL STATEMENTS ON 28 FEBRUARY 2019
9. TRADE AND OTHER PAYABLES
Trade creditors
SARS (income tax)
–
7 000
7 000
Reason
Example: Income tax (continued)
Danjo Traders Ltd made the following payments to SARS during the financial year ending 29 February 2020:
• On 31 May 2019, paid R7 000 that was still payable to SARS for income tax from the previous period.
• First provisional payment on 31 August 2019
R85 000
• Second provisional payment on 29 February 2020
R85 000
Danjo Traders Ltd calculated the profit before tax for the year ended 29 February 2020 to be R550 000.
Tax should be provided for at 30% for the 2020 tax year.
Required:
1. Show the entries in the General Ledger for the period 1 March 2019 to 29 February 2020.
2. Show the entry for SARS (Income Tax) on 29 February 2020 in the notes to the Financial Statements.
Posting to the General Ledger:
General Ledger of Danjo Traders Ltd
Balance Sheet accounts
Dr
SARS (Income Tax)
2019
May 31 Bank
Aug
CPJ
7 000
00
2019
Mar
1
2020
Feb
29 Income tax (550 000  30%)
31 Bank
CPJ
85 000
00
2020
Feb 29 Bank
CPJ
85 000
00
177 000
00
5 000
00
2020
Mar
1 Balance
b/d
B12
Balance
Balance
Cr
b/d
7 000 00
GJ
165 000 00
c/d
5 000 00
177 000 00
Example: Income tax (continued)
Posting to the General Ledger (continued):
General Ledger of Danjo Traders Ltd
Nominal accounts
Dr
2020
Feb 29 SARS (income tax)
Income Tax
GJ
165 000
00
165 000
00
2020
Feb
N22
29 Appropriation account
Danjo Traders Ltd
NOTES TO THE FINANCIAL STATEMENTS ON 29 FEBRUARY 2020
5. TRADE AND OTHER RECEIVABLES
SARS (income tax)
165 000 00
165 000 00
Notes to the financial statements:
Trade debtors
GJ
Cr
–
5 000
5 000
Dividends
Shareholders receive dividends as a “reward” for the money they invested in a company.
Interim dividends
❖
These dividends are declared and distributed (paid) during the financial year.
❖
Since an interim dividend is paid immediately, this transaction will be entered in the CPJ.
❖
This will then be recorded in the General Ledger as follows:
Debit: Dividends on Ordinary Shares
Credit: Bank
Final dividends
❖
These dividends are declared at the end of the financial year, but are not distributed.
❖
Since final dividends are only declared and not distributed, this will be reflected as a liability
in the Statement of Financial Position (Balance Sheet) at the end of the financial year.
❖
These final dividends will only be paid in the next financial period.
❖
Since this is a non-cash transaction, this transaction will be entered in the GJ.
❖
This will then be recorded in the General Ledger as follows:
Debit: Dividends on Ordinary Shares
Credit: Shareholders for Dividends
_______________________________________________________________________________
Example: Dividends
The financial year of Danjo Traders Ltd ends on 28/29 February.
On 28 February 2018, Danjo Traders Ltd had an issued share capital of R990 000 consisting of 60 000 ordinary shares.
Transactions with regards to dividends for the financial year ending 28 February 2019:
• Declared and paid interim dividends of 20 cents per share on 31 August 2018
• Declared a final dividend of 60 cents per share on 28 February 2019
Transactions with regards to dividends for the financial year ending 29 February 2020:
• Pay the amount owed to shareholders declared in the previous financial year on 2 April 2019
• Declared and paid an interim dividend of 43 cents per share on 31 August 2019
• Declared a final dividend of 107 cents per share on 29 February 2020
Required:
1. Show the journal entries on 31 August 2018 and 28 February 2019.
2. Show the entries in the General Ledger for the period 1 March 2018 to 29 February 2020.
3. Show the effect of the transactions from 1 March 2018 to 28 February 2019 on the accounting equation.
4. Show the entry for Shareholders for dividends on 28/29 February 2019 and 2020 in the notes to the Financial Statements.
Entries in the journals:
Cash Payments Journal of Danjo Traders Ltd for August 2018
Doc
no.
CPJ
Sundry accounts
Day Details
Fol.
Bank
Amount
31
Shareholders (60 000  0.20)
12 000 00
12 000 00
Details
Dividends on ordinary shares
General Journal of Danjo Traders Ltd for February 2019
Day
28
Details
Dividends on ordinary shares
Shareholders for dividends
[Final dividends declared (60 000  0.60)]
Fol.
GJ
Debit
Credit
36 000 00
36 000 00
Example: Dividends (continued)
Posting to the General Ledger:
General Ledger of Danjo Traders Ltd
Balance Sheet accounts
Dr
2019
Apr
Shareholders for Dividends
2 Bank
CPJ
36 000
00
36 000
00
2019
Feb
28 Dividends on ordinary shares
B13
GJ
Cr
36 000 00
36 000 00
2020
Feb
29 Dividends on ordinary shares
GJ
64 200 00
Nominal accounts
Dr
2018
Aug 31 Bank
2019
Feb 28 Shareholders for dividends
2019
Aug 31 Bank (60 000  0.43)
2020
Feb 29 Shareholders for dividends
(60 000  1.07)
Dividends on Ordinary Shares
CPJ
12 000
00
GJ
36 000
00
48 000
00
CPJ
25 800
00
GJ
64 200
00
90 000
00
2019
Feb
28 Appropriation account
N24
GJ
Cr
48 000 00
48 000 00
2020
Feb
29 Appropriation account
GJ
90 000 00
90 000 00
Example: Dividends (continued)
The effect on the accounting equation:
31 Aug 2018
Owner’s equity
Assets
Date
Effect
Reason
– 12 000
Cash decreases
28 Feb 2019
Effect
Liabilities
Reason
Effect
– 12 000
Dividends – distribution of profit
– 36 000
Dividends – distribution of profit
+ 36 000
Reason
Debt to Shareholders for
dividends increases
Notes to the financial statements:
Danjo Traders Ltd
NOTES TO THE FINANCIAL STATEMENTS ON 28 FEBRUARY 2019 AND 29 FEBRUARY 2020
9. TRADE AND OTHER PAYABLES
Trade creditors
SARS (income tax)
Shareholders for dividends
28 Feb 2019
29 Feb 2020
–
–
7 000
–
36 000
64 200
43 000
64 200
Retained income (accumulated profit)
❖
Reserves are part of the equity of a company.
❖
They consist of profits that are not distributed, but are saved for future use.
❖
Although there are other types of reserves, we will only discuss retained income.
❖
Retained income is the portion of the net profit that is not distributed to shareholders
in the form of dividends during the current financial year.
❖
Retained income is kept in reserve and these funds can be used:
•
to create bigger future profits (by re-investing these funds in the company), or
•
to pay future dividends.
❖
The retained income amount is calculated in the Appropriation account.
❖
This calculation is performed by subtracting:
•
the income tax for the year, and
•
the dividends for the year
Retained income = Net profit – Income tax – Dividends
… from the net profit for the year.
_______________________________________________________________________________
Example: Retained income
The financial year of Danjo Traders Ltd ends on 28/29 February. On 28 February 2018, Danjo Traders Ltd
had an issued share capital of R990 000 consisting of 60 000 ordinary shares.
On 28 February 2019 the following information was given:
• Net profit for the year ending 28 February 2019, according to the Profit & Loss account, was R540 000.
• Income tax for the financial year amounted to R162 000.
• Total dividends declared and paid during the financial year amounted to R48 000.
Required: Create the Appropriation and Retained Income accounts in the General Ledger.
Posting to the General Ledger:
General Ledger of Danjo Traders Ltd
Dr
Appropriation account
2019
Feb 28 Income tax
Dr
GJ
162 000
00
Dividends on ordinary shares
GJ
48 000
00
Retained income
GJ
330 000
00
540 000
00
2019
Feb
28 Profit and loss
F3
GJ
Cr
540 000 00
540 000 00
Retained Income
2019
Feb
28 Appropriation
B2
GJ
Cr
330 000 00
Note:
• In the following financial year, the balance of the Retained Income account must first be written back to the Appropriation account.
• The amount available for distribution would then be this retained income plus the profit generated during the current year.
Example: Retained income (continued)
On 1 March 2019 the following balances appeared in the books of Danjo Traders Ltd:
• Ordinary share capital
R990 000
• Retained income
R330 000
On 29 February 2020, the end of the financial year, the following information was given:
• Net profit for the year ending 29 February 2020 was R550 000.
• Income tax for the financial year amounted to R165 000.
• Total dividends declared and paid during the financial year amounted to R90 000.
Required:
1. Show the entries as they would appear in the General Journal.
2. Create the Appropriation and Retained Income accounts in the General Ledger.
3. Show Note 8 to the Financial Statements for Retained Income.
Entries in the General Journal:
General Journal of Danjo Traders Ltd for February 2019
Day
29
Details
Retained income
Fol.
GJ
Debit
330 000 00
330 000 00
Appropriation account
(Write back retained income from previous year)
Profit and loss account
Appropriation account
Credit
550 000 00
550 000 00
(Net profit transferred to Appropriation account)
Appropriation account
Income tax
Dividends on ordinary shares
Retained income
(Calculating new balance for retained income)
880 000 00
165 000 00
90 000 00
625 000 00
Example: Retained income (continued)
Posting to the General Ledger:
General Ledger of Danjo Traders Ltd
Dr
Appropriation account
2020
Feb 29 Income tax
GJ
165 000
00
Dividends on ordinary shares
GJ
90 000
00
Retained income
GJ
625 000
00
880 000
00
Dr
2020
Feb 29 Appropriation
2020
Feb
F3
29 Profit and loss
Retained income
330 000
00
GJ
550 000 00
GJ
330 000 00
880 000 00
Retained Income
GJ
Cr
B2
Cr
2019
Mar
1
Balance
b/d
330 000 00
2020
Feb
29 Appropriation
GJ
625 000 00
Notes to the financial statements:
Danjo Traders Ltd
NOTES TO THE FINANCIAL STATEMENTS ON 29 FEBRUARY 2020
8. RETAINED INCOME
Balance on 1 March 2019
330 000
Net profit after tax (550 000 – 165 000)
385 000
Dividends
(90 000)
Balance on 28 February 2020
625 000
Interest capitalised
What is interest?
❖
Interest can be:
•
the cost of borrowed money (interest on loan) or
•
the earnings on an investment (interest on fixed deposit).
❖
The total interest expense must be disclosed separately on the Income Statement.
❖
There are different ways to calculate interest.
Simple interest
Where:
❖
Simple interest is calculated on the original amount only.
❖
Accumulated interest is not used in this calculation.
P = the principal amount (the original amount
borrowed/invested)
❖
The formula for simple interest is:
i = the interest rate for one period
A = P(1 + i.n)
A = the final amount, including the interest
n = number of periods
Compound interest
❖
Compound interest is calculated on the total of the principal (original) amount plus interest
accumulated during past periods.
❖
So we say interest is earned on interest (interest is compounded).
❖
The formula for compound interest is:
A = P(1 + i )n
____________________________________________________________________________________
Example: Interest capitalised
Information:
R3 000 is invested in a fixed deposit account at a bank for four years. The interest is 12% p.a.
Required:
Show the value of the investment at the end of the four years if:
• Simple interest is used
• Compound interest is calculated on a annual basis.
Calculations:
Simple interest
Compound interest
The interest is 12% on R3 000 each year for 4 years. The
interest received is the same every year.
At the end of each year, the interest is added to the principal (original) amount
and 12% interest is then calculated on the total amount.
End of year 1: R3 000 + (0,12)(R3 000) = R3 360
End of year 1: R3 000 + (0,12)(R3 000) = R3 360
End of year 2: R3 360 + (0,12)(R3 000) = R3 720
End of year 2: R3 360 + (0,12)(R3 360) = R3 763,20
End of year 3: R3 720 + (0,12)(R3 000) = R4 080
End of year 3: R3 763,20 + (0,12)(R3 763,20) = R4 214,78 (to the nearest cent)
End of year 4: R4 080 + (0,12)(R3 000) = R4 440
End of year 4: R4 214,78 + (0,12)(R4 214,78) = R4 720,56 (to the nearest cent)
By using the formula for each it is much faster:
Simple interest
Compound interest
A = P(1 + i.n) = R3 000 [1 + (0,12)(4)] = R4 440
A = P(1 + i )n = R3 000(1 + 0,12)4 = R4 720,56
Interest capitalised (continued)
❖
We have seen how interest is calculated mathematically, but how will the bookkeeper
enter this information in the business’s books?
❖
The bookkeeper needs to apply GAAP’s matching principle.
❖
This principle should be applied as follows:
Interest on fixed deposit earned in a financial period, must be accounted for as income
in that financial period, even if it will only be received in a later period.
Matching
Interest on loan incurred in a financial period, must be accounted for as an expense
in that financial period, even if it will only be paid in a later period.
❖
Most lending institutions (banks etc.) capitalised interest on loans.
❖
This means the interest is charged (added) directly to the loan account.
❖
Since the interest is not actually being paid, this entry can not be made in the CPJ.
❖
Therefore this transaction will be recorded in the General Journal, as follows:
Debit: Interest on Loan
❖
Credit: Loan
Banks usually send statements to the business at the end of each period to indicate
the amount of interest that has accrued.
____________________________________________________________________________________
Example: Interest on loan capitalised
On 1 March 2017, Joanne’s Boutique applied for a loan of R100 000 from AB Bank.
The application was successful and the proceeds of the loan were paid into the bank
account of Joanne’s Boutique.
Required:
1. Complete the entries in the journals.
2. Post to the General Ledger.
3. Show the effect on the accounting equation.
The loan agreement stipulates that interest on loan will be capitalised and that loan
instalments of R6 000 are payable every 6 months starting on 31 August 2017.
On 28 February 2018, the loan statement reflected that the interest for the year had
amounted to R9 200.
Entries in the journals:
Cash Receipts Journal of Joanne’s Boutique for March 2017
Doc
no.
Day
BS
1
Details
Fol.
Analysis of
receipts
AB Bank
CRJ
Sundry accounts
Bank
Amount
100 000 00
100 000
Details
00
Cash Payments Journal of Joanne’s Boutique for the year ended 28 February 2018
Doc
Date
no.
CPJ
Sundry accounts
Details
Fol.
Bank
Amount
Details
BS
31 Aug 2017
AB Bank
6 000 00
6 000 00
Loan: AB Bank
BS
28 Feb 2018
AB Bank
6 000 00
6 000 00
Loan: AB Bank
General Journal of Joanne’s Boutique for February 2018
Day
28
Details
Interest on loan
Loan: AB Bank
(Adjustment for interest on loan for the year)
Fol.
GJ
Debit
Loan: AB Bank
Credit
9 200 00
9 200 00
Example: Interest on loan capitalised (continued)
Posting to the General Ledger:
General Ledger of Joanne’s Boutique
Balance Sheet accounts
Dr
Loan: AB Bank
Cr
2017
Aug 31 Bank
CPJ
6 000
00
2017
Mar
1
2018
Feb 28 Bank
CPJ
6 000
00
2018
Feb
28 Interest on loan
c/d
97 200
00
109 200
00
Balance
Bank
CRJ
GJ
100 000 00
9 200 00
109 200 00
2018
Mar
1
Balance
b/d
97 200 00
Nominal accounts
Dr
2018
Feb 28 Loan: AB Bank
Interest on Loan
GJ
9 200
00
9 200
00
2018
Feb
28 Profit and loss
Cr
GJ
9 200 00
9 200 00
Note:
• The Interest on Loan account is closed off to the Profit and Loss account as it is regarded as an expense for the financial period.
• It is the cost of borrowing the money from the bank, the finance cost.
Example: Interest on loan capitalised (continued)
The effect on the accounting equation:
Owner’s equity
Assets
Effect
Reason
Effect
Reason
Liabilities
Effect
Reason
+ 100 000
Cash in bank increases
+ 100 000
Loan increases
– 6 000
Cash in bank decreases
– 6 000
Loan decreases
– 6 000
Cash in bank decreases
– 6 000
Loan decreases
+ 9 200
Loan increases
– 9 200
Interest on loan is an expense
Interest on loan capitalised (continued)
Flow diagram showing the process followed in the previous example:
An application is made
for a loan of R100 000.
The loan is approved by AB Bank
and paid to the business.
AB Bank processes the
application.
The entry is made in the CRJ:
Debit: Bank
Credit: Loan: AB Bank
Instalments of R6 000 are paid to AB Bank every six
months. The instalments include capital repayments
as well as interest which is calculated by the bank.
The entry is made in the CPJ:
Debit: Loan: AB Bank
Credit: Bank
The interest on loan is recorded in
the General Journal:
At the end of the financial year the business needs to
know what the finance cost (interest) is on the loan.
Debit: Interest on loan
AB Bank would have sent them a loan statement
periodically, reflecting this information.
Credit: Loan: AB Bank
____________________________________________________________________________________
Directors’ fees
❖
Directors’ fees is the remuneration earned by the directors of a company.
❖
This remuneration may include:
•
the salaries of the executive directors,
•
compensation to non-executive directors for attending meetings,
•
bonuses, car allowances and medical and retirement benefits.
❖
The remuneration of directors is determined by the company’s remuneration committee.
❖
This proposed remuneration must be approved by the shareholders at the AGM.
❖
Remuneration packages should be reviewed annually to ensure that they are fair and
market-related.
❖
Directors’ fees is recorded as an expense in the books of the company.
❖
Directors’ fees paid during the financial year will be entered in the CPJ.
Debit: Directors’ Fees
❖
Credit: Bank
Directors’ fees owing at the end of the financial year will be entered in the GJ.
Debit: Directors’ Fees
Credit: Accrued Expense
____________________________________________________________________________________
Audit fees
❖
Audit fees is the fee charged by the independent auditor for performing an audit.
❖
The company’s audit committee is responsible for appointing an independent
auditor and negotiating the audit fee.
❖
Audit fees is recorded as an expense in the books of the company.
❖
Audit fees paid during the financial year will be entered in the CPJ.
Debit: Audit Fees
❖
Credit: Bank
Audit fees owing at the end of the financial year will be entered in the GJ.
Debit: Audit Fees
Credit: Accrued Expense
❖
A company may also choose to make provision for the audit in the same year as
that of the financial statements being audited.
❖
The company will then have to estimate the cost of the audit.
❖
This transaction will also be entered in the GJ.
Debit: Audit Fees
Credit: Provision for Audit Fees
____________________________________________________________________________________
Buying back shares
❖
The most common way in which companies “return wealth” to their shareholders
is by paying dividends.
❖
However, another way is by buying back shares (repurchase of shares).
❖
Buying back shares means a company buys back its own shares on the stock
exchange – almost like investing in itself.
❖
Some of the reasons why companies would buy back shares include:
❖
•
to increase the relative ownership stake of each investor
(since there would be fewer issued shares)
•
to increase the market value of its shares
(if the company feels that their shares are undervalued by the market)
•
to improve the financial ratios
(however, this should not be done to manipulate financial indicators,
as that is not good corporate governance)
Share buy-back transactions are only allowed to take place if:
•
permitted in the MOI and approved by a special resolution.
•
the solvency and liquidity of the company satisfies certain specific tests.
____________________________________________________________________________________
Buying back shares (continued)
❖
❖
How is a share buy-back carried out?
•
Shareholders will be presented with a tender offer to sell all or a portion of
their shares back to the company within a certain time frame.
•
The tender offer will state the number of shares the company is looking to
buy back, as well as the price they are willing to pay.
•
Interested shareholders will then submit their tenders, stating the number of
shares and the price they are willing to accept.
•
Once the company has received all the tenders, they will find the right
combination to buy back shares at the lowest price.
The transaction will be entered in the business’s books as follows:
Debit: Ordinary Share Capital
Debit: Retained Income
Credit: Bank
Amount recorded in the Ordinary Share Capital account
= no. of shares repurchased  original selling price
Amount recorded in the Retained Income account
= no. of shares repurchased  amount exceeding original price
Amount recorded in the Bank account
= the amount paid
____________________________________________________________________________________
Example: Buying back shares
The financial year of Danjo Traders Ltd ends on 28/29 February.
On 1 March 2019, the following balances appeared in the books of Danjo Traders Ltd:
• Ordinary share capital (60 000 shares at R6,50 each)
R390 000
• Retained income
R320 000
On 30 June 2019, the company bought back 20 000 shares at R7 each.
Required:
1. Complete the entries in the journals.
2. Post to the General Ledger.
3. Show the effect on the accounting equation.
4. Show the note to the financial statements for ordinary share capital.
Calculations:
• Amount paid for the shares = 20 000  R7 = R140 000
• Ordinary share capital amount = 20 000  R6,50 = R130 000
• Retained income amount = 20 000  R0,50 (R7 – R6,50) = R10 000
Entries in the journals:
Cash Payments Journal of Danjo Traders Ltd for June 2019
Doc
no.
CPJ
Sundry accounts
Day
30
Details
Shareholders
Fol.
Bank
140 000 00
Amount
Details
130 000 00
Ordinary share capital
10 000 00
Retained income
Example: Buying back shares (continued)
Posting to the General Ledger:
General Ledger of Danjo Traders Ltd
Balance Sheet accounts
Dr
Ordinary Share Capital
2019
Jun 30 Bank
Balance
CPJ
130 000
00
c/d
260 000
00
390 000
00
2019
Mar
Balance
1
Balance
Retained Income
2019
Jun 30 Bank
Balance
CPJ
10 000
00
c/d
310 000
00
320 000
00
b/d
Cr
390 000 00
390 000 00
2019
Jul
Dr
1
B1
2019
Mar
1
b/d
B2
Balance
b/d
260 000 00
Cr
320 000 00
320 000 00
2019
Jul
1
Balance
b/d
310 000 00
Example: Buying back shares (continued)
The effect on the accounting equation:
Owner’s equity
Assets
Effect
– 140 000
Reason
Cash decreases
Effect
Reason
– 130 000
Ordinary share capital decreases
– 10 000
Retained income decreases
Liabilities
Effect
Reason
Notes to the financial statements:
Danjo Traders Ltd
NOTES TO THE FINANCIAL STATEMENTS ON 29 FEBRUARY 2020
7. ORDINARY SHARE CAPITAL
AUTHORISED
Number of ordinary authorised shares: 100 000 shares
ISSUED
60 000 ordinary shares in issue at 1 March 2019
20 000 ordinary shares bought back during the financial year
40 000 ordinary shares in issue at 29 February 2020
390 000
(130 000)
260 000
Solutions to activities
▪ Activity 1.1
▪ Activity 1.11
▪ Activity 1.2
▪ Activity 1.12
▪ Activity 1.3
▪ Activity 1.13
▪ Activity 1.4
▪ Activity 1.14
▪ Activity 1.5
▪ Activity 1.15
▪ Activity 1.6
▪ Activity 1.16
▪ Activity 1.7
▪ Activity 1.17
▪ Activity 1.8
▪ Activity 1.9
▪ Informal assessment 1.1
▪ Activity 1.10
▪ Informal assessment 1.2
________________________________________________________________________
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