How to Pass
Book-keeping
and Accounts
SECOND LEVEL
Teacher's Guide
Michael Mincher
ACMA Cert Ed
First published 1999
# LCCI CET 1999
British Library Cataloguing-in-Publication Data
Mincher, Michael
How to pass book-keeping and accounts, second level
Teacher's guide
1. Accounting ± Study and teaching (Higher) ± Great Britain
I. Title
657.2'071141
ISBN 1 86247 061 8
All rights reserved; no part of this publication may be reproduced, stored
in a retrieval system, or transmitted in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise without the prior written
permission of the Publisher. This book may not be lent, resold, hired out, or
otherwise disposed of by way of trade in any form of binding or cover, other
than that in which it is published, without the prior consent of the Publisher.
This is the only book endorsed by the LCCIEB for use by teachers
of this LCCIEB examination subject at this level. No other book is
endorsed by the LCCIEB for this subject at this level.
10
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Typeset by LaserScript Limited, Mitcham, Surrey
Printed in Hong Kong
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1
Contents
About the author
Acknowledgements
Introduction
Lesson
1
Advanced aspects of the syllabus for First Level Book-keeping (1)
2
Advanced aspects of the syllabus for First Level Book-keeping (2)
3
Partnerships (1)
4
Partnerships (2)
5
Partnerships (3)
6
Company accounts (1)
7
Company accounts (2)
8
Company accounts (3)
9
Incomplete records
10
Manufacturing accounts
11
Stocks, stock valuations and stock losses
12
Accounts of non-trading organisations
13
Branch accounts (1)
14
Branch accounts (2)
15
Bills of exchange
16
Consignment accounts
17
Sales and purchases ledger control accounts
18
Errors and the use of suspense accounts
19
Accounts interpretation
20
Computerised book-keeping and accounts
Page
iv
iv
1
2
7
15
25
32
47
54
60
71
85
100
112
125
131
151
160
172
180
190
209
iii
About the author
Michael Mincher is a former Course Director of Professional Accountancy Studies in the
West Midlands School of Accountancy at Sandwell College. He has over 20 years'
experience of teaching accountancy at all levels. His association with the LCCIEB has been
for more than 20 years. He is currently a visiting lecturer at the University of
Wolverhampton.
Acknowledgements
In the preparation of this book my thanks are due to Ron Goose, Examiner of LCCIEB, for
his careful reading of the draft of this book and his suggestions for its improvement.
My thanks are also due to Christine Winters, LCCIEB Publishing Manager, for her
continuous encouragement during the preparation of the book.
iv
Introduction
This book has been written to help teachers who are preparing candidates for the LCCIEB
Second Level Book-keeping and Accounts examination.
Teachers are advised to use the book in conjunction with:
(a) the Extended Syllabus
(b) the textbook How to Pass Book-keeping and Accounts, Second Level
(c) the LCCIEB Practice Questions Booklet Examination Practice Questions for Book-keeping
and Accounts, Second Level
(d) the LCCIEB Answers to Practice Questions Booklet Answers to Examination Practice
Questions for Book-keeping and Accounts, Second Level
(e) past examination papers of the LCCIEB
(f) suggested answers to past examination papers of the LCCIEB
(g) Examiners' reports.
There are 20 lessons in the book, and each of the lessons relates to particular parts of the
How to Pass Book-keeping and Accounts, Second Level textbook. The coverage of the complete
syllabus will require a minimum of 60 hours' class time. It is suggested that each lesson
should be of about 2 hours' duration. However, teachers are advised that although the
lessons in the book could be covered in 2 hours, some will require more than 2 hours,
whereas others may be covered in less than 2 hours.
Teachers are encouraged to provide their students with questions for examination practice.
The author feels that if the students practise answering examination questions and have the
solutions explained to them, their understanding of the syllabus will increase. This will
result in the students being well prepared for the examination.
Teachers are advised to use the variety of sources of LCCIEB examination questions that are
available: at the end of each lesson in this book, at the end of each chapter in the How to Pass
textbook, in the Practice Questions Booklet and past examination papers of the LCCIEB.
This number of questions is likely to be too large to use in the class time, so teachers are
asked to encourage their students to work by themselves and devote some of their private
time to this.
Finally, the author, wishes you well in preparing your students for the examination and asks
that you pass on his best wishes to your students: he wants them to be successful at the
examination!
1
Lesson 1: Advanced aspects of the syllabus for
First Level Book-keeping (1)
Lesson topics
.
.
.
The book-keeping system
Prime entry records
Accruals and prepayments
Extended Syllabus references
1.4
Prime entry records
1.4.2 Preparation of prime entry records for sales, sales returns, purchases and
purchases returns, from given data, not all of which is to be used
1.4.4 Preparation of Cash Book entries and establishing the balance at bank per the
Cash Book. Adjustment of the Cash Book balance using information from
bank statements, and production of a reconciliation statement
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
Introduce the course of Second Level Book-keeping and Accounts
Explain the purpose of book-keeping and the use of prime entry records for the
recording of ®nancial transactions
The lesson
1
Begin by advising the students of the areas they will be studying for the examination.
You may ®nd it helpful to provide the students with a copy of the Extended Syllabus so
that they are aware of the topics they will need to study before attempting the
examination. Also advise the students of the format of the examination; there are 4
compulsory questions, each of 25 marks. The time allowance is 3 hours.
2
Explain the purpose of book-keeping; why transactions need to be recorded in a
formalised set of accounting books. Try to involve the students in a discussion and ask
them why they feel that a formalised set of accounting records needs to be maintained
by all forms of businesses. There are legal reasons and reasons for informing the owners
2
Advanced aspects of the syllabus (1)
of the ®nancial state of the business. Also there may be external people and other
businesses that have an interest in the ®nancial state of the business. In order to provide
the variety of information, then a formalised set of books will need to be continually
and accurately maintained.
3
Involve the students by asking them the type of ®nancial information that will be
required from the accounting records. Hopefully their replies will include such items
as the amount of pro®t or loss that the business has made in the last accounting period,
the amount of money the business has, and the amounts of money that are owed to
and by the business. Explain that this information can be found in the business'
®nancial records, provided that they are being updated in a regular and accurate
manner.
4
Explain that prime entry records will be prepared. These are details of purchases,
purchase returns, sales, sales returns and cash and bank transactions. Explain that, from
these initial records of both cash and credit transactions, the postings to the various
accounts in the business' ®nancial records can be made.
Explain, for example, that the recording of these types of transactions will assist in
determining the amount of money that is owed to the business by its debtors. Refer to
Example 1 on page 5 of the Candidate's Guide book and explain to your students that
the amount owed to Neil Roberts' business by its debtors has increased by £10,369
during February Year 7, and that this ®gure has been obtained from the preparation of
the Sales Journal/Sales Day Book for that month. Explain also that the amount owed
by the debtors could also have decreased. This could have arisen from a variety of
reasons, such as the receipt of money, allowing cash discounts due to the prompt
payment by the debtors, sales returns and the writing off of debts that have been
become uncollectable.
Explain that all of these items would also be recorded in the business' accounts so that
the balance outstanding from the debtors will be continually updated.
5
Explain that to calculate the pro®t or loss a business has made will require the use of
the matching concept. Provide an example of what is meant by this concept. For
example, explain that a business has purchased 1,200 items for £30 each but sold 1,000
items for £50 each. Now ask the students to calculate the amount of pro®t the business
has made. In order to calculate the pro®t made, the income from the sale of the 1,000
items, 1,0006£50, = £50,000 should be matched with the purchase cost of the 1,000
items sold, 1,0006£30, = £30,000. The pro®t made, therefore, is sales of £50,000
less the purchase cost of £30,000 = £20,000. Explain that it would have been
incorrect to try to match the total cost of the purchases, 1,2006£30, = £36,000
against the sales income of £50,000 to calculate the pro®t made. To provide the
students with a small revision exercise, ask them to regard the purchase and sales
transactions from the above example as being made on credit terms and to show the
effect upon the Balance Sheet of the business following the sales and purchases
transactions.
3
Lesson 1
This should produce the following:
Debtors
£
+ 50,000
Stock
+ 6,000
+ 56,000
Pro®t
+ 20,000
Creditors
+ 36,000
+ 56,000
Hopefully the students will recall the fact that any unsold goods will be classi®ed as
stock and recorded in the Balance Sheet at the lower of their cost or realisable
value.
6
Explain that the calculation of the pro®t or loss made is in¯uenced by the accruals
concept. Illustrate this concept by reference to Examples 3, 4 and 5 on pages 11, 12, 13,
14 and 15 of the Candidate's Guide book. Explain how the entries to the Pro®t and
Loss Accounts have been calculated. Also refer to the balances that remain in the
accounts following the postings to the Pro®t and Loss Accounts. These are the accruals
and prepayments that will appear in the Balance Sheets that will be prepared at the end
of the ®nancial period.
7
Although the syllabus reference refers to First Level Book-keeping areas, please
recognise that a thorough understanding of the accruals concept is essential for the
preparation of many answers to questions set at the Second Level examination. For
example, consider a question that requires the preparation of a Trading, Pro®t and Loss
Account. Such a question will require the candidate to display a sound knowledge of
this concept.
8
Explain that for a business to be certain that its balance at bank records are accurate will
involve a reconciliation exercise that compares its own records to those reported on the
bank statement. Explain how differences may occur between the balances. These may
arise when items have not been recorded in the business' records, such as Standing
Order and Direct Debit payments, and items have not been recorded on the bank
statements, such as receipts paid into the bank after the date the bank statement had
been prepared. Explain the various forms of payments and receipts as mentioned on
page 7 of the Candidate's Guide book.
9
Note to all teachers:
All areas of the First Level Book-keeping syllabus are examinable at the Second Level
examination.
4
Advanced aspects of the syllabus (1)
QUESTION FOR CLASS PRACTICE
Question 1.1
The debit balance on the Cash at Bank Account of John Lawley at 31 July Year 6 was
£4,321. The bank statement, which was received in early August, did not agree with this
®gure. In attempting to reconcile the ®gures in the account and on the bank statement he
found the following:
(a) A Standing Order for rent of £152 paid by the bank in July had not been entered in the
Cash Book.
(b) The monthly wages and salaries had been paid by cheques on 31 July and amounted to
£2,462. These did not appear on the bank statement at 31 July.
(c) The bank statement showed that Lawley's account had been debited with bank charges
of £312. These had not been entered in the Cash Book in July.
(d) During July, Susan Parkes, one of Lawley's debtors, had paid £398 directly into
Lawley's Bank Account. This had not been entered in the Cash Book.
(e) A cheque payment of £753 made to Andrew Harvey, one of Lawley's suppliers, had not
been presented to the bank at 31 July.
(f) On 30 July Lawley paid into the bank a total of £4,120 which he had received in
cheques from his customers. This amount did not appear on the bank statement at 31
July.
(g) A cheque payment of £420 for telephone charges was shown in the Cash Book as
£402.
Required
(a) Prepare the adjusted Cash at Bank Account for John Lawley at 31 July Year 6.
(b) Prepare ®gures which show the balance on the bank statement at 31 July Year 6. You
are advised to begin your workings with the adjusted Cash Book balance.
(c) State the balance of cash at bank that should be shown on the Balance Sheet of John
Lawley at 31 July Year 6.
(LCCIEB 1998)
You may now wish to ask your students to answer the above question.
Solution to Question 1.1
(a)
Cash at Bank Account
Year 6
31 July
July
Balance b/d
Susan Parkes
£
4,321
398
4,719
August
Balance b/d
Year 6
31 July
31 July
31 July
31 July
£
Rent (Standing Order)
Bank charges
Telephone
Balance c/d
152
312
18
4,237
4,719
4,237
5
Lesson 1
(b)
Adjusted Cash Book balance
add Wages and salaries
£
4,237
2,462
6,699
add Cheque not presented
(Andrew Harvey)
753
7,452
less Deposit not recorded
(c)
6
Balance as per bank statement at 31 July Year 6
4,120
3,332
Balance at bank shown on Balance Sheet at 31 July Year 6
£4,237
Lesson 2: Advanced aspects of the syllabus for
First Level Book-keeping (2)
Lesson topics
.
.
Methods of depreciation
Bad debts and provision for bad and doubtful debts
Extended Syllabus references
1.2 Depreciation
1.3 Bad debts and provision for bad and doubtful debts
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
.
.
.
Prepare the book-keeping entries for the purchase of ®xed assets, depreciation
expense, accumulated provision for depreciation and sale and disposal of ®xed
assets
Present the ®xed assets in the Balance Sheet
Explain the distinction between a bad debt and a provision for doubtful debts
Prepare the book-keeping entries for bad debts and the provision for doubtful
debts
Show how debtors would appear in the Balance Sheet when there is a balance in
the Provision for Doubtful Debts Account
The lesson
Depreciation
1
Begin by explaining that depreciation is provided for in the accounts when the value of
the ®xed assets decreases.
2
Explain what is meant by the term ®xed assets and involve the class by asking them for
examples of ®xed assets. Examples are provided in the Candidate's Guide book on
page 23.
7
Lesson 2
3
Explain how businesses create the charge for depreciation; and so advise the class that
the value of the ®xed assets will reduce due to the use of them and/or the passage of
time.
4
Explain that the pro®tability of a business will be affected by depreciation; the cost is
debited to the Pro®t and Loss Account and so reduces the amount of pro®t earned by
the business.
5
Explain that the postings relating to the depreciation cost will be:
(a) A debit entry to the Depreciation Expense Account, sometimes referred to as
Depreciation Account; and
(b) a credit entry to the Accumulated Provision for Depreciation Account, sometimes
referred to as Provision for Depreciation Account.
6
Advise the class that the Depreciation Expense Account is credited with the periodic,
eg monthly or annual, charge, and this amount is debited to the Pro®t and Loss
Account. This means that when the entry has been made to the Pro®t and Loss
Account, there is no longer a balance on the Depreciation Expense Account.
7
Advise the class that the Accumulated Provision for Depreciation Account is credited
with the periodic depreciation expense amounts. This means that as long as a ®xed asset
is retained by the business and its useful life has not expired, then the balance in the
Accumulated Provision for Depreciation Account will continue to be accumulated.
This is the reason why the account is referred to as the Accumulated Provision for
Depreciation.
8
Explain that the Accumulated Provision for Depreciation Accounts are maintained
separately from the Fixed Asset Accounts. Explain that the Fixed Asset Accounts should
not include any entries relating to depreciation. Advise the class that if depreciation
does appear in the Fixed Asset Accounts, then this is poor and incorrect practice and
will not earn marks in any examination question.
9
Explain that the depreciation entries in respect of a ®xed asset would stop being made
when either:
(a) The ®xed asset has been sold or scrapped.
(b) The ®xed asset remained in the business but its useful life had expired. For example,
a machine may have been purchased and its expected useful life was 4 years.
However, if the machine remained in use for a period beyond the 4 years and had
not been revalued, then no further charges for depreciation would be made in
respect of that machine.
Explain that if the circumstances in (b) above prevailed, then the Accumulated
Provision for Depreciation Account would continue to re¯ect the accumulated
amount of depreciation that had been charged in the ®rst 4 years.
10 Use the Candidate's Guide book (pages 24 to 27) to explain and illustrate the reasoning
for the adoption of the methods of depreciation. Also use these examples to illustrate
8
Advanced aspects of the syllabus (2)
how the ®xed assets would be presented in the Balance Sheet; and so show that the net
book value is derived by deducting the balance in the Accumulated Provision for
Depreciation Account from the balance in the Fixed Asset Account.
11 Explain that ®xed assets are often sold or scrapped and that this can result in either a
pro®t or loss arising on the sale or disposal of the ®xed asset. Use Example 3 on pages 28
and 29 of the Candidates Guide book to illustrate the Fixed Asset, Depreciation
Expense, Accumulated Provision for Depreciation and the Disposal of Fixed Asset
Accounts.
12 Illustrate how the pro®t arose on the sale of the machine and how this was re¯ected by
the entries made in the Disposal of Fixed Asset Account. Explain that the entries were
obtained from the Machine Account, representing the cost of the machine when it was
originally purchased, and the Provision for Depreciation Account, representing the
total amount of depreciation that had been charged for the machine up to the date of its
sale. So the net book value of the machine at the time of sale, cost less accumulated
depreciation, was compared with the sales proceeds to determine the pro®t made on
the sale of the machine.
13 Explain that by crediting the Machine Account with its cost value and debiting the
Provision for Depreciation Account with the accumulated amount of depreciation, the
machine's net book value is removed from the ledger accounts.
14 As referred to earlier, a ®xed asset may be retained after its expected useful life. To
illustrate this further then use the example on pages 29 and 30 of the Candidate's Guide
book.
15 Explain the concept of the ®xed asset register and particularly its role in acting as a
support to the ledger accounts that relate to the business' ®xed assets. Explain how
impracticable it would be to maintain separate ledger accounts for each item of ®xed
asset owned by the business.
16 Explain that the ®xed assets would be classi®ed by their type such as plant and
machinery, motor vehicles and ®xtures and ®ttings. Explain that such classi®cations
would be used to prepare the Fixed Assets, Depreciation Expense and Provision for
Depreciation Accounts. This means, therefore, that the Balance Sheet would show
details of cost, accumulated depreciation and net book value for each of the
classi®cations. Also explain that the classi®cation of the ®xed assets into their
various forms allows the depreciation expense to appear in the Pro®t and Loss
Account for each classi®cation of ®xed asset, so that the depreciation charge for the
period will be shown for plant and machinery separately from the charge for motor
vehicles etc.
17 Explain how the ®xed asset register would include all relevant accounting details such as
cost, useful life, method of depreciation, expected residual value etc for each of the
businesses' ®xed assets. Example 4 on page 31 of the Candidate's Guide book in some
part re¯ects the use of a ®xed asset register. Ask the class to answer the problems posed
by the example and review their answers with them.
9
Lesson 2
18 Explain that the ledger accounts for each of the classi®cations of ®xed assets and their
related accounts for depreciation are control accounts in that they are summaries of the
entries made for each of the ®xed assets in the ®xed asset registers.
Bad debts
19 Explain to the class that a bad debt arises when the business acknowledges that a debtor
is unable to settle the whole or part of the debt owed. This will arise when goods or
services that have been sold on credit have not been paid for in part or in whole. In
such circumstances, the business knows that a speci®c debtor is not going to fully pay
for the goods supplied.
20 Explain that when the goods/services were originally sold on credit, then the entries in
the ledger accounts, for the amount of the sale, would have been as follows:
Debit:
Credit:
Debtor's personal account, or Sales Ledger Control Account
Sales account
21 Explain that when it is acknowledged that a bad debt has arisen, the entries that will be
made in the ledger accounts, for the amount of the debt that is being regarded as a bad
debt, will be as follows:
Debit:
Credit:
Bad Debts Account
Debtor's personal account (or Sales Ledger Control Account)
22 Explain that these last entries remove the debt from the debtor's personal account and/
or the Sales Ledger Control Account and recognise that there is an expense incurred by
the business in the form of a bad debt. Explain that the total of the bad debts written off
in an accounting period will be credited to the Bad Debts Account and debited to the
Pro®t and Loss Account for that same accounting period.
23 Explain that the effect of debiting the total of the Bad Debts Account to the Pro®t and
Loss Account has eliminated the sales income that would have originally been credited
to the Trading Account.
24 To illustrate the preparation of a Bad Debts Account, refer to the examples in the
Candidate's Guide book, pages 34 and 35.
25 Illustrate the partial recovery of a debt and hence a bad debt arising for a percentage of
the original amount from the example on page 35 of the Candidate's Guide book.
26 Explain that there are occasions when a bad debt that has been written off may be
recovered in whole or in part in a subsequent ®nancial year. When this situation arises
then a Bad Debts Recovered Account is prepared. An example relating to the recovery
of a debt that had been previously been written off as a bad debt is provided as Example
5, pages 35, 36, 37 and 38 of the Candidate's Guide book.
10
Advanced aspects of the syllabus (2)
Provision for doubtful debts
27 Explain to the class that businesses are not always certain that amounts outstanding
from debtors will be received. Explain that because of this uncertainty, businesses
will make provisions for doubtful debts. The provision is made to acknowledge that
there may be a bad debt arising in the future. The making of such a provision is an
illustration of how a business can incorporate the prudence concept into its accounts.
In this case this means that if a business is not fully con®dent of receiving all the
monies outstanding to it from its debtors, then it would be prudent for the business
to acknowledge this. The business will do this by making a provision for doubtful
debts.
28 Explain that the provision made can be either a speci®c provision, ie a provision for a
particular debtor for which there is doubt whether the debt will be fully recovered,
and/or a general provision. Explain that the general provision is usually calculated as a
percentage of the outstanding debtors at the end of an accounting period. The
percentage calculation would be made after deducting the amounts for speci®c
provisions from the balance of the outstanding debtors.
29 Illustrate both types of the provisions for doubtful debts and also bad debts by using
Example 6 on pages 39 and 40 of the Candidate's Guide book. The example also shows
how the debtors' ®gure would be presented in the Balance Sheet.
30 In preparing the Provision for Doubtful Debts Account refer the students to the
amounts charged to the Pro®t and Loss Account in each of 3 years. Explain why, in
Years 13 and 14, the Pro®t and Loss Account is debited, whereas in Year 15 the
account is credited. Also emphasise the importance of carrying down and bringing
down the balance on the account at the beginning and end of each of the accounting
years.
31 Explain to the class the importance of distinguishing between a bad debt and a provision
for a doubtful debt. Explain also that an account should never be prepared with a title of
`Provision for Bad Debts'; this is not good practice.
32 Explain that the Bad Debts Account and the Provision for Doubtful Debts Account
should not be merged into one ledger account; they should always be maintained
separately.
33 In showing the debtors' ®gure in the Balance Sheet, explain why the balance in
the Provision for Doubtful Debts Account is deducted from the ®gure for total
debtors.
11
Lesson 2
QUESTION FOR CLASS PRACTICE
Question 2.1
The following data have been obtained from the records of Westerns Ltd:
Financial year to 30 September
Trade debtors at year end
(before allowing for any bad or doubtful debts)
Debts to be written off at year end
Provision for doubtful debts
Year 6
£
Year 7
£
224,520
5,720
4%
142,380
2,980
3%
The provision for doubtful debts at 1 October Year 5 amounted to £7,600.
Required
(a) Prepare, for the years ended 30 September Year 6 and 30 September Year 7, the
following accounts:
(i) Bad Debts Account.
(ii) Provision for Doubtful Debts Account.
(b) Show how the trade debtors would appear in the Balance Sheet of Westerns Ltd at 30
September Year 7.
It is the policy of Medvale Ltd to depreciate vehicles by 20% per annum on cost, on
vehicles owned at the year end.
During the year ended 31 December Year 13:
1
Vehicle X, purchased on 1 January Year 9 for £18,000 was sold for £3,950.
2
Vehicle Y, purchased on 1 January Year 11 for £22,000, was sold for £10,300.
3
Vehicle Z was purchased on 1 January Year 13 for £24,000.
(c) Complete the information below relating to the 3 vehicles:
Vehicle X
£
Cost
Accumulated depreciation
at 31 December Year 12
Depreciation in Year 13
Sale price
Pro®t or (loss) on disposal
12
Vehicle Y
£
Vehicle Z
£
Advanced aspects of the syllabus (2)
Note
Any loss sustained on the disposal of a vehicle should be shown in parentheses, ie ( ).
Solution to Question 2.1
(a)
(i)
Bad Debts Account
30 Sep Year 6
Debtors
£
5,720
30 Sep Year 6
Pro®t & Loss Account
£
5,720
30 Sep Year 7
Debtors
2,980
30 Sep Year 7
Pro®t & Loss Account
2,980
Balance b/d
Pro®t & Loss Account
£
7,600
1,152
(ii)
Provision for Doubtful Debts Account
30 Sep Year 6
Balance c/d
£
8,752
1 Oct Year 5
30 Sep Year 6
8,752
30 Sep Year 7
30 Sep Year 7
Pro®t & Loss Account 4,570
Balance c/d
4,182
8,752
1 Oct Year 6
Balance b/d
8,752
8,752
8,752
1 Oct Year 7
Balance b/d
4,182
Workings
Note that the balance on the Provision for Doubtful Debts Account is calculated by
deducting the bad debts that are to be written off from the ®gure for trade debtors at the
year end, and then applying the relevant percentage to the net debtors' ®gure.
Balance at 30 September Year 6:
(£224,520 less £5,720)64%
£218,80064% = £8,752
Balance at 30 September Year 7:
(£142,380 less £2,980)63%
£139,40063% = £4,182
Explain to the class that the difference in the provisions at each of the year ends, Years 6 and
7, results in the charge to the Pro®t and Loss Account for each of the years.
13
Lesson 2
(b)
Westerns Ltd
Balance Sheet extract at 30 September Year 7
£
139,400
4,182
Trade debtors
less Provision for doubtful debts
135,218
(c)
Cost
Accumulated depreciation to
31 December Year 12
Depreciation in Year 13
Sale price
Pro®t or (loss) on disposal
Vehicle X
£
18,000
Vehicle Y
£
22,000
14,400
Nil
3,950
350
Vehicle Z
£
24,000
8,800
Nil
10,300
(2,900)
Nil
4,800
±
±
Workings
Accumulated depreciation
Vehicle X was purchased on 1 January Year 9 and sold in Year 13, so would have been
depreciated in Years 9, 10, 11 and 12, a total of 4 years.
£18,000620%64 years = £14,400
Vehicle Y was purchased on 1 January 11 and sold in Year 13, so would have been
depreciated in Years 11 and 12, a total of 2 years.
£22,000620%62 years = £8,800
Depreciation in Year 13
As Vehicles X and Y were sold in Year 13 no depreciation is charged on vehicles that are not
owned at the year end.
The depreciation charge in Year 13 for Vehicle Z is calculated as follows:
£24,000620% = £4,800
Pro®t/loss on disposal
Vehicle X
£
Cost
18,000
14,400
less Accumulated depreciation
Net book value
Sales price
Pro®t/(loss) on disposal
14
3,600
3,950
350
Vehicle Y
£
22,000
8,800
13,200
10,300
(2,900)
Lesson 3: Partnerships (1)
Lesson topics
.
.
.
.
.
Formation of a partnership
Treatment of goodwill
Preparation of the partnership Pro®t and Loss and Appropriation Account
Preparation of the partnership Balance Sheet
Preparation of the partners' capital and current accounts
Extended Syllabus references
2.1
The nature, meaning and signi®cance of partnership
2.2.1 Understanding of why an agreement is needed, and what it can be expected to
include
2.2.2 Understanding of what happens where no partnership agreement exists
2.3.1 Journal and ledger entries for the formation of a new partnership
2.3.2 Understanding of how sole trader assets and liabilities become partnership
assets and liabilities
2.3.3 Calculation of capital introduced by a sole trader to a partnership
2.3.4 Understanding of the meaning and effect of goodwill in this context
2.3.5 The purpose of the personal accounts of partners ie capital and current
accounts
2.4.1 Understanding of the distinction between the partnership Pro®t and Loss
Account proper and the Appropriation Account
2.4.2 Understanding of how to deal with interest on a loan made by a partner to the
partnership
2.4.3 Understanding of the reason for allowing interest on capital and current
account balances and for charging interest on drawings
2.4.4 Calculation of interest as in 2.4.3
2.4.5 Entries for interest in the Appropriation Account and in partner's current
accounts
2.4.6 Preparation of a partnership Balance Sheet in traditional or vertical format
15
Lesson 3
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
.
Prepare entries in the journal and ledger accounts when a partnership is formed
Prepare the entries when goodwill is introduced to the partnership, and the entries
when the goodwill is withdrawn from the partnership ledger
Prepare the ®nal accounts of a partnership and the partner's current accounts in
columns
The lesson
Formation of a partnership
1
Explain to the class the meaning of a partnership, and use the points made on page 48 of
the Candidate's Guide book to highlight the items that are likely to be included in the
partnership agreement.
2
Emphasise the importance of this agreement and advise the class how pro®ts or losses
would be distributed if there is no formal agreement between the partners. Also advise
the class that without a formal partnership agreement, then no salaries, interest on
capital and interest on drawings will appear in the partnership accounts. Explain that the
partners' capital accounts and current accounts will be separately maintained and advise
the class that these accounts should never be merged.
3
Explain that the capital accounts are likely to remain as ®xed amounts, whereas the
current accounts will change continuously as a result of the variety of entries into these
accounts. Advise the class that examples of these entries are interest on capital, interest
on drawings, partnership salaries and the share of the pro®ts or losses between the
partners. Use Example 1 on pages 49, 50 and 51 of the Candidate's Guide book to
show the variety of charges to the partnership made by the partners themselves. Advise
the class that the reason for these charges appearing in the partnership accounts is due
to the fact these items were included in the partnership agreement and so the partners
accepted these charges at the time the partnership was formed.
4
Explain to the class that when a partnership is formed, then the assets, and any liabilities
that are introduced to the partnership will not be identi®ed with the partner who
introduced them.
This point needs to be emphasised. Illustrate this from the example on page 51 of the
Candidate's Guide book where an incorrect Balance Sheet has been deliberately
prepared. Present to the class the correct way to prepare the initial Balance Sheet of the
Bob Ross and Chow Lee partnership; this is presented on page 51 of the Candidate's
Guide book.
16
Partnerships (1)
5
A more complicated example of a formation of a partnership is shown as Example 2 on
pages 52, 53, 54 and 55 of the Candidate's Guide book. This example is of a similar
standard to the type of question related to this topic that could appear in the
examination. Involve the class by asking them to calculate the amount of capital
introduced by each partner, before Point 6 on page 53 of the Candidate's Guide book
which refers to each partner introducing a ®xed capital of £90,000.
The amounts of capital introduced by each partner are shown on pages 53 and 54 of the
Candidate's Guide book, so explain the calculation of these amounts to the class.
6
Explain why the ®gures that appear in the Balance Sheets of the individuals when they
were trading as sole traders are irrelevant to the calculation of the amount of capital
introduced by each partner. Explain that the values that are relevant to the partnership
are those that have been agreed between each of the partners at the commencement of
their partnership.
7
The agreement of the values of assets and liabilities introduced to the partnership could
mean that the value agreed for a particular asset is the same as the value that appears in
the sole trader's Balance Sheet.
8
Emphasise again that this value is the one agreed by the partners and it is not transferred
from the Balance Sheet of the sole trader.
9
The example states that each partner would introduce ®xed capitals of £90,000; so
illustrate that Carl Stone would need to introduce additional cash of £2,690 and also
that Tanya Little would withdraw cash from the partnership of £13,430. Explain that
this introduction and withdrawal of cash would mean that both of the partners would
have a balance of £90,000 in their capital accounts.
10 Involve the class by asking them to calculate the amount of cash that the partnership
would begin with. Go through the calculation to determine this ®gure; this is shown on
page 54 of the Candidate's Guide book.
11 Now ask the class to prepare the opening Balance Sheet of the partnership. In showing
the class the answer emphasise again that the Balance Sheet will not specify the value of
the assets and liabilities introduced by each of the partners. Also illustrate how each of
the values for the assets and liabilities have been determined. Illustrate the vertical
presentation of the Balance Sheet; this is the preferred form of presentation irrespective
of whether or not the question speci®es it.
Goodwill
12 Explain the concept of goodwill to the class, emphasising that it is an intangible
asset. Explain the reasoning for the inclusion of goodwill in the accounts of a
business.
17
Lesson 3
13 An illustration of a calculation of goodwill being introduced into the accounts of a
business appears on page 56 of the Candidate's Guide book. Before calculating the
amount of goodwill, show that the value of the tangible net assets sold by Tanya Little is
made up as follows:
Premises
Motor vehicles
Stocks
Debtors
less Creditors
£
58,000
24,200
480
18,560
101,240
2,250
98,990
14 Explain that the value of the goodwill is calculated by deducting the sales value of the
tangible net assets, £98,990, from the agreed sales value of the business, £105,000 or
£112,000. This means the goodwill ®gure in the accounts of the purchasing company
will be either £6,010 or £13,010 depending upon the purchase price paid for Tanya
Little's business.
15 Explain to the class that at the Second Level examination, only a calculation such as the
one illustrated above will be required to determine the valuation of goodwill. Also
advise the class that a question could be set that involves the purchase of a business, yet
the question does not mention the presence of goodwill. However, there could be
goodwill present in the purchase transaction. For example, refer to the sale of Tanya
Little's business above; if the question had given the agreed values for each of the net
tangible assets, but had not given the total value of them and had also given the selling
price of the business, then the candidates would be expected to calculate the total sales
value of the net tangible assets and compare this ®gure with the agreed selling price of
the business, in order to determine whether there was any goodwill present.
16 Explain the entries in the partnership accounts for the introduction of goodwill, using
this adaptation of the example in the Candidate's Guide book on page 57:
Carl Stone and Tanya Little have decided to form a partnership from their individual
businesses and have agreed to share pro®ts and losses in the ratio of Carl Stone 2 and Tanya
Little 1.
Carl Stone has valued the goodwill of his business at £15,000 and Tanya Little has agreed
with this valuation.
Tanya Little has valued the goodwill of her business at £9,000 and Carl Stone has agreed with
this valuation. The partners have agreed that the goodwill should remain in the accounts of the
new partnership.
17 Show the class the following journal entries, without narrations, that would be made to
record the introduction of goodwill to the partnership:
18
Partnerships (1)
Goodwill Account
Carl Stone capital
Goodwill Account
Tanya Little capital
Dr
£
15,000
Cr
£
15,000
9,000
9,000
Explain these journal entries to the class and advise that the goodwill would be shown
in the partnership accounts as £24,000. Also explain that the opening Balance Sheet of
the partnership would show the goodwill with this amount.
18 Show the class the following journal entries that would be made if the partners did not
want the goodwill to continue to appear in the partnership's accounts:
Carl Stone capital
Tanya Little capital
Goodwill Account
Dr
£
16,000
8,000
Cr
£
24,000
Explain these journal entries to the class and emphasise that the goodwill is written
off to the partners' capital accounts in the agreed pro®t sharing ratio of 2 : 1. Also
advise the class that following these entries into the partnership ledger, there will no
longer be a balance for goodwill in the accounts. Explain that this will also mean that
there will not be an entry for goodwill in the opening Balance Sheet of the
partnership.
Partnership ®nal accounts
19 Explain to the class that a partnership's ®nal accounts will include a Pro®t and Loss
Appropriation Account. Explain that this account is prepared after the Pro®t and Loss
Account has been prepared.
20 Explain that the ®rst entry in the Appropriation Account is the net pro®t that will have
been transferred from the Pro®t and Loss Account. Other entries that will appear in the
Appropriation Account are the partners' interest on capital, partnership salaries and the
interest on drawings and the partners' share of the pro®t or loss. Illustrate how the
entries that affect the Appropriation Account would be made by referring to the 7
points shown on page 60 of the Candidate's Guide book.
21 Involve the class by asking them to prepare an answer to Example 3 on page 61 of
the Candidate's Guide book. In addition to answering the Sections (a) and (b) also
ask the class to prepare the capital accounts and the current accounts for each of the
partners.
19
Lesson 3
22 Show the class the answer to Sections (a) and (b) and emphasise the following points:
(i) The net pro®t, before appropriation, is calculated by deducting the bank interest
and loan interest from the pro®t before interest on capital. It is important for the
students to realise that the net pro®t for the year is the ®nal entry in the Pro®t and
Loss Account and then the Appropriation Account is prepared. Advise your
students that if they did not make the distinction between the Pro®t and Loss
Account and the Appropriation Account, then this would cause them to lose
marks.
(ii) The partnership salaries and the interest on the ®xed capitals are both debited to the
Appropriation Account.
Following the posting of the above entries in the Appropriation Account, the net loss of
£390 is then determined and this is shared between the partners in the ratio of 2 : 1.
23 Advise the students of the manner in which the ®xed capital and current accounts have
been prepared and that the closing balances on these accounts are the ®gures that appear
in the Balance Sheet of the partnership.
24 Show the class how the current accounts are prepared. These appear on page 62 of the
Candidate's Guide book.
Advise the class that they should practise the preparation of these accounts in columns.
This format is often required in answers to examination questions involving
partnerships at this level of examination.
The ®xed capital accounts, also prepared in columns, would appear as follows:
Partner's capital accounts
Balance c/d
Wren
£
92,400
Hawk
£
141,600
92,400
141,600
Balance b/d
Goodwill
Balance b/d
Wren
£
90,000
2,400
92,400
Hawk
£
140,000
1,600
141,600
92,400
141,600
Explain to the class that the entries relating to goodwill in the above accounts are due to
the value of goodwill increasing by £4,000. This increase is re¯ected in the capital
accounts as the increase in the value means that the partners' capital accounts will re¯ect
this in the pro®t sharing ratios of 3 : 2.
The increases are calculated as follows:
Wren
20
£4,00063/5 = £2,400
Hawk
£4,00062/5 = £1,600
Partnerships (1)
QUESTION FOR CLASS PRACTICE
Question 3.1
J Angus and H Knott were both sole traders and they agreed to form a partnership on
1 January Year 7. They agreed to share pro®ts and losses equally.
On 1 January Year 7 their Balance Sheets were as follows:
Fixed assets
Premises
Motor vehicles
Plant and machinery
Fixtures and ®ttings
Goodwill
Current assets
Stock
Debtors
Bank
Current liabilities
Creditors
Bank overdraft
Capital
J Angus
£
H Knott
£
150,000
40,000
90,000
±
30,000
190,000
22,000
±
43,000
24,000
17,600
31,900
±
19,300
5,200
11,300
359,500
314,800
19,300
4,200
7,400
±
23,500
7,400
336,000
307,400
336,000
307,400
J Angus and H Knott agreed the following:
1
To value the assets of the businesses using the ®gures given below:
Premises
Motor vehicles
Plant and machinery
Fixtures and ®ttings
Goodwill
Stock
Debtors
Bank
J Angus
£
210,000
35,000
85,000
±
32,000
16,500
31,300
±
H Knott
£
240,000
20,000
±
40,000
24,000
19,000
5,100
11,300
The debtors' ®gures had been determined after each business had written off its bad
debts.
21
Lesson 3
2
To accept the creditors' balances at their book values for each of the partners.
3
To accept that Angus should be personally responsible for his bank overdraft and that it
should not be taken over by the partnership.
4
That goodwill is not to remain in the accounts of the new partnership.
Required
(a) Prepare the journal entries to open all the accounts of the new partnership
at 1 January Year 7. Narrations are not required.
(11 marks)
(b) Prepare, in vertical format, the Balance Sheet of the new partnership at
1 January Year 7.
(14 marks)
(Total 25 marks)
(LCCIEB 1998)
Solution
(a)
Journal of J Angus and H Knott
Dr
£
1 January Year 7
Premises
Motor vehicles
Plant and machinery
Goodwill
Stock
Debtors
Creditors
Capital ± J Angus
Premises
Motor vehicles
Fixtures and ®ttings
Goodwill
Stock
Debtors
Bank
Creditors
Capital ± H Knott
Capital ± J Angus
Capital ± H Knott
Goodwill
22
Cr
£
210,000
35,000
85,000
32,000
16,500
31,300
19,300
390,500
240,000
20,000
40,000
24,000
19,000
5,100
11,300
7,400
352,000
28,000
28,000
56,000
Partnerships (1)
An alternative and acceptable answer to this section of the question is as follows:
Journal of J Angus and H Knott
Dr
£
450,000
55,000
85,000
40,000
56,000
35,500
36,400
11,300
Premises
Motor vehicles
Plant and machinery
Fixtures and ®ttings
Goodwill
Stock
Debtors
Bank
Creditors
Capital ± J Angus
Capital ± H Knott
Cr
£
26,700
390,500
352,000
An alternative and acceptable treatment for the goodwill is explained as follows.
When the goodwill was introduced to the partnership the capital accounts of each partner
were credited with the amounts introduced by each of the partners; £32,000 from J Angus
and £24,000 from H Knott and the Goodwill Account debited with the total introduced of
£56,000. Note that these amounts were included in the total amounts of the net assets that
were credited to the partners' capital accounts in Part (a) of the answer.
When the goodwill was withdrawn from the partnership's accounts, then the Goodwill
Account was credited with £56,000 and the partners' capital accounts would have been
debited with each partner's share of the goodwill being written off. This meant that the
goodwill was written off equally between the partners as this was the agreed pro®t sharing
ratio between the partners, ie £28,000 each.
This means that the Goodwill Account was initially debited with £56,000 when the
goodwill was introduced to the partnership and later credited with £56,000 when the
goodwill was withdrawn from the partnership's accounts.
Therefore there was an opportunity to record the introduction and withdrawal of the
goodwill without involving the Goodwill Account. The only accounts that needed to be
involved in the goodwill transactions were the partners' capital accounts. These accounts
were affected as follows:
Capital accounts
J Angus
H Knott
Credit entries
£
32,000
24,000
Debit entries
£
28,000
28,000
Net effect
£
4,000 Credit
4,000 Debit
23
Lesson 3
This means that the answers could have been prepared to deal with the goodwill as follows:
Journal of J Angus and H Knott
Dr
£
Capital account ± J Angus
Capital account ± H Knott
(a)
Cr
£
4,000
4,000
J Angus and H Knott
Balance Sheet at 1 January Year 7
Fixed assets
Premises
Plant and machinery
Fixtures and ®ttings
Motor vehicles
Current assets
Stock
Debtors
Bank
£
450,000
85,000
40,000
55,000
£
630,000
35,500
36,400
11,300
83,200
less Amounts due within one year
Creditors
Working capital
26,700
56,500
686,500
Capital accounts
J Angus
H Knott
362,500
324,000
686,500
Note
Net current assets would be an acceptable alternative description to working capital.
24
Lesson 4: Partnerships (2)
Lesson topics
The treatment of goodwill when:
.
.
.
.
.
.
It is introduced to the partnership
There is an increase in the value of the goodwill
There is an increase in the value of the goodwill and a partner retires from the
partnership
There is a change in the pro®t/loss sharing ratio and goodwill is not shown in the
partnership ledger.
A partner retires from the partnership, there is an increase in the value of the
goodwill and the remaining partners decide not to show goodwill in the
partnership ledger
A new partner is introduced to the partnership, with a resultant change in the
pro®t/loss sharing ratio and the goodwill is not shown in the partnership ledger
Extended Syllabus references
2.5.1 Adjustments for goodwill necessary on the retirement of a partner
2.6.1 Adjustments for goodwill necessary on the admission of a partner
2.7.2 Adjustments for goodwill necessary when a change occurs in the ratio in
which pro®ts and losses are shared
2.7.3 Writing off goodwill where it is not to remain as an asset in the partnership
ledger
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
Make the entries in the partnership ledger for the introduction of goodwill to the
partnership and for any increase in the value of the existing goodwill
Prepare the entries when goodwill is not to be shown in the partnership ledger
25
Lesson 4
The lesson
1
Begin by explaining that there are occasions when there may be changes to the
agreement that was made by the partners at the time the partnership was formed.
Explain reasons that changes to the partnership agreement may arise by referring to
page 72 of the Candidate's Guide book.
Explain to the class the implications of changes in the pro®t/loss sharing ratio and also
how this change will in¯uence the treatment of goodwill in the partnership ledger.
2
Illustrate the implications for the treatment of the goodwill in each of the following
situations:
(a) Where goodwill is shown in the partnership ledger. Use Example 1 on page 73 of
the Candidate's Guide book and explain the solution and also use the Notes to the
solution that are provided in the book.
(b) Where goodwill is introduced into the partnership ledger. Use Example 2 on pages
73 and 74 and explain the solution and also use the Notes to the solution that are
provided in the book.
(c) Where goodwill is shown in the partnership ledger and there is an increase in its
valuation. Use Example 3 on page 74 and Example 4 on page 75. Explain both of
the solutions and use the Notes to the solutions that are provided in the Candidate's
Guide book.
3
For Example 3 on page 74 of the Candidate's Guide book explain that the
retirement of Birch, the partner, has not in¯uenced the way in which the increased
goodwill valuation has been distributed to each of the 3 partners. Advise the class
that the increased amount of goodwill is shared between the original partners in
their agreed pro®t/loss sharing ratio. Emphasise that it is through the efforts of the
3 partners, Birch, Elder and Spruce, that the goodwill of the partnership increased
by £6,600. It is therefore correct that this increase is shared between the partners in
the originally agreed pro®t sharing ratio. Also advise the students that as Birch is
retiring, then he should be paid the total amount of money that is due to him. This
therefore includes his share of the value of the partnership goodwill at the time of
his retirement.
4
Using the illustrations in the above examples, explain to the class that there are
occasions when a partner retires from the partnership. This will mean that the
partnership will come to an end, but often the business will continue with the
formation of a new partnership. The new partnership will often involve the continuing
partners of the previous partnership who may be joined by new partners.
5
Explain that when a partner retires, then the partnership will need to pay the retiring
partner all monies that are owing to him. You should also advise that, on occasions, the
retiring partner may agree to make a loan to the new partnership. So rather than receive
the total amount owing to him, the retiring partner may receive a lower amount
because of the loan arrangement.
26
Partnerships (2)
Explain how such an arrangement can bene®t the cash ¯ow situation for the new
partnership.
Advise that the amounts owed to the retiring partner are re¯ected in his capital and
current accounts.
6
Involve the class by asking them to answer the question in Example 5 on page 76 of the
Candidate's Guide book. In addition to the questions asked in the example also ask the
students to prepare the Bank Account and the capital accounts of the 3 partners, in
columns. The preparation of the capital accounts should assist the students in
understanding the necessary entries in relation to the increased value of goodwill, the
additional capital introduced by 2 of the partners and the money paid to the retiring
partner.
The accounts should appear as follows:
Bank Account
Balance b/d
Pepper capital
Mustard capital
£
1,000
23,320
23,320
£
44,640
3,000
Salt capital
Balance c/d
47,640
Balance b/d
47,640
3,000
Capital accounts
Bank
Balance c/d
Salt
£
44,640
44,640
Pepper
£
Mustard
£
101,960
83,640
101,960
83,640
Balance b/d
Goodwill
Bank
Balance b/d
Salt
£
42,000
2,640
Pepper
£
76,000
2,640
23,320
Mustard
£
59,000
1,320
23,320
44,640
101,960
83,640
101,960
83,640
7
Explain that there may be times when the partners acknowledge the presence of
goodwill in their partnership, but decide not to show it in the partnership ledger.
8
Illustrate this by using Example 6 on pages 78 and 79 of the Candidate's Guide book
and also use the Notes to the solution and explain the solution to your students.
9
Explain to the class the important concept of the way in which the goodwill is shared
by the partners, when it is initially brought into the partnership ledger and when it is
written out of the ledger. Initially it is shared between the partners in a 3 : 1 ratio, but
from 1 January Year 16 the pro®ts and losses are to be shared equally. The goodwill is
written out of the partnership ledger in the new pro®t/loss sharing ratio.
27
Lesson 4
10 Now illustrate Example 7 on page 79 of the Candidate's Guide book. This example
considers the retirement of a partner and an increase in the value of the goodwill. The
remaining partners continue in partnership with a revised pro®t/loss sharing ratio and
the goodwill no longer to be shown in the new partnership ledger.
Explain the solution to this example, emphasising that the increased valuation of the
goodwill is shared between the 3 partners in the original pro®t sharing ratio of 2 : 1 : 1.
Advise the students that when this entry has been made, the valuation of the goodwill
that appears in the Goodwill Account is £11,500.
11 Explain that the partners in the new partnership have decided not to show the goodwill
in the partnership ledger. This means that the goodwill is written out of the partnership
ledger by crediting the Goodwill Account with £11,500 and debiting the partners'
capital accounts with each partner's share of the written off goodwill. The new pro®t/
loss sharing ratio of 3 : 2 is used to share the written off goodwill between the partners.
Explain that the entries that are made to write out the goodwill will not affect the capital
account of Cotton; this is because he has retired and he will have been paid the amounts
due to him, including his share of the increased value of the partnership's goodwill.
Therefore there will not be a capital account for Cotton in the new partnership ledger.
12 Explain to the class that when a new partner is introduced to a partnership, then he will
introduce capital to the business. Explain that this will entitle the new partner to have a
share in any future pro®ts or losses that the partnership may achieve.
13 Explain to the class that the new partner could be entering a partnership that has
developed popularity with its customers, so that customers are likely to return in the
future with more business.
Advise the class that this future business will, hopefully, result in future pro®tability for
the partnership. Explain that this development of good customer relationships is often
re¯ected in the value of the goodwill of the partnership. Explain that it is therefore
reasonable to expect the incoming partner to make a contribution for the goodwill that
he will be inheriting when he joins the partnership. Explain that this contribution is, in
effect, a payment for the share of the future pro®ts that will result from the efforts of the
other partners in previous years.
14 Show the class the illustration of this concept that appears as Example 8 on pages 80 and
81 of the Candidate's Guide book. Explain the solution to Part (a) of the example in the
Candidate's Guide where the incoming partner, Grant, does not make a speci®c
payment for goodwill, but makes a contribution for it by having his capital account
debited with £3,000. Explain to the class that this is an alternative and acceptable way
in which the incoming partner contributes an amount for the goodwill of the
partnership. The goodwill is not shown in the partnership ledger, so explain to the class
that the goodwill is initially shared between the partnership's original partners, Walton
and Fox, in the pro®t/loss sharing ratio of 2 : 1. In removing the goodwill from the
partnership ledger, it is written out in the new pro®t/loss sharing ratio of 3 : 2 : 2. The
net effect of these calculations is as follows:
28
Partnerships (2)
Dr
£
Walton capital
Fox capital
Grant capital
Cr
£
2,500
500
3,000
This shows, therefore, that Grant's contribution to the goodwill developed by the
partnership before he joined it is £3,000. This is shared between Walton and Fox; each
receives the difference between the share of the goodwill when it was introduced in the
pro®t/loss sharing ratio of 2 : 1 and when it was written out of the partnership in the
new pro®t/loss sharing ratio of 3 : 2 : 2.
15 Explain to the class that an alternative way to determine these amounts is as
follows:
Pro®t sharing ratios
Walton
Fox
Grant
2 partners
Ratio
%
2
66.67
1
33.33
3 partners
Ratio
%
3
42.86
2
28.57
2
28.57
Change
%
+ 23.81
+ 4.76
± 28.57
3
7
Nil
100.00
100.00
The amounts relating to goodwill that will be, subject to rounding, entered into the
partners' capital accounts will be as follows:
Walton capital
Fox capital
Grant capital
23.81%6£10,500 = £2,500 Credit
4.76%6£10,500 = £500 Credit
28.57%6£10,500 = £3,000 Debit
16 Section (b) of the example in the Candidate's Guide book relates to Grant making a
payment for goodwill. The solution is shown on page 81 of the Candidate's Guide
book. Explain to the students the amount payable by Grant is shared between Walton
and Fox and the individual amounts for each partner are determined by calculating
the difference between the partner's share of the goodwill when it has been
distributed:
(a) in the original pro®t/loss sharing ratio for Walton and Fox of 2 : 1; and
(b) in the pro®t/loss sharing ratio for Walton, Fox and Grant of 3 : 2 : 2.
17 Explain to the students that the entries relating to the capital accounts of Walton and
Fox are the same as those that appear in the summarised journal entries for the solution
to Part (a) that are shown above. Also explain that the amount of £3,000 that is debited
to Grant's capital account in the summarised journal entries above is replaced by a debit
to the partnership's Bank Account for £3,000 when Grant makes a speci®c payment for
the goodwill.
29
Lesson 4
18 Also explain to the students that the table prepared above can also be used to determine
the amount of money payable by Grant for his share of the goodwill and also for its
distribution between Walton and Fox.
QUESTION FOR CLASS PRACTICE
Question 4.1
Spey, Tweed and Clyde are in partnership sharing all pro®ts and losses equally. They decided
not to show goodwill in the partnership ledger.
On 1 January Year 7 Tweed retired; Spey and Clyde elected to continue in partnership
sharing pro®ts and losses in the ratio of 3 : 2 respectively.
On 1 January Year 7 the partners agreed that the value of the goodwill was £15,000. Spey
and Clyde also agreed not to show the goodwill in their partnership ledger.
Required
Prepare the journal entries that are necessary at the time of Tweed's retirement and the
commencement of Spey and Clyde's partnership.
Solution to Question 4.1
Journal
Goodwill
Spey capital
Tweed capital
Clyde capital
Spey capital
Clyde capital
Goodwill
Dr
£
15,000
Cr
£
5,000
5,000
5,000
9,000
6,000
15,000
Explain this answer to the class and advise the students that when Tweed retired he would
have withdrawn his capital from the business. This would have included the £5,000 share of
the partnership's goodwill that had been created up to the date of his retirement.
Also explain that the journal entries could have been summarised as follows:
Journal
Spey capital
Clyde capital
Tweed Capital
30
Dr
£
4,000
1,000
Cr
£
5,000
Partnerships (2)
Explain that the amounts to enter into the partners' capital accounts could have been
determined by adopting the table that had been shown earlier in this chapter.
Pro®t sharing ratio
Spey
Tweed
Clyde
2 partners
Ratio
%
1
33.33
1
33.33
1
33.33
3 partners
Ratio
%
3
60
2
40
3
5
100
100.00
Change
%
± 26.67
+ 33.33
± 6.67
Nil
Explain that the amounts relating to goodwill that will be posted into the partners' capital
accounts will be as follows:
Spey capital
Tweed capital
Clyde capital
£15,000626.67% = £4,000 Debit
£15,000633.33% = £5,000 Credit
£15,00066.67% = £1,000 Debit
Explain to the students that there has been some rounding in obtaining the answer.
31
Lesson 5: Partnerships (3)
Lesson topics
.
.
.
Revaluation of partnership assets
The partnership comes to an end
A partnership is sold
Extended Syllabus references
2.8.1
Distinction between the partnership business ceasing to exist (eg because
of business failure) and the partnership business being sold as a going
concern
2.8.2
The purpose of a dissolution or realisation account
2.8.3
Entries in the partnership ledger for assets and/or liabilities taken over by an
individual partner
2.8.4
Treatment of partners' loans upon dissolution
2.8.5
Sale of partnership assets for cash
2.8.6
Collection of amounts from partnership debtors and the treatment of bad
debts and discounts
2.8.7
Settlement of partnership creditors and the treatment of discounts
2.8.9
Entries to close partners' personal account balances
2.8.10 Entries necessary to deal with outstanding debit balances on partners'
personal accounts. Application of the rule in Garner v Murray
2.8.11 Sale of partnership as a going concern, to another partnership or to a limited
company
2.8.12 Entries to deal with the settlement of the purchase consideration whether
received in cash or in securities such as shares or debentures
2.8.13 Transfer of securities to the partners on an agreed basis
2.8.14 Closure of the partners' personal accounts with cash transactions
32
Partnerships (3)
Aim of the lesson
At the end of the lesson the students will be able to prepare the entries in the
partnership ledger when the assets are revalued, when the partnership comes to an
end and when the partnership is sold
The lesson
Partnership assets are revalued
1
Explain to the class that, on occasions, the assets of a partnership may increase or
decrease in value. The previous lesson gave an example of this when the valuation of a
partnership's goodwill changed. Explain that the valuation of the tangible assets could
also alter. For example, explain that the valuation of the partnership's motor vehicles
could be lower than their net book value shown in the partnership's accounts. This
could be due to a larger amount of mileage being travelled than had been originally
anticipated for the motor vehicles. This could mean, therefore, that their worth is lower
than that shown as their current net book values.
2
Explain to the class that any change in the valuation of any assets should be recorded in
the partnership ledger. Explain that a Revaluation Account is used to record the change
in the valuation of the affected assets.
3
Refer to Example 9 on pages 82 and 83 of the Candidate's Guide book and begin by
showing the class how the Revaluation Account is prepared. The solution in the
Candidate's Guide book shows the entries in the Revaluation Account as being the
differences in the valuation of those assets that have been revalued. Explain that the net
difference, £5,500, is the de®cit or loss caused by the revaluation of the assets. Explain
that this de®cit is divided between the partners in their existing pro®t and loss sharing
ratio of 3 : 1. Explain to the students that an alternative approach to prepare the
Revaluation Account is as follows:
(a) Credit the relevant asset account with its existing value in the partnership
ledger.
(b) Debit the Revaluation Account with the relevant asset's existing valuation in the
partnership ledger.
(c) Credit the Revaluation Account with the relevant asset's revised valuation.
(d) Debit the relevant asset account with the revised valuation.
(e) If a net gain has been made on the revaluation of the assets, debit the Revaluation
Account with the amount of the gain. The gain should be shown as being shared
between the partners in their pro®t sharing ratio.
(f) Following the entry described in (e) above, credit each partner's capital account
with their share of the gain.
33
Lesson 5
(g) If a net de®cit has been made in the revaluation of the assets, credit the Revaluation
Account with the amount of the de®cit. The de®cit should be shown as being
shared between the partners in their loss making ratio.
(h) Following the entry described in (f) above, debit each partner's capital account with
their share of the de®cit.
4
Show the class the following Revaluation Account that has been prepared in the
manner described above:
Revaluation Account
Goodwill
Freehold premises
Motor vehicles
Stocks
£
7,000
62,500
23,900
7,480
100,880
Goodwill
Freehold premises
Motor vehicles
Stocks
Capital account:
J Rudge
S Young
£
13,500
55,900
19,300
6,680
4,125
1,375
100,880
Continue to show the class the solution to Example 9 on pages 82 and 83 of the
Candidate's Guide book. Emphasise to the class of the preferred vertical presentation
of the Balance Sheet, even though this form of presentation is not speci®cally asked
for.
5
Now refer the class to Example 10 on pages 85 and 86 of the Candidate's Guide book.
Explain to the class that this example involves the retirement of a partner, the
revaluation of assets at the time the partner retires, the admittance of a new partner to
the partnership and a change in the pro®t and loss sharing ratio on the admittance of the
new partner.
6
Involve the class by asking them to prepare the Balance Sheet for the new partnership.
Also emphasise to the students the need to show all of their workings to the solution. It
will be good practice to the students to prepare the following accounts before they
prepare the Balance Sheet: Revaluation Account, Goodwill Account, Bank Account
and each partner's capital account.
7
Use the Notes to the solution to explain the answers to the students, noting again the
comment relating to the goodwill not appearing in the partnership ledger.
A partnership comes to an end
8
34
There are occasions when a partnership ceases to trade: reasons for this are given on
page 88 of the Candidate's Guide book.
Partnerships (3)
9
Advise the class that when a partnership ceases to trade, then this means that it is
dissolved, and so a Dissolution Account is prepared to deal with this. Explain to the
students the principles that should be observed when closing the books of the
partnership. These principles are explained on pages 88 and 89 of the Candidate's
Guide book. Now refer the class to Example 11 on pages 89 and 90 of the Candidate's
Guide book and explain the solution to them.
10 Show the students how the following ledger accounts would appear when the
partnership is dissolved: Dissolution Account, Bank Account and the partner's capital
accounts in columns.
Dissolution Account
£
48,000
6,500
10,900
Fixed assets
Stocks
Debtors
Bank
Capital account:
Bill
Ben
65,400
£
49,700
9,420
6,280
65,400
Capital accounts
Dissolution Account
Bank
Bill
£
9,420
29,980
39,400
Ben
£
6,280
16,820
39,400
Balance b/d
Bill
£
39,400
Ben
£
23,100
39,400
39,400
Bank Account
Balance b/d
Dissolution Account
£
1,200
49,700
50,900
Creditors
Capital account:
Bill
Ben
£
4,100
29,980
16,820
50,900
Emphasise to the class that after these entries have been made, there is not a balance in
the Bank Account and there are not any balances in the partners' capital accounts. In
fact there are not any balances on any account in the partnership ledger; this means that
the partnership has been dissolved.
11 Involve the class by asking them to answer Example 12 on pages 91 and 92 of the
Candidate's Guide book.
12 When explaining the solution to the class emphasise that the book values of the assets at
the time the partnership is dissolved are debited to the Dissolution Account. Also explain
that the values that the assets are sold for or taken over by a partner are credited to the
35
Lesson 5
Dissolution Account. Explain that following these entries, a pro®t or loss on dissolution
is calculated and shared between the partners in their pro®t and loss sharing ratio.
Explain the solution to the class using the Notes to the solution on page 94 of the
Candidate's Guide book.
13 Involve the class again by asking them to prepare a solution to Example 13 on pages 94
and 95 of the Candidate's Guide book. This example relates to another partnership
being dissolved. In addition to asking the class to prepare the journal entries, also ask
them to prepare the Dissolution Account, the Bank Account and the partners' capital
accounts in columns. These accounts should be prepared as follows:
Dissolution Account
Goodwill
Tangible assets
£
20,000
60,000
Bank
Creditors
Capital account:
Andrew
Brian
Colin
80,000
£
48,000
200
15,900
10,600
5,300
80,000
Bank Account
Dissolution Account
Capital account:
Brian
£
48,000
Balance b/d
Creditors
Capital account:
Andrew
Colin
600
48,600
£
22,000
7,800
4,100
14,700
48,600
Capital accounts
Dissolution Account
Bank
Andrew
£
15,900
4,100
20,000
Brian
£
10,600
10,600
Colin
£
5,300
14,700
20,000
Balance b/d
Bank
Andrew
£
20,000
20,000
Brian
£
10,000
600
10,600
Colin
£
20,000
20,000
Emphasise to the class that the ®nal entry in the capital accounts and the Bank Account
relates to the settlement of the partners' capital accounts. Andrew and Colin are owed
£4,100 and £14,700 respectively, whilst Brian owes the partnership £600 and so has to
introduce this amount as additional capital to the business.
14 Explain to the class that a common error is for students to apportion the balance in the
Bank Account, between the partners in the pro®t and loss sharing ratio, at the time
36
Partnerships (3)
the partnership is dissolved. Please emphasise that this is incorrect practice. Use the
Notes to the solution to explain the preparation of the journal and the ledger
accounts.
15 Use Example 14 on page 96 of the Candidate's Guide book to illustrate the Garner v
Murray rule. The example states that Brian does not have any personal assets to
introduce to the partnership in order to settle his debt of £600 to the partnership.
Explain to the class that this debt will have to be shared between Andrew and Colin in
the proportion of their capital balances prior to the dissolution of the partnership. The
capital balances of Andrew and Colin were £20,000 and £10,000 respectively and so
the debt should be shared between these partners in a 2 : 1 ratio.
16 Show the class the journal entries, the Bank Account and the partners' capital accounts
in columns for the situation described above.
Journal
Debit
£
400
200
Capital account ± Andrew
Capital account ± Colin
Capital account ± Brian
Credit
£
600
Bank Account
Tangible assets
£
48,000
Balance b/d
Creditors
Capital account:
Andrew
Colin
48,000
£
22,000
7,800
3,700
14,500
48,000
Capital accounts
Andrew Brian
£
£
Dissolution Account
15,900 10,600
Brian ± capital account
400
Bank
3,700
20,000
10,600
Colin
£
5,300
200
14,500
20,000
Balance b/d
Capital accounts:
Andrew and
Colin
Andrew Brian
£
£
20,000 10,000
Colin
£
20,000
600
10,600
20,000
20,000
A partnership is sold
17 Refer the class to Example 15, on pages 96 and 97 of the Candidate's Guide book,
which relates to a partnership being sold. Explain to the class that when a partnership is
37
Lesson 5
sold as a going concern, then this will involve the preparation of a Realisation Account.
Explain that this account is used to close the ledger accounts for the net assets of the
partnership. The account also determines whether a pro®t or loss has arisen on the sale
of the partnership.
18 Explain to the class the distinction between the use of a Dissolution Account (used
when the partnership ceases) and a Realisation Account (used when the partnership is
sold as a going concern).
19 Refer the class to the section of the solution for Example 15 on pages 96 and 97 of the
Candidate's Guide book that relates to the preparation of the journal entries. Now
show the class the following ledger accounts: Realisation Account, Litton plc and the
partners' capital accounts, in columns. These should appear as follows:
Realisation Account
Tangible ®xed assets
Capital account:
Janet
John
£
248,000
Creditors
Litton plc
16,500
16,500
281,000
£
31,000
250,000
281,000
Litton plc
£
250,000
Realisation Account
Bank
£
250,000
Capital accounts
Bank
Janet
£
118,500
John
£
150,500
118,500
150,500
Balance b/d
Realisation Account
Janet
£
102,000
16,500
118,500
John
£
134,000
16,500
150,500
20 Explain to the class how the consideration, purchase price of £250,000 from Litton plc,
for the partnership is treated in the partnership ledger. Explain that the entries relate to
the Realisation Account and the Litton plc ledger account.
21 Example 15 related to the purchasers paying cash for Janet and John's partnership. Now
refer to Example 16 on pages 98 and 99 of the Candidate's Guide book, where the
purchase of a partnership is partially settled by the issuing of shares in the buying
company and partially by a cash payment.
22 The example also involves the revaluation of the partnership's premises and the
introduction of goodwill into the partnership ledger prior to the sale of the partnership.
38
Partnerships (3)
Explain to the class that these two items will require the preparation of a Revaluation
Account before the Realisation Account is prepared.
23 Explain the solution to the class by also referring to the Notes to the solution.
Emphasise the treatment of the goodwill in the solution. Explain that an alternative and
acceptable treatment of the goodwill is as follows, prepared in a journal format.
Journal
Debit
£
24,600
Goodwill Account
Capital account:
J Small
R Davis
A Price
Goodwill Account
Realisation Account
Credit
£
12,300
8,200
4,100
24,600
24,600
24 Explain that this method acknowledges the amount of goodwill attributable to each
partner before the partnership is sold. Explain to the class that if the above treatment of
the goodwill had been adopted, then the Revaluation Account would have appeared as
follows:
Revaluation Account
Premises
£
12,000
12,000
£
Capital account:
J Small
R Davis
A Price
6,000
4,000
2,000
12,000
25 Explain to the class that the entries to the partners' capital accounts give the same `net
effect' as appear in the Revaluation Account on page 99 of the Candidate's Guide
book.
26 Explain to the class how the consideration, purchase price £480,000, from Brightside
plc is treated. Remind the class that the price is made up partially by an issue of shares
and partially by a payment in cash.
27 Explain to the class that the valuation of the shares is determined by: 120,000
shares6£3.90 = £468,000. Advise the class that the par or nominal value of the
shares, £1 per share in this example, is irrelevant in this calculation. Explain that as
the value of the shares being issued is £468,000, then this means that the balance of
cash required to meet the purchase price in full is £480,000 less £468,000 =
£12,000.
39
Lesson 5
28 Advise the class that the shares have been distributed between the partners in their
pro®t and loss sharing ratio of 3 : 2 : 1. Explain that the entries relating to the
distribution of the shares to each partner are made in the partners' capital accounts and
the Ordinary shares in Brightside plc account.
29 Advise the class that the cash received from Brightside plc is not distributed between the
partners, but is debited to the partnership's Bank Account.
30 Advise the class that the Brightside plc account is similar to that of a Debtor Account.
This means that Brightside has agreed to pay an amount of £480,000 to the
partnership. So the account for Brightside plc is credited with £480,000: the
company therefore is a creditor of the partnership. The corresponding debit entry is
made in the Realisation Account, this is the `Sales value' of the partnership and it is in
the Realisation Account where a pro®t or loss on the sale of the partnership is
determined.
31 Refer the class back to the account for Brightside plc and advise the class how the
account is cleared. One debit entry is made to the account for Ordinary shares in
Brightside plc, £468,000, and another debit entry is made to the Bank Account,
£12,000.
32 Refer the class to the Ordinary shares in Brightside account and explain the entries in
the account: explain the debit entry from the account for Brightside plc and the credit
entries relating to the distribution of the shares to the partners in their pro®t and loss
sharing ratio.
33 Refer the class to the Bank Account, explaining all of the entries in the account.
Note particularly the cash received from Brightside plc and how the the
partnership's bank balance has been used to settle the debts owed to the partners
R Davis and A Price. These debts included the repayment of the loan that R Davis
had made to the partnership. Also explain to the class that they should recognise
that the partner, J Small, owed money to the partnership and that he had settled
this, by introducing more money into the partnership before it was sold to
Brightside plc.
34 Explain to the class that it is important that they are able to make the accounting entries
into the partnership ledger when the partnership is sold as a going concern when the
purchase consideration is made up of:
(a) Totally cash or
40
(b) Shares in the purchasing
company or
(c) A combination of both cash and
shares in the purchasing company
Partnerships (3)
QUESTIONS FOR CLASS PRACTICE
Question 5.1
The partnership Balance Sheet of John Codsall and Nick Perton at 30 April Year 8 was as
follows:
Fixed assets
Freehold premises
Fixtures and ®ttings
Motor vehicles
Current assets
Stocks
Debtors
RM
RM
120,000
24,000
18,000
162,000
12,300
8,700
21,000
Current liabilities
Creditors
Bank overdraft
6,200
5,300
11,500
Working capital
9,500
171,500
Capital accounts
John Codsall
Nick Perton
105,000
63,000
168,000
Current accounts
John Codsall
Nick Perton
2,025
1,475
3,500
171,500
The partnership has operated for many years and pro®ts and losses have been shared
between John Codsall and Nick Perton in the proportion of 3 : 1.
On 1 May Year 8 the partners decided to revalue some of the partnership assets as follows:
Freehold premises RM130,000 and Fixtures and ®ttings RM28,000
The value of the partnership goodwill on 1 May Year 8 was RM15,000 and the partners
decided that this should be shown in the partnership accounts.
On 2 May Year 8 the partners agreed to admit Mary Shaw to the partnership. The new
partnership agreement stated that any pro®ts and losses would be shared between Codsall,
Perton and Shaw in the ratio 2 : 2 : 1 respectively.
41
Lesson 5
Mary Shaw introduced the following assets to the partnership:
Fixtures and ®ttings
Motor vehicles
Stocks
Bank balance
Goodwill
RM
11,500
12,000
2,300
4,100
5,000
All 3 partners agreed that goodwill should not appear in the accounts of the new partnership.
Required
(a) Prepare the Revaluation Account for the partnership of John Codsall and
Nick Perton.
(6 marks)
(b) Prepare the capital accounts, in columns, for Codsall, Perton and Shaw.
(5 marks)
(c) Prepare the Balance Sheet of Codsall, Perton and Shaw at 2 May Year 8. (14 marks)
(Total 25 marks)
(LCCIEB 1998)
Question 5.2
Anchor, Blake and Cole are in partnership sharing pro®ts and losses in the ratio 2 : 1 : 1
respectively. The Balance Sheet of the ®rm at 31 October Year 9 was as follows:
Anchor, Blake and Cole
Balance Sheet at 31 October Year 9
Cost
Fixed assets
Freehold premises
Fixtures and ®ttings
Motor vehicles
Net
book value
£
140,000
8,000
17,000
165,000
±
3,500
9,000
12,500
140,000
4,500
8,000
Current assets
Stock
Debtors
Balance at bank
16,000
8,600
3,200
less Creditors
27,800
6,100
Net current assets/working capital
less Loan ± Anchor
42
£
Aggregate
depreciation
£
152,500
21,700
174,200
25,000
149,200
Partnerships (3)
Financed by:
Capital accounts
Current accounts
Anchor
£
75,000
2,700
Blake
£
35,000
1,800
Cole
£
35,000
(300)
145,000
4,200
149,200
The partners agreed to dissolve the partnership on 1 November Year 9. One of the motor
vehicles was to be taken over by Anchor at a valuation of £3,500, the other one by Blake at
a ®gure of £3,000.
The remaining assets were sold for the following amounts and the proceeds were banked:
Freehold premises
Fixtures and ®ttings
Stock
£
122,000
2,700
11,300
The debtors realised £8,200 and dissolution expenses of £900 were paid. The amount
owing to creditors was settled for £5,800.
Required
Prepare the following in the books of the partnership to show the closing down of the
business at 1 November Year 9:
(a) Dissolution Account.
(8 marks)
(b) Capital accounts in columns.
(10 marks)
(c) Bank Account.
(7 marks)
(Total 25 marks)
(LCCIEB 1997)
Solution to Question 5.1
(a)
Revaluation Account
Year 8
1 May Freehold premises
1 May Fixtures and ®ttings
1 May Capital accounts
John Codsall
Nick Perton
RM
120,000
24,000
10,500
3,500
158,000
Year 8
1 May Freehold premises
1 May Fixtures and ®ttings
RM
130,000
28,000
158,000
43
Lesson 5
(b)
Capital accounts
Year 8
2 May
Goodwill
2 May
Balance c/d
Codsall Perton
Shaw
RM
RM
RM
8,000
Codsall Perton
Shaw
RM
RM
RM
8,000
4,000
1 May
Balance b/d
118,750 62,250
30,900
1 May
Goodwill
11,250
3,750
1 May
Revaluation Account
10,500
3,500
2 May
Sundry assets
2 May
Balance b/d
126,750 70,250
(c)
Year 8
34,900
105,000 63,000
34,900
126,750 70,250
34,900
118,750 62,250
30,900
John Codsall, Nick Perton and Mary Shaw
Balance Sheet at 2 May Year 8
Fixed assets
Freehold premises
Fixtures and ®ttings
Motor vehicles
Current assets
Stocks
Debtors
RM
RM
130,000
39,500
30,000
199,500
14,600
8,700
23,300
less Amounts due within one year
Creditors
Bank overdraft
6,200
1,200
7,400
Working capital
15,900
215,400
Capital accounts
John Codsall
Nick Perton
Mary Shaw
118,750
62,250
30,900
Current accounts
John Codsall
Nick Perton
2,025
1,475
211,900
3,500
215,400
Note
Treatment of goodwill: on 1 May, goodwill was valued at RM15,000 and was to be shown
in the partnership's accounts. The entries would be as follows:
Debit
Credit
Credit
44
Goodwill Account
Capital account ± John Codsall
Capital account ± Nick Perton
RM
15,000
11,250
3,750
Partnerships (3)
On 2 May, Mary Shaw was admitted to the partnership and included in the assets she
introduced was goodwill valued at RM5,000. This means that the total value of goodwill in
the partnership increased to RM20,000. However, the partners agreed that goodwill should
not appear in the partnership accounts. The entries would be as follows:
Debit
Capital account ± John Codsall
Capital account ± Nick Perton
Capital account ± Mary Shaw
RM
8,000
8,000
4,000
Credit
Goodwill Account
20,000
This means that the Goodwill Account will now have a nil balance.
An alternative way in which to introduce the goodwill and then remove it from the
partnership accounts would be to recognise the treatment of the goodwill in the capital
accounts as follows:
Capital account ± John Codsell
Capital account ± Nick Perton
Capital account ± Mary Shaw
Introduced
RM
11,250 Credit
3,750 Credit
5,000 Credit
Withdrawn
RM
8,000 Debit
8,000 Debit
4,000 Debit
The net effect of these entries on the capital accounts will be:
Capital account ± John Codsall
Capital account ± Nick Perton
Capital account ± Mary Shaw
3,250 Credit
4,250 Credit
1,000 Credit
Please note that the net effect of these entries is nil.
Solution to Question 5.2
(a)
Dissolution Account
Year 9
1 Nov
Freehold premises
Fixtures and ®ttings
Motor vehicles
Stock
Debtors
Bank
£
140,000
4,500
8,000
16,000
400
900
169,800
Year 9
Capital ± Anchor
Capital ± Blake
Bank
Bank
Bank
Creditors
Loss on dissolution:
Capital ± Anchor
Capital ± Blake
Capital ± Cole
£
3,500
3,000
122,000
2,700
11,300
300
13,500
6,750
6,750
169,800
45
Lesson 5
(b)
Capital accounts
Year 9
1 Nov
Anchor Blake
Cole
£
£
£
Current account
Year 9
300
Dissolution Account
3,500
Dissolution Account
13,500
6,750
6,750
Bank
60,700
27,050
27,950
77,700
36,800
35,000
(c)
Balances b/d
Current accounts
Cole
£
£
£
75,000
35,000
2,700
1,800
77,700
36,800
35,000
35,000
Bank Account
Year 9
1 Nov
Balance b/d
Debtors
Dissolution Account
Dissolution Account
Dissolution Account
£
3,200
8,200
122,000
2,700
11,300
147,400
46
1 Nov
3,000
Anchor Blake
Year 9
1 Nov
£
Creditors
Dissolution Account
Loan ± Anchor
Capital ± Anchor
Capital ± Blake
Capital ± Cole
5,800
900
25,000
60,700
27,050
27,950
147,400
Lesson 6: Company accounts (1)
Lesson topic
Preparation of the ®nal accounts of a company
Extended Syllabus references
3.1.1 The distinction between a private company (Limited) and a public company
(Public Limited Company, ie plc)
3.1.3 Understanding of the difference between authorised share capital and called
up share capital
3.2.1 Preparation of a Pro®t and Loss Account in vertical format to show the net
pro®t of a company
3.2.2 Understanding of the purpose of the appropriation section of the Pro®t and
Loss Account
3.2.3 Awareness that the reward to shareholders is by way of dividends
3.2.4 Calculation of dividends by using the nominal % for preference share capital
and pence per share or £ per share for ordinary share capital
3.2.6 Calculation of the retained pro®t for the year
3.2.7 Preparation of a vertical Balance Sheet in good format
Aim of the lesson
At the end of the lesson the students will be able to prepare, in vertical format, the
®nal accounts of a company
The lesson
1
Begin the lesson by explaining to the class the following points:
(a) The background to the formation of companies.
(b) The requirements for annual accounts, an annual general meeting and the need for
external auditors.
47
Lesson 6
(c) The distinction between a private company and a limited company.
These items are explained on pages 110 and 111 of the Candidate's Guide book.
2
Now explain to the class that the Trading and Pro®t and Loss Account for a company is
prepared in the same way as any other type of business such as a sole trader or
partnership.
3
Explain to the class that an Appropriation Account will also be prepared. This account
will be debited with all of the appropriations of the company's pro®t. Examples of
appropriations are dividends that have been paid or are payable to the company's
shareholders.
4
Explain to the class that it is important for the students to show a clear distinction
between the Trading and Pro®t and Loss Account and the Appropriation Account.
Advise the class that the examiner will want to see this distinction and will not award
marks where incorrect presentations have been used. Advise the class that a correct net
pro®t can be calculated, but if the calculation has been made when an incorrect
presentation has been adopted, then few, if any, marks will be awarded.
5
An illustration of a company's Appropriation Account is given in Example 1 of the
Candidate's Guide book on pages 114 and 115. Explain the preparation of this to the
class using the Notes to the solution which are provided on pages 115 and 116.
6
Explain to the class the importance of showing the amount of pro®t that is available for
distribution to the shareholders. In the example this ®gure is given, £2,700,000, but there
are examination questions set that will require the completion of Trading, Pro®t and Loss
and Appropriation Accounts. The correct preparation of these accounts will require gross
pro®t, net pro®t and retained pro®t for the year, ie that which is transferred to reserves, to
be clearly shown. For an explanation of the retained pro®t for the year refer the class to
Note 5 of the Notes to the solution for Example 1 in the Candidate's Guide book.
7
Ask the class to attempt an answer to Example 2 on pages 116 and 117 of the
Candidate's Guide book. Explain the solution to the class, emphasising again the
importance of showing the net pro®t, before appropriations, of £1,700 and the pro®t
transferred to reserves of £590. Advise the class that the term ``Retained pro®t for the
year'' is an alternative for the term ``Pro®t transferred to reserves''.
When explaining the solution to the class use the Notes to the solution on pages 118
and 119 of the Candidate's Guide book.
The use of the Notes to the solution will also be helpful to the class in later studies of
this syllabus, such as the accounting entries relating to the dividends, the make up of a
statement of the shareholders' funds, and the meaning and accounting treatment of a
share premium.
8
48
Explain to the class the format and presentation of the Balance Sheet of a company.
Emphasise the importance of preparing the Balance Sheet in a vertical format. An
Company accounts (1)
example of such a presentation is provided on pages 121 and 122 of the Candidate's
Guide book together with Notes to its presentation on pages 122 and 123. Ask the class
to familiarise themselves with this style of presentation.
9
Advise the class that the vertical presentation of a Balance Sheet is the preferred style of
presentation and should be adopted in all situations. Advise the class that, at times, the
examiner will specify this style of presentation and this style will carry marks. Advise the
class that even where the style is not speci®cally requested, they should still adopt the
vertical form of presentation. Advise the class that this style allows more useful
information to be shown than with the traditional horizontal format.
10 Explain to the class the distinction between authorised share capital and called up share
capital. This distinction is explained on pages 113 and 114 of the Candidate's Guide
book. Advise the class that when preparing a Balance Sheet of a company, the full
details for both the authorised share capital and the called up share capital should be
shown. The details are: the class of share, eg preference shares or Ordinary shares; the
number of shares; the par value of each class of share; and the total value.
Also advise the class of the meaning of the par, or nominal, value of a share.
11 Ask the class to attempt an answer to Example 3 on page 123 of the Candidate's Guide
book. Please make the following amendments to the example:
.
.
Advise the class that the authorised share capital of the company is 30,000,000
Ordinary shares of £0.25 each. This will mean that when the class prepares the
Balance Sheet, the authorised share capital should be shown.
Revise the required section to read:
``Prepare the following for Fulford plc:
(a) an Appropriation Account for the year ended 31 March Year 16; and
(b) a Balance Sheet, in vertical format, at 31 March Year 16.''
12 Explain the solutions to the class. The solutions appear on page 124 of the Candidate's
Guide book. Please note that there should be a heading placed above the Appropriation
Account, and it should appear as follows:
Fulford plc
Pro®t and Loss Appropriation Account
for the year ended 31 March Year 16
13 When explaining the solutions to the class, use the Notes to the solution. These are
provided on page 125 of the Candidate's Guide book. Note 4 provides information that
will prove useful for a later item in this syllabus.
14 When the class have prepared their Balance Sheets, ask the students to compare them
with the example of a pro-forma balance sheet that was used to introduce the topic on
pages 121 and 122 of the Candidate's Guide book. Ask the students to try to ensure that
the Balance Sheets are comparable.
49
Lesson 6
QUESTION FOR CLASS PRACTICE
Question 6.1
The ®nancial year of PTC Ltd ends on 30 June. After preparing a provisional Pro®t and
Loss Account for the year ended 30 June Year 6, the company's books showed the following
summarised information:
Provisional net pro®t for year ended 30 June Year 6
Authorised and called up share capital (Ordinary shares of $1 each)
Share premium
Pro®t and loss balance brought forward at 1 July Year 5
Land and buildings
Fixtures and ®ttings at cost
Motor vehicles at cost
Stock at 30 June Year 6
Debtors
Bank balance
Creditors
Provision for depreciation of motor vehicles
Provision for doubtful debts at 1 July Year 5
$'000
1,260
5,000
1,600
1,470
5,000
600
3,000
960
700
200
300
800
30
After calculating the provisional net pro®t, $1,300 was received in cash in respect of a trade
debt which had been written off during the year ended 30 June Year 5.
In addition, the company decided to:
1
Write off bad debts amounting to $21,000 and adjust the provision for doubtful debts to
of remaining debtors.
2
Provide for depreciation as follows:
Fixtures and ®ttings
Motor vehicles
±
±
at 10% on cost
at 20% on cost
3
Show the land and buildings at the revised valuation of $6,000,000.
4
Recommend the payment of a dividend on the share capital of $0.065 per share.
Required
(a) Show the following accounts for the year ended 30 June Year 6, appropriately balanced
at the year end:
(i) Provision for doubtful debts.
(ii) Provision for depreciation of ®xtures and ®ttings.
(iii) Provision for depreciation of motor vehicles.
50
Company accounts (1)
(iv) Land and buildings.
(v) Revaluation reserve.
(8 marks)
(b) Prepare, for PTC Ltd the:
(i) Completed Pro®t and Loss Account and Appropriation Account
for the year ended June Year 6.
(ii) Balance Sheet at 30 June Year 6.
(17 marks)
(Total 25 marks)
(LCCIEB 1997)
Solution to Question 6.1
(a)
(i)
Year 6
30 Jun
30 Jun
In the books of PTC Ltd
Provision for doubtful debts
Pro®t & Loss Account
Balance c/d
$
2,840
27,160
30,000
Year 5
1 Jul
30,000
Year 6
1 Jul
(ii)
Year 6
30 Jun
Balance b/d
$
60,000
Balance c/d
Year 6
30 Jun
Pro®t & Loss Account
$
60,000
1 Jul
Balance b/d
60,000
Provision for deprecation of motor vehicles
Balance c/d
$
1,400,000
Year 5
1 Jul
Year 6
30 Jun
$
Balance b/d
Year 6
1 Jul
(iv)
Year 6
1 Jul
800,000
Pro®t &Loss Account
600,000
1,400,000
Balance b/d
1,400,000
Balance c/d
$
6,000,000
1,400,000
Year 5
1 Jul
Year 6
30 Jun
27,160
Provision for deprecation of ®xtures and ®ttings
(iii)
Year 6
30 Jun
$
30,000
Balance b/d
Land and buildings
Balance b/f
Revaluation reserve
Balance b/d
$
5,000,000
1,000,000
6,000,000
Year 6
30 June
6,000,000
6,000,000
51
Lesson 6
(v)
Revaluation reserve
Year 6
30 Jun
(b)
(i)
Land and buildings
$
1,000,000
PTC Ltd
Pro®t & Loss and Appropriation Account for the year ended 30 June Year 6
$
$
$
1,260,000
Provisional net pro®t
add:
Bad debts recovered (in respect of year ended 30/6/5)
Reduction in provision for doubtful debts
1,300
2,840
4,140
1,264,140
less:
Bad debts
Depreciation:
Fixtures and ®ttings
Motor vehicles
21,000
60,000
600,000
660,000
Net pro®t for year ended 30 June Year 6
583,140
less:
Proposed Ordinary share dividend
325,000
Pro®t retained for the year
Pro®t & Loss Account balance (1 July Year 5)
258,140
1,470,000
1,728,140
Pro®t & Loss Account balance (30 June Year 6)
(ii)
PTC Ltd
Balance Sheet at 30 June Year 6
Fixed assets
Land and buildings
Fixtures and ®ttings
Motor vehicles
Current assets
Stock
Debtors
less Provision for doubtful debts
Bank
Cost or
revaluation
$
6,000,000
600,000
3,000,000
9,600,000
$
Aggregate
depreciation
$
60,000
1,400,000
1,460,000
$
960,000
679,000
27,160
651,840
201,300
1,813,140
52
681,000
Net book
value
$
6,000,000
540,000
1,600,000
8,140,000
Company accounts (1)
less Amounts due within one year
Creditors
Proposed dividend
Net current assets
Financed by: Capital and reserves
Authorised and called up share capital:
5,000,000 Ordinary shares of $1 each
Share premium
Revaluation reserve
Pro®t & Loss Account
Shareholders' funds
300,000
325,000
625,000
1,188,140
9,328,140
5,000,000
1,600,000
1,000,000
1,728,140
9,328,140
53
Lesson 7: Company accounts (2)
Lesson topic
Purchase of a partnership by a limited company
Extended Syllabus references
3.5.1 Introduction of acquired asset and liability values into the company's ledger
3.5.2 Use of a Business Purchase Account
3.5.3 Introduction of the agreed purchase price of the business
3.5.4 Understanding of the meaning of the balance on the Business Purchase
Account, whether debit or credit
3.5.5 Issue of securities or payment of cash by the purchasing company
Aim of the lesson
At the end of the lesson the students will be able to record the entries relating to the
purchase of a partnership in a company's ledger
The lesson
1
Companies may, on occasions, purchase partnerships. There are many reasons for this:
the partnership may be highly pro®table and so this could make it attractive to the
purchasing company or the company may wish to reduce the amount of competition to
it by purchasing the partnership which is one of its competitors.
Explain to the class that when the purchase is made, the partners will be compensated
by a payment either in cash and or shares in the purchasing company.
2
54
Explain to the class that the payment made for the purchase of the partnership and the
assets and liabilities that the company takes from the partnership will need to be
recorded in the books of the company. Illustrate this to the class by using Example 5 on
page 127 of the Candidate's Guide book. In order to provide the class with a revision
exercise, ask the students to answer Section (a) of the example. This section deals with
Company accounts (2)
the recording of the sale of the partnership in the partnership's ledger; this part of the
syllabus has been dealt with in an earlier lesson.
3
Explain the solution to Part (a) of the example to the class and use the Notes to the
solution. In particular emphasise Note 1 which explains the treatment of the goodwill
in the sale of the partnership.
4
Illustrate the solution to Part (b) of the example; this is the section that relates to the
recording of the purchase of the partnership in the accounts of the company. Again use
the Notes to the solution.
5
Advise the class that in recording the purchase in the company's accounts, the value of
the assets in the partnership ledger should be ignored. The values that should be
considered are those that the company has placed upon them and will, therefore,
incorporate into the company's accounts.
There may be times when the values of some of the assets in the partnership ledger and
the values placed on them by the company will be identical. The important point to
advise the class of is that it is the value that the company places upon the assets that will
be recorded in the company's accounts, whether they are the same as those in the
partnership ledger or whether they are different.
6
Advise the class that the company paid an amount for goodwill. The amount paid for
the goodwill is the difference between the purchase consideration, the price paid for
the partnership, and the company's valuation of the net assets being taken from the
partnership. Illustrate this calculation by using Example 5 from the Candidate's Guide
book on pages 127 and 128.
£'000
£'000
Purchase consideration
Net assets from partnership:
(company's valuation)
Freehold premises
Fixtures and ®ttings
Motor vehicles
Stocks
Debtors
£'000
390
113
68
35
11
114
341
less:
Creditors
46
Accruals
14
Goodwill
60
281
109
Advise the class that there is no relationship between the valuation of the goodwill that
is shown in the partnership ledger and the value of the goodwill that the company pays
for when it purchases the partnership.
55
Lesson 7
7
When explaining the solution advise the class that the account for Travis, Carr and Stott
is similar to the account of a creditor, ie the company owes money to the partnership.
Illustrate that this debt of £390,000 is settled by the issue of shares at a premium,
220,0006£1.50 = £330,000, and the balance by a cash payment, £60,000. Explain
that the corresponding double entries for the settlement of the debt are made in the
ledger accounts for Ordinary share capital, £220,000, share premium, £110,000 and
bank, £60,000.
8
Illustrate that the corresponding double entry to the £390,000 credit entry in the
account of Travis, Carr and Stott is a debit entry in the Business Purchase Account.
Advise the class that the Business Purchase Account will need to be cleared by the
entries made to the variety of asset and liabilities accounts that were introduced to the
company from the partnership.
9
Advise the class that the Business Purchase Account can be used to determine the value,
if any, of the goodwill on the purchase of the partnership. The value of the goodwill is
the balancing ®gure in the Business Purchase Account.
QUESTION FOR CLASS PRACTICE
Question 7.1
Palmer, Andrew and Taylor were partners sharing pro®ts and losses in the ratio 2 : 2 : 1.
Their Balance Sheet at 31 March Year 7 was as follows:
Palmer, Andrew and Taylor
Balance Sheet at 31 March Year 7
$
$
120,000
20,500
20,500
10,500
Fixed assets
Freehold premises
Fixtures and ®ttings
Motor vehicles
Current assets
Stock
Debtors
less Provision for
doubtful debts
Bank
less Amounts due within one year
Creditors
56
$
151,000
10,000
12,600
300
12,300
3,850
26,150
6,200
19,950
170,950
Company accounts (2)
Financed by:
Capital accounts
Palmer
Andrew
Taylor
Current accounts
Palmer
Andrew
Taylor
70,000
55,000
35,000
4,250
3,720
2,980
160,000
10,950
170,950
On 1 April Year 7, the partners sold the business to Hat®eld Ltd for $200,000.
On the same date:
1
A motor vehicle was taken over by Taylor at its book value of $2,500.
2
All other assets except bank were taken over by Hat®eld Ltd.
3
The creditors were taken over at book value by Hat®eld Ltd.
4
The purchase price for the business was settled by Hat®eld Ltd by the issue of 100,000
Ordinary shares of $1 at $1.75 each and the balance was paid by cheque.
The partners divided the shares between them in the partnership pro®t sharing ratio.
Remaining balances on their capital accounts were settled from the Bank Account.
Required
(a) In the books of the partnership, show the following:
(i) the Realisation Account.
(ii) the capital accounts of the partners, in columns.
(iii) Hat®eld Ltd Account.
(iv) the Bank Account.
Note
The current account balances are transferred to the capital accounts before
making any adjustments.
(18 marks)
Hat®eld Ltd valued the ®xed and current assets taken over as follows:
Freehold premises
Fixtures and ®ttings
Motor vehicles
Stock
Debtors
$
135,000
18,000
7,500
8,500
12,000
57
Lesson 7
(b) In the books of Hat®eld Ltd, show the journal entries to record the
purchase of the business of Palmer, Andrew and Taylor.
(7 marks)
(Total 25 marks)
(LCCIEB 1997)
Solution to Question 7.1
(a)
(i)
Realisation Account
Year 7
1 April
$
120,000
20,500
10,500
10,000
12,600
Freehold premises
Fixtures and ®ttings
Motor vehicles
Stock
Debtors
Year 7
1 April
$
Provision for doubtful debts
Creditors
Capital account
Taylor (Motor)
Hat®eld Ltd:
consideration for business
purchase
Capital accounts
Palmer 2/5 14,160
Andrew 2.5 14,160
7,080
Taylor 1/5
35,400
209,000
(ii)
2,500
200,000
209,000
Partners' capital accounts
Palmer Andrew Taylor
Year 7
1 April
$
$
$
Palmer Andrew Taylor
Year 7
Dissolution Account
1 Apr
Motor vehicle
$
$
$
70,000
55,000
35,000
Balance b/f
2,500
Hat®eld Ltd
Current Account
Shares
70,000
70,000
35,000
Bank
18,410
2,880
7,560
88,410
72,880
45.060
(iii)
Dissolution pro®t
4,250
3,720
2,980
14,160
14,160
7,080
88,410
72,880
45,060
Hat®eld Ltd Account
Year 7
1 Apr
$
Dissolution Account
± consideration
200,000
200,000
58
300
6,200
Year 7
1 Apr
$
Capital accounts ±
shares:
Palmer
Andrew
Taylor
Bank
70,000
70,000
35,000
25,000
200,000
Company accounts (2)
(iv)
Bank Account
Year 7
1 Apr
Balance b/f
Hat®eld Ltd
$
3,850
25,000
Year 7
1 Apr
$
Capital accounts ±
Palmer
Andrew
Taylor
28,850
(b)
18,410
2,880
7,560
28,850
Hat®eld Ltd
Journal
Year 7
1 April
$
Creditors
Goodwill
Freehold premises
Fixtures and ®ttings
Motor vehicles
Stock
Debtors
Provision for doubtful debts
Business purchase
6,200
25,200
135,000
18,000
7,500
8,500
12,600
206,800
1 April
Business purchase
Ordinary share capital
Share premium
Bank
$
600
200,000
206,800
200,000
200,000
100,000
75,000
25,000
200,000
59
Lesson 8: Company accounts (3)
Lesson topics
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
Issue of shares to the general public
Issue of shares via a rights issue
Issue of shares at a premium
Use of an Application and Allotment Account
Use of a Call Account
Preparation of Share Capital and Share Premium Accounts
Treatment of over subscription of shares
Allocation of shares following an over subscription of shares
Preparation of a Statement of Ordinary Shareholders' Funds
Types of reserves
Types of borrowing
Issue of debentures
Treatment of loan interest and dividends
Treatment of borrowings in the Balance Sheet
Redemption of debentures
Use of Debenture Redemption Account
Extended Syllabus references
3.1.3
Understanding of the difference between authorised share capital and called
up share capital
3.1.4
Understanding of the difference between share capital and loan capital
3.1.5
Types of loan capital, eg debentures, loan stock, bank loan, bank overdraft
3.1.6
Calculation of loan interest and recognition that interest is a charge to the
Pro®t and Loss Account
3.2.10 Understanding of what is included under the heading `Capital and reserves'
3.3.1
Recording share or debenture issues by journal entries or in ledger accounts
3.3.2
Issue of debentures or loan stock (only at par)
3.3.3
Issue of preference or Ordinary shares at par or at a premium
3.3.4
Treatment of share premium as a statutory reserve
3.3.5
Issue of shares or debentures where proceeds are receivable by instalments
(continued)
60
Company accounts (3)
3.4.1 Repayment of bank loans and overdrafts
3.4.2
Redemption of debentures (only at par)
3.4.3
Sale of assets, eg investments, to raise funds for the repayment of borrowings
3.4.4
Issue of shares to raise funds for the repayment of borrowings
Aim of the lesson
At the end of the lesson the students will be able to prepare the entries relating to the
issue of shares and loans and the repayment of the loans
The lesson
1
Chapter 6 of the Candidate's Guide book explains that companies will, on occasions,
make issues of shares for items such as the ®nancing of an expansion.
2
Advise the class that they will need to be able to record the issue of shares that will
involve the following:
.
.
.
.
The issue of shares to the existing shareholders of the company. This is referred to as
a rights issue.
The issue of shares to the general public, as the company wishes to attract additional
shareholders.
The issue of shares, in both of the above circumstances, at a price in excess of the
share's par, or nominal, value. Advise the class that the portion of the share price that
is in excess of the par, or nominal, value is referred to as the share premium.
Advise the class that the accounting entries made in relation to the shares being
issued at a premium will require separate entries that distinguish between the par, or
nominal, value of the shares and the share premium. Advise the class that separate
accounts are maintained for the par, or nominal, value of the shares and the share
premium.
3
Illustrate to the class Example 1 on page 141 of the Candidate's Guide book, and
explain its solution. Explain that the amount of money raised from the issue of the
shares is calculated as 6,000,0006£1.65 = £9,900,000.
4
Explain to the class that the distinction between the par, or nominal, value of the
shares, £0.50 per share, and the share premium,£1.15 per share, needs to be made as
follows:
61
Lesson 8
Par value
Share premium
6,000,0006£0.50
6,000,0006£1.15
Total amount received from the issue of the shares
5
£
3,000,000
6,900,000
9,900,000
Advise the class that they should always use an Application and Allotment Account
when recording an issue of shares.
In Example 1 on page 141 of the Candidate's Guide book the number of applications for
the shares equalled the number of shares that were to be issued. Advise the class that this
will not always be the case, as there are occasions when the share issue is very popular.
Advise the class that this can mean that there is an excess of applications for the shares, ie
the company receives applications for shares that are greater than the number of shares to
be issued. Advise the class that this is referred to as an over subscription for the shares.
6
Advise the class that the Applications and Allotment Account will also be used to record
the return of the excess monies.
7
Advise the class that questions relating to the issue of shares can require the answers to
be prepared in either journal or ledger account format.
8
Example 1 in the Candidate's Guide book also showed the preparation of a Statement
of Ordinary Shareholders' Funds. Ask the class to familiarise themselves with this type
of statement; such a requirement could be asked in a variety of examination questions.
9
Illustrate Example 2 on page 143 of the Candidate's Guide book. This example involves
an issue of shares where an over subscription has occurred. Applications have been
received for 6,600,000 shares when the number of shares to be issued is 6,000,000 shares.
This means that there has been an over subscription of 600,000 shares. Advise the class
that the company needed to make a decision on how to allocate the shares to the
applicants. The example has made two suggestions: allocate the shares on the basis of 10
shares for every 11 shares applied for; or allocate the shares to only the small investors.
Explain to the class that whichever arrangement of allocation of the shares is decided,
the application monies for the over subscribed 600,000 shares needs to be returned to
the unsuccessful applicants. The amount of money to be returned is £990,000 (600,000
shares6£1.65 per share). This is accounted for in the solution to the example in the
Candidate's Guide book by debiting the Application and Allotment Account and
crediting the Bank Account with the £990,000.
10 Explain the other parts of the solution to the class. You may wish to provide the class
with some practice in this area of the syllabus, by asking them to prepare the solution by
preparing both journal entries and ledger accounts.
11 Advise the class that despite the over subscription there will be no alteration to the
Statement of Ordinary Shareholders' Funds that was prepared at the end of Example 1
in the Candidate's Guide book.
62
Company accounts (3)
12 Refer the class to Example 3 on page 144 of the Candidate's Guide book. This example
introduces the concept of a call. The concept of a call relates to another timing of
payment for the shares after the payment on application for the shares. The price of
each share is £1.65 and is payable as follows:
20 January
30 September
On application
On call
Share price
£
1.25
0.40
1.65
13 Advise the class that the share premium on each share is £1.15, issue price £1.65 less
par value £0.50. The share premium is paid when application for the shares is made,
and so is accounted for at that time. Advise the class that this means that the amount
payable per share on application of £1.25 is classi®ed as follows: the par, or nominal,
value is 10p and the share premium is £1.15.
14 Show the class the calculations relating to the applications received, allocations made
and monies returned for the over subscriptions. These are as follows:
Amount received on application:
7,200,000 shares6£1.25 = £9,000,000
Par, or nominal, value of the allotted shares:
6,000,000610p = £600,000
Share premium value of the allotted shares:
6,000,0006£1.15 = £6,900,000
Amount repaid due to over subscription:
7,200,000 shares were applied for. The number of shares that were available for issue was
6,000,000 shares. Therefore, there was an over subscription of 1,200,000 shares.
The amount of money to be returned was:
1,200,0006£1.25 = £1,500,000
Advise the class that following the allotment of the shares on 31 January, the balance of
40p per share is payable on 30 September, and is referred to as a call on the shares. The
amount paid on the call is calculated as follows:
6,000,000 shares640p per share = £2,400,000
Explain the solution to the class.
15 Ask the class to prepare a Statement of Ordinary Shareholders' Funds after the call has
been made on 30 September Year 13.
In explaining the solution to the class for this statement, advise the students that the
®gures are the same as those that appear in the solution for this statement in Example 1
in the Candidate's Guide book. The only difference in the statements is the dates at the
heading of them. In Example 1 the date is 31 January Year 13 and the date to use in this
exercise is 30 September Year 13.
63
Lesson 8
16 Refer the class to Example 4 on page 145 of the Candidate's Guide book. This example
involves a rights issue and the shares are issued at a premium. Advise the class that when
recording the issue of the shares, there are items in the example that they will not need
to use. These are:
.
.
.
The authorised share capital.
The current market price of the share.
The balances on the Share Premium and Pro®t and Loss Accounts. Advise the
students, however, that whilst these balances will not be used in recording the issue
of the shares, they will be used when preparing the Statement of the Ordinary
Shareholders' Funds.
17 Advise the class that, in this example, they do not have to calculate the number of shares
that are being issued. The example provides the number of shares being issued. If,
however, the question had stated that the company had already issued 45,000,000 shares
and now wished to issue shares on a rights basis of 1 for 3, then the number of shares to
be issued would need to be calculated.
In this case the number of shares to be issued would be calculated as:
45,000,000 shares
6 1 share = 15,000,000 shares
3 shares
Advise the class that the money raised from the issue of the shares would be calculated as:
15,000,000690p per share = £13,500,000
Advise the class that the share premium on each share was 80p; issue price per share 90p
less nominal value per share 10p.
18 Explain to the class that this means that the amounts relating to the share capital and
share premium accounts are calculated as follows:
Share Capital Account, nominal or par value:
15,000,000610p = £1,500,000
Share Premium Account:
15,000,000680p = £12,000,000
19 Explain to the class the preparation of the journal entries and the Statement of the
Ordinary Shareholders' Funds.
20 Explain to the class that, on occasions, companies borrow money. Explain to the class
the distinction between equity and debt. An explanation is provided on page 147 of the
Candidate's Guide book.
21 Advise the class that the lenders of the borrowed money receive interest in contrast to the
shareholders of the company who receive dividends. Explain to the class that the interest
on the borrowed money is always payable whether the company has had a successful
64
Company accounts (3)
trading period or not. Explain to the class that this is not the case with the dividends for
the shareholders. Explain that the amount of dividends paid to the shareholders will often
re¯ect how successful the trading period has been for the company.
22 Illustrate to the class the types of borrowing the company can have: bank overdraft,
bank loan, and debentures. An explanation of these terms is provided on pages 147 and
148 of the Candidate's Guide book. Also please make the class aware of the distinction
between debentures and unsecured loan stock. An explanation of this distinction is
provided on page 148 of the Candidate's Guide book.
23 Explain to the class that the interest paid on all of the borrowings is charged to the
Pro®t and Loss Account, whereas the dividends paid to the company's shareholders are
charged in the Pro®t and Loss Appropriation Account. Please emphasise this point to
the class; questions are often set where this distinction needs to be made. Advise the
class that it is possible to obtain the correct ®gure for the retained pro®t for the year, but
in an incorrect manner, eg charging loan interest in the Appropriation Account and/or
charging dividends paid in the Pro®t and Loss Account.
24 Explain to the class the positioning in the Balance Sheet of the borrowings. Advise
the class that they should be aware of the repayment dates of all of the borrowings as
this will in¯uence the position of them in the Balance Sheet. Explain to the class that
they should be aware of the two classi®cations of amounts owed by the company:
amounts due within one year and amounts due in more than one year. Advise the
class that a bank overdraft is regarded as a creditor that is due within one year and
that the classi®cations of the other borrowings will depend upon their repayment
dates.
25 Explain to the class that they should be aware that a debenture that is repayable, say, in
10 years time will be shown in the Balance Sheet as creditor due in more than one year,
and will in 9 years' time be classi®ed as a creditor due within one year.
A further explanation of the positioning of the borrowings in the Balance Sheet is
provided on page 148 of the Candidate's Guide book.
26 Examples 6 and 7 on page 148 of the Candidate's Guide book provide illustrations of
the accounting treatment of a bank overdraft. Use these examples as illustrations to the
class and explain the related solutions to them.
27 Example 8 on page 149 of the Candidate's Guide book introduces the concept of a
bank loan made to a company. Use this example as an illustration of a bank loan to the
class and explain the related solution to them.
28 Example 9 on page 150 of the Candidate's Guide book is an illustration of the issue of
some debenture stock. Again use this in the class and explain the related solution on
page 152 to the students. Emphasise to the class the way in which the debentures are
presented in the Balance Sheet. In addition to the positioning of the debentures, there
should also be reference made to the interest rate and the date of repayment in the
description of the debentures.
65
Lesson 8
29 Example 10 on page 151 of the Candidate's Guide book also relates to the issue of
some debentures, but excess applications have been received for them. Use this
example in the class and explain the solution on page 152 of the Candidate's Guide
book. Also explain that the accounting entries for the return of the excess
application monies is similar to the accounting entries for the return of the excess
monies received in an over subscription of shares that was covered earlier in the
lesson.
30 Explain to the class that companies will repay money that has previously been
borrowed. Explain how a bank overdraft and a bank loan are repaid. An explanation of
these procedures is given on page 152 of the Candidate's Guide book.
31 Example 11 on page 153 of the Candidate's Guide book provides an illustration of
the accounting entries made when debentures are repaid. The example also includes
an illustration of a company selling some investments, the proceeds of which will
provide the money to repay the debentures. Illustrate this example to the class and
show the students the solution that also appears on page 153 of the Candidate's Guide
book.
Emphasise the use of the Debenture Redemption Account and also the way in which
the pro®t on the sale of the investments is determined and how it is treated in the
ledger.
32 Ask the class to attempt an answer to Example 12 on page 153 of the Candidate's Guide
book. The example relates to the redemption (or repayment) of the loan stock and the
issue of shares by way of a rights issue.
Explain the solution to the class and use the Notes to the solution that are on pages 154
and 155 of the Candidate's Guide book.
QUESTIONS FOR CLASS PRACTICE
Question 8.1
The directors of Fairford plc have decided to reduce the borrowings of the company.
On 1 March Year 14, the company has an authorised capital of 800,000 Ordinary £1 shares,
of which 500,000 are called up and fully paid.
There is a credit balance of £213,500 on the Pro®t and Loss Account and £98,600 on the
Share Premium Account. There are no other reserves.
The company's 10% debentures are to be immediately repaid at par.
There is a bank overdraft of £169,750, but this does not include accrued interest which
amounts to £5,750.
66
Company accounts (3)
To obtain the funds to repay the borrowings, the directors have decided to:
1
Ask the shareholders to take 80,000 additional £1 Ordinary shares at a price of £3.90
per share.
2
Sell investments which have a book value of £92,000, for £83,500.
The total amount raised will be just suf®cient to discharge the bank overdraft, including
accrued interest, and to repay the 10% debentures at par.
Required
(a) A director has suggested that the reserves should be used to repay the
borrowings. Using not more than 3 lines, give your reply to this
suggestion.
(3 marks)
(b) Assuming that the directors' plan is implemented, prepare journal entries
(without narrations) to record:
(i) The issue of shares.
(ii) The sale of the investments.
(iii) The repayment of the 10% debentures.
All transactions can be assumed to take place on 1 March Year 14.
(17 marks)
(c) Prepare a Balance Sheet extract, after the above transactions, showing
the items which make up shareholders' funds.
(5 marks)
(Total 25 marks)
(LCCIEB 1997)
Question 8.2
Blackmore plc has an authorised share capital of 4,000,000 Ordinary $0.50 shares and
1,000,000 6% $1 preference shares.
The company's called up share capital on 1 January Year 10 was 2,500,000 Ordinary $0.50
shares and 200,000 6% $1 preference shares.
The preference shares had been issued at par, but the Ordinary shares had been issued at a
premium of £0.40 per share.
At that same date the Pro®t and Loss Account carried a credit balance of $935,000.
The net pro®t before appropriation for Year 9 was $419,000.
Required
(a) Calculate the return on shareholders' funds for Year 9 to 2 decimal
places.
(7 marks)
67
Lesson 8
During Year 10, the company issued 1,210,000 Ordinary $0.50 shares for $1.10 each,
on the following terms:
1 March
1 April
$0.30 per share on application
$0.80 per share on allotment
The issue was fully subscribed and all allotment monies were received by 12 April.
The company used the issue proceeds to repay short-term borrowings, to provide
working capital and to replace some ®xed assets.
As a result of this, the net pro®t before appropriation for Year 10 increased to $712,000.
On 31 July, the company paid a half year's preference dividend, and an interim dividend
of $0.02 per Ordinary share, for which the newly issued shares did not qualify.
On 23 December, the company paid the second half year's preference dividend. The
directors recommended a ®nal ordinary dividend of $0.06 per Ordinary share, for
which the new shares would be eligible.
(b) Prepare accounts for the year ended 31 December Year 10 for:
(i) 6% preference share capital.
(ii) Ordinary share capital.
(iii) Ordinary share application and allotment.
(iv) Share premium.
(11 marks)
(c) Prepare the Pro®t and Loss Appropriation Account for Year 10.
(7 marks)
(Total 25 marks)
(LCCIEB 1997)
Solution for Question 8.1
(a)
Reserves are already represented by assets which may or may not include cash. Reserves
cannot be spent. They are not cash reserves. Reserve Accounts carry credit balances and
cannot therefore be used to remove another credit balance.
(b)
Working:
Funds to be raised from share issue, 80,0006£3.90
Sale of investments
Overdraft + interest = £169,750 + £5,750
Therefore, debentures must be
68
£
312,000
83,500
395,500
175,500
220,000
Company accounts (3)
1 March Year 14
£
312,000
Bank
Ordinary share capital
Share premium
80,000
232,000
Bank
Loss on sale of investments
Investments
83,500
8,500
92,000
10% debentures
Bank
(c)
£
220,000
220,000
Authorised share capital
£
800,000
800,000 Ordinary £1 shares
Called up share capital
£
580,000
580,000 Ordinary £1 shares, fully paid
Reserves
£
330,600
205,000
Share premium £98,600 + £232,000
Pro®t and loss £213,500 ± £8,500
Shareholders' funds
£
535,600
1,115,600
Solution to Question 8.2
$
(a)
$
Called up Ordinary share capital
2,500,000 Ordinary $0.50 shares
1,250,000
Reserves
Share premium
Pro®t and loss
1,000,000
935,000
Ordinary shareholders' funds
6% $1 preference shares
(b)
1,935,000
3,185,000
200,000
3,385,000
Pro®t
419,000
Return on shareholders' funds
12.38%
6% preference shares
Year 10
1 Jan
Balance b/f
$
200,000
69
Lesson 8
Ordinary share capital
Year 10
1 Jan
1 April
Balance b/f
Application and allotment
$
1,250,000
605,000
1,855,000
Ordinary shares application and allotment
Year 10
12 April
12 April
$
Ordinary share capital
Share premium
605,000
726,000
Year 10
1 March Bank
12 April
Bank
$
363,000
968,000
1,331,000
Share premium
Year 10
1 Jan
1 April
1,331,000
Balance b/f
Ordinary share application
and allotment
$
1,000,000
726,000
1,726,000
(c)
Blackmore plc
Pro®t & Loss Appropriation Account
for the year ended 31 December Year 10
$
Net pro®t for the year
Preference dividends
Interim ordinary dividend
Proposed ®nal dividend
Retained pro®t for the year
70
12,000
50,000
222,600
$
712,000
284,600
427,400
Lesson 9: Incomplete records
Lesson topics
.
.
.
Preparation of a Statement of Affairs
Preparation of accounts for sales, purchases, and expenses from incomplete records
Preparation of ®nal accounts for a sole trader from incomplete records
Extended Syllabus references
9.1
Understanding of the sense in which the records are incomplete
9.2.1 Understanding of the meaning and use of a Statement of Affairs
9.2.3 Calculation of apparent pro®t by measuring the increase in capital
9.2.4 Adjustments for drawings, and for new capital introduced, in order to arrive at
the net pro®t
9.3.1 Constructing a total sales ®gure for a period from opening and closing debtors,
cash received from customers, bad debts written off, discounts allowed, etc
9.3.2 Constructing a total purchases ®gure for a period from opening and closing
creditors, cash paid to suppliers, discounts received, etc
9.3.3 Constructing expense accounts
9.3.4 Constructing a Trading and Pro®t and Loss Account and a Balance Sheet from
incomplete records, for a sole trader
9.3.5 Constructing a Trading and Pro®t and Loss Account (including appropriation)
and a Balance Sheet, from incomplete records, for a partnership
Aim of the lesson
At the end of the lesson the students will be able to prepare the ®nal accounts of a
business that has not maintained proper accounting records
71
Lesson 9
The lesson
1
Begin the lesson by advising the class of the problems that are caused by the lack of
accounting records by contrasting the examples given on pages 162 and 163 of the
Candidate's Guide book.
2
Use the illustration on pages 163 and 164 of the Candidate's Guide book that expands
upon the information for trader A used in the introduction to the topic in the
Candidate's Guide book. Show the class that the ®gures used to prepare the statement
from which the pro®t was calculated are as follows:
£
Capital (1 April Year 8)
Motor vehicle
Cash in hand
less Owed on the vehicle
£
500
100
600
150
450
Capital (31 March Year 9)
Motor vehicle
Cash in hand
Owed from customer
less:
Owed to suppliers
Owed on the vehicle
300
110
800
1,210
90
25
115
1,095
Capital introduced
Gift from uncle
Drawings for the year
£500 per month612 months
100
6,000
Illustrate the statement that determines the pro®t for the year that is shown on page 164
of the Candidate's Guide book.
3
Advise the class that the pro®t could also be determined by preparing the statement in a
different order. The statement shown below is likely to be recognised by the class as the
way in which the capital account of a sole trader is presented on a Balance Sheet:
£
Opening capital (1 April Year 8)
450
add Capital introduced
100
550
add Pro®t for the year
72
?
less Drawings
6,000
Closing capital (31 March Year 9)
1,095
Incomplete records
4
Explain to the class that the pro®t ®gure is the missing ®gure in the above statement.
The pro®t is calculated in the following way:
£1,095 + £6,000 7 £550 = £6,545
Ask the class to insert the pro®t of £6,545 in the above statement, and ask them to
work through the statement by completing the additions and subtractions to obtain the
closing capital balance of £1,095.
5
Advise the class that although the statement allows the pro®t for the year to be
calculated, the accuracy of this ®gure is dependent upon the accuracy of the trader's
recollections.
Advise the class that if accurate records had been kept then there would not be any need
for the trader to be asked to recall facts to be used to estimate the amount of pro®t
achieved by the business.
6
Refer the class to Example 1 on page 165 of the Candidate's Guide book and ask the
students to prepare an answer to Parts (a) and (b).
Advise the class that a Statement of Affairs is a statement which shows the net assets of a
business at a particular date. The ®gure obtained for the net assets of the business will
mean that this ®gure is also the ®gure that represents the capital of the business at that
time.
7
Explain the solution to the class also using the Notes to the solution. Explain to the class
that the net pro®t ®gure could also have been determined by using the following
statement which places the items in a different order than appears in the solution on
page 166 of the Candidate's Guide book:
£
Opening capital (1 January Year 6)
560
add Net pro®t
?
?
less Drawings
Closing capital (31 December Year 6)
14,250
2,349
Explain to the class that this means that the net pro®t is calculated as follows:
£2,349 + £14,250 7 £560 = £16,039
8
Advise the class, again, that the accuracy of the pro®t ®gure is dependent upon the
accuracy of Jack Frame's advice of his net asset ®gures at 1 January Year 6 and 31
December Year 6 together with his recollections of the amount of his drawings for the
year. Advise the class that if any item has been overlooked, over estimated or under
estimated, then this will cause a change in the amount of net pro®t calculated. Advise
73
Lesson 9
the class, therefore, that to obtain a more accurate ®gure, then proper accounting
records should be maintained.
9
Refer the class to Example 2 on page 167 of the Candidate's Guide book and ask them
to prepare an answer.
Explain the solution to the class; this is provided with the related notes on pages 168
and 169 of the Candidate's Guide book. Explain to the class that as insuf®cient
accounting records have been maintained, the net pro®t ®gure is determined by the use
of Statements of Affairs and the drawings for the year.
Explain to the class that the ®rst exercise to complete was the Statement of Affairs at 31
December Year 7. Advise the class that the statement should provide the ®gures for the
net assets of the business at that date, and not be in¯uenced by such items as the value of
the motor vehicle at 1 January Year 7. This vehicle was sold during the year and so its
value should be ignored in this exercise.
10 Advise the class that the alternative statement used to calculate the net pro®t earlier in
this lesson could also be used in this example:
Opening capital (1 January Year 7)
add Net pro®t
less Drawings for the year
Closing capital (31 December year 7)
£
2,349
?
16,300
3,728
Advise the class that this means that the net pro®t ®gure is now calculated as follows:
£3,728 + £16,300 7 £2,349 = £17,679
11 Repeat to the class that the net pro®t ®gure is in¯uenced by estimates made by Jack
Frame. This means again that the accuracy of the ®gure for the net pro®t is in¯uenced
by the accuracy of Jack's estimates. Stress to the class that an estimate of the net pro®t
would be unnecessary if proper accounting records had been maintained.
12 Now refer the class to Example 3 on page 169 of the Candidate's Guide book and ask
the class to prepare an answer.
Explain the solution to the class also using the Notes to the solution. The Notes to the
solution are on pages 169, 170 and 171 of the Candidate's Guide book.
Advise the class that the opening capital balances for each partner are calculated as
follows:
74
Incomplete records
Cash introduced
Rent payment
Motor vehicle
Alton
£
1,000
1,050
Grove
£
1,000
4,250
2,050
5,250
13 In explaining the Statement of Affairs at 31 March Year 8, advise the students that the
loan and accrued loan interest are creditors of the partnership. This is despite the fact
that the loan has been provided by one of the partners ± Grove. Advise the class that the
loan and its related interest are treated as though it had been provided by another party
unrelated to the partnership.
14 Advise the class that the use of the alternative statement shown earlier in this lesson
could be used again to calculate the net pro®t. To provide the class with some practice
of this, ask them to prepare the statement and to calculate the net pro®t. The answer is
as follows:
£
Opening capitals: Alton
Grove
£
2,050
5,250
add Total net pro®t
?
?
less Drawings: Alton
Grove
10,400
6,240
Total closing capitals (31 March Year 8)
16,640
13,520
Advise the class that this means that the partnership net pro®t is calculated as follows:
£13,520 + £16,640 7 £7,300 = £22,860
Explain to the class that the net pro®t for the partnership was calculated from the use of
®gures that had not been estimated. Explain to the class that this improves the accuracy
of the ®gure, but it is still not as satisfactory as using proper accounting records.
15 Now refer to the section relating to the calculation of total sales on pages 171 and 172
of the Candidate's Guide book and illustrate this to the class.
Ask the class to prepare an answer to Example 4 on page 172 of the Candidate's Guide
book. Explain both of the solutions: one is shown as a statement, the other is shown as a
ledger account. Also use the Notes to the solution in your explanation.
16 Alternatively, show the class the solution that is shown as a statement and then advise
the class that the solution could be determined by using a ledger account to obtain the
total sales. Involve the class by asking them to prepare the Total Sales Account, or
Debtors' Account, and then explain the solution to the class.
75
Lesson 9
Advise the class that the question did not specify that a ledger account should be
prepared in answering the question. Therefore, it was not necessary to prepare a ledger
account, but if the candidates preferred to prepare one in answering the question, then
they would not be penalised by adopting that approach.
However, please emphasise to the class that if the question had speci®ed the use of a
ledger account in the answer, then a ledger account must be used. If a candidate did not
use one in the answer, then they are likely to lose all of the marks for that particular
section, even though a correct ®nal ®gure for the sales may have been obtained.
17 Refer to the section relating to the calculation of total purchases on page 174 of the
Candidate's Guide book. Illustrate this to the class.
Ask the class to prepare an answer to Example 5 on page 174 of the Candidate's Guide
book.
18 Explain the solution to the class. In your explanation advise the class that the previous
example, Example 4 in the Candidate's Guide book, advised that Sarah Plaidy owed
£985 to one of her customers, Polly Ltd. Polly Ltd, in turn, owed Sarah £530. This
debt of £530 had been settled by a contra arrangement and so this needed to be
recorded in the Total Purchases/Creditors' Account.
Ask the class to recognise that the contra entry was also recorded in the Total Sales/
Debtors' Account.
19 Advise the class of the meaning of a contra entry. Explain to the class that a contra entry
can be made when two businesses are both suppliers to and customers of each other.
For example, assume that business A sells goods, on credit, to business B for £300. This
means, therefore, that business B will appear in A's ledger as a debtor and business A will
appear in B's ledger as a creditor.
Assume that during the same period business B sells goods, on credit, to business A for
£500. This means, therefore, that business A will appear in B's ledger as a debtor and
business B will appear in A's ledger as a creditor.
An entry, referred to as a contra entry, is now possible in the Purchase Ledger Control
and Sales Ledger Control Accounts in both of the businesses' ledgers.
In this example this will mean that in the ledger of business A:
.
.
.
76
The Sales Ledger Control Account will be credited with £300. Also the Purchase
Ledger Control Account will be debited with £300.
The personal accounts for business B in both the purchase and sales ledgers will show
the same entries made in the Control Accounts.
The effect of the contra entries in business A's ledger will mean that the balance due
from business B in the Sales Ledger Control Account is removed and the creditor
balance of £500 in the Purchase Ledger Control Account is reduced to £200.
Incomplete records
In this example this will mean that in the ledger of business B:
.
.
.
The Purchase Ledger Control Account will be debited with £300. Also the Sales
Ledger Control Account will be credited with £300.
The personal accounts for business A in both the purchase and sales ledgers will
show the same entries made in the control accounts.
The effect of the contra entries in business B's ledger will mean that the balance
payable to business A in the Purchase Ledger Control Account is removed and
the debtor balance of £500 in the Sales Ledger Control Account is reduced to
£200.
20 Refer the class back to Example 5 on pages 174 and 175 of the Candidate's Guide book
and explain the solution to Part (b) of this example. Remind the class that the sales
®gure of £32,315 was obtained from the solution to Example 4 on page 173 of the
Candidate's Guide book.
21 Show the class how the total purchases could have been calculated if a Total Purchases/
Creditors' Account had not been speci®cally asked for. Explain to the class that this
approach is similar to the approach that was initially used to calculate the total sales in
Example 4 on page 173 of the Candidate's Guide book. The calculation of the total
purchases would be made as follows:
Creditors at 31 May Year 4
During the year ended 31 May Year 4:
Cheque payments to creditors
Cash purchases
Discounts received
Balance treated as a contra
£
1,121
18,344
180
166
530
20,341
less Creditors at 1 June Year 3
Total purchases for the year ended 31 May Year 4
864
19,477
22 Refer to the section relating to the calculation of expenses on page 176 of the
Candidate's Guide book.
Refer the class to Example 6 on pages 176 and 177 of the Candidate's Guide book and
explain the solution relating to the rent expense. Explain to the class that there are 3
ways shown as to how the charge to the pro®t and loss account, £3,600, can be
determined.
Note again that the question did not specify that a ledger account was required, so any
one of 3 methods would have been acceptable to the examiner. Remind the class that if
a ledger account had been requested, then a ledger account must be prepared. If either
of the other solutions were adopted then marks would not have been awarded for such
an approach.
77
Lesson 9
Explain to the class that the ®gure relating to the amount of rent expense that had been
paid through the business bank account was calculated as follows:
7 payments at £290 each =
6 payments at £310 each =
£2,030
£1,860
£3,890
23 Involve the class by asking them to prepare a solution to Part (b) of the example,
which relates to calculating the charge for stationery expense to the Pro®t and Loss
Account.
In explaining the solution to the class show the 2 solutions; these are shown on page
178 of the Candidate's Guide book.
Advise the class that the majority questions that require the calculation of the charge to
the Pro®t and Loss Account will require the preparation of ledger accounts. Advise the
students that they should familiarise themselves with this approach.
24 Refer the class to the section relating to the depreciation expense on page 178 of the
Candidate's Guide book.
Advise the class that when a business has not maintained normal accounting records, it
is very unlikely that it has prepared a formal ®xed asset register. This register is used as
the normal basis to determine the depreciation costs.
Advise the class, therefore, that without a formal ®xed asset register, the charges for
depreciation will be made by calculating the difference between the valuation of the
®xed assets at the beginning and end of the ®nancial period.
Use Example 7 on page 179 of the Candidate's Guide book to illustrate how the
charges for depreciation have been made when a formal ®xed asset register has not been
maintained.
25 Advise the class that the approach adopted in the example to determine the charges for
depreciation is not the approach that should always be adopted.
Advise the class that a better approach would be to keep records of each item of the
®xed assets the business has purchased, record the charges for depreciation and to
maintain a continuous record of costs, accumulated depreciation and the net book value
for each of the ®xed assets.
Explain to the class that this approach would have allowed the pro®t or loss on the sale
of the unwanted equipment to be calculated, rather than incorporate it in the total
charge for depreciation for the year of £125.
26 Involve the class by asking them to prepare an answer to Example 8 on pages 179, 180
and 181 of the Candidate's Guide book. This example provides a full problem relating
78
Incomplete records
to incomplete records and requires the preparation of the ®nal accounts for a sole
trader.
Before asking the class to prepare an answer to the example, advise the class of the
importance of preparing workings. Advise the class that their workings should always be
presented with their answers. The examiner does hope that the candidate's ®gures will
be correct, but, unfortunately, this is not always the case! However, the examiner will
award marks for partially correct answers if they are supported by the workings. Please
emphasise this to your students: it is very important.
27 Explain the solution to the class, and remember to show all of your workings to the
class, so that they are able to see how each of the ®gures have been calculated. In
addition to the workings provided on pages 181 and 182 of the Candidate's Guide
book, advise the class of the following ®gures:
£
£
Motor vehicle depreciation:
Valuations:
1 April Year 9
31 March Year 10
6,900
5,800
Depreciation charge for the year
1,100
Interest on loan
8%6£1,000
Bank balance
Balance at 1 April Year 9
80
3,500
add Amounts banked
37,465
40,965
less:
Cheque payments
Other charges
Bank overdraft at 31 March
Year 10
41,514
1,075
42,589
1,624
Advise the class that the approach adopted to prepare the ®nal accounts for this business
would also be used to prepare the ®nal accounts of other forms of business, such as a
partnership.
28 Finally, advise the class that all organisations should maintain proper accounting
records. Emphasise to the class that if they become involved with any form of business
then they should ensure that the business does have a proper system of accounting
records.
79
Lesson 9
QUESTION FOR CLASS PRACTICE
Question 9.1
J Enn does not keep full account records. The following information is available at 30
September:
Year 1
£
42,600
24,800
5,610
450
250
2,150
15,200
35,000
6,250
2,500
Freehold premises
Plant and equipment
Trade creditors
Wages accrued
Insurance prepaid
Stock
Motor vehicle
Bank loan
Trade debtors
Cash in hand
Year 2
£
?
?
9,320
670
370
3,910
?
?
8,700
?
Cash receipts and payments in the year ended 30 September Year 2:
£
Receipts
Sales of motor vehicles
Rent
Cash sales
Trade debtors
£
2,000
1,500
43,810
3,640
Payments
Sundry expenses
Cash purchases
Drawings
Wages
Paid into bank
Motor vehicle expenses
850
16,230
1,600
8,300
15,080
3,010
The following is a summary of the Bank Current Account of the year ended 30 September
Year 2:
£
Receipts
Balance, 1 October Year 1
Trade debtors
Cash paid into bank
Balance at 30 September Year 2
17,650
33,840
15,080
10,350
76,920
80
£
Payments
Trade creditors
Addition to freehold premises
Salaries
Bank loan repayments
Bank loan interest
Insurance
Purchase of motor vehicle
Purchase of plant and equipment
14,620
8,600
22,400
13,000
3,400
1,300
6,400
7,200
76,920
Incomplete records
Further information:
1
A motor vehicle, included at 30 September Year 1 at £2,800, was sold on 1 October
Year 1. For the year ended 30 September Year 2, Enn decided to depreciate the
remaining ®xed assets as follows:
Plant and equipment
Motor vehicles
2
by 15% per annum
by 25% per annum
During the year ended 30 September Year 2, Enn drew goods from the business for his
own private use, £2,500.
Required
For J Enn, prepare:
(a) A Trading and Pro®t and Loss Account for the year ended
30 September Year 2.
(13 marks)
(b) A Balance Sheet at 30 September Year 2.
(12 marks)
(Total 25 marks)
(LCCIEB 1996)
Solution to Question 9.1
Workings
Capital at 30 September Year 1
Assets:
Premises
Plant and equipment
Insurance prepaid
Stock
Motor vehicles
Debtors
Bank
Cash
£
42,600
24,800
250
2,150
15,200
6,250
17,650
2,500
Creditors
Wages acrrued due
Bank loan
5,610
450
35,000
£
111,400
less Liabilities:
Capital
41,060
70,340
81
Lesson 9
Sales:
Debtors
Cash received
Bank received
3,640
33,840
37,480
less Opening debtors
6,250
add Closing debtors
31,230
8,700
Credit sales for year
39,930
add Cash sales
Total sales for year
43,810
83,740
Purchases:
Creditors
Bank paid
less Opening creditors
14,620
5,610
add Closing creditors
9,010
9,320
Credit purchases for year
add Cash purchases
18,330
16,230
less Drawings
34,560
2,500
32,060
Purchases for year
Wages:
Cash paid
less Accrued Year 1
8,300
450
Wages for year
7,850
670
8,520
Insurance:
Bank paid
add Prepaid Year 1
1,300
250
less Prepaid Year 2
1,550
370
Insurance for year
1,180
add Accrued Year 2
Loss on motor vehicles:
Book value
less Cash received
Loss
2,800
2,000
800
Depreciation:
Plant and equipment 15% of (£24,800 + £7,200) = £4,800
Motor vehicles
25% of (£15,200 7 £2,800 + £6,400) = £4,700
82
Incomplete records
Notes to candidates: This answer assumes a full year's charge on assets purchased during the
year.
Freehold premises:
At Year 1
Additions
42,600
8,600
51,200
Total
Drawings:
Cash £1,600 + Goods £2,500 = £4,100
(a)
J Enn
Trading and Pro®t & Loss Account
for the year ended 30 September Year 2
Opening stock
Purchases
£
2,150
32,060
less Closing stock
34,210
3,910
Cost of sales
Gross pro®t c/d
30,300
53,440
83,740
Sundry expenses
Wages
Motor expenses
Loss on sale of motor vehicle
Salaries
Bank loan interest
Insurance
Depreciation ± Plant and equipment
± Motor vehicles
Net pro®t
(b)
£
8,3740
Sales
850
8,520
3,010
800
22,400
3,400
1,180
4,800
4,700
5,280
54,940
83,740
Gross pro®t b/d
Rent received
53,440
1,500
54,940
J Enn
Balance Sheet at 30 September Year 2
Cost
depreciation
£
Fixed assets
Freehold premises
Plant and equipment
Motor vehicles
51,200
32,000
18,800
102,000
Aggregate
value
£
4,800
4,700
9,500
Net book
£
51,200
27,200
14,100
92,500
83
Lesson 9
Net current assets
Current assets
Stock
Debtors
Insurance prepaid
Cash
3,910
8,700
370
8,380
21,360
less Creditors' amounts due within one year
Creditors
Wages accrued
Bank overdraft
9,320
670
10,350
20,340
1,020
93,520
less Creditors' amounts due after one year
Bank loan
Capital
Opening
add Net pro®t
less Drawings
84
22,000
71,520
70,340
5,280
4,100
1,180
71,250
Lesson 10: Manufacturing accounts
Lesson topics
.
.
.
.
.
Cost accounting terms that are used in the preparation of manufacturing accounts
Preparation of manufacturing accounts in vertical format
Transfer of completed production to the Trading Account at cost
Transfer of completed production to the Trading Account at a transfer price
Recognition and treatment of unrealised pro®t
Extended Syllabus references
8.1 Preparation in vertical and T-account format
8.2 Understanding of cost accounting terms, direct materials, direct labour, direct
expense, prime cost, factory or production overhead, administration, selling and
distribution overhead, and production cost
8.3 Adjustment for the increase or decrease in work in progress, and its location in
the Manufacturing Account
8.4 Transfer of completed production at cost
8.5 Transfer of completed production at cost plus a margin of pro®t
8.6 The corresponding entry for manufacturing pro®t
8.7 Provision for unrealised manufacturing pro®t
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
Prepare a Manufacturing Account at cost and at a transfer price
Prepare an account for the provision of unrealised pro®t
The lesson
1
This lesson will explain the procedures to adopt in the preparation of a Manufacturing
Account and the calculation of the manufacturing pro®t. The lesson will also deal with
the meaning and treatment of unrealised pro®t.
85
Lesson 10
Begin the lesson by explaining to the class that there are organisations that produce the
products that they sell. Contrast this type of organisation with one that purchases the
goods that it sells. Provide the class with examples of organisations that produce the
items that they sell, eg producers of motor vehicles, producers of clothing, producers of
food products. Ask the class if they can give some of their own examples.
2
Explain to the class that the cost of the goods produced will be recorded in a
Manufacturing Account. Tell the class that the Manufacturing Account is prepared
immediately before the Trading Account. Advise the class that when the total cost of
manufacture has been calculated, then the total cost or value of production is credited
to the Manufacturing Account and the Trading Account is debited.
3
Advise the class that the preferred form of presentation of manufacturing accounts is the
vertical format. Advise the class that an example of a vertically presented Manufacturing
Account appears on page 190 of the Candidate's Guide book.
4
The students will be assisted in preparing manufacturing accounts if they understand
the variety of cost accounting terms that are incorporated into the account.
The ®rst term explained in the Candidate's Guide book is ``Cost of Raw Materials
Used'' and is on pages 190 and 191. Use the example in the Candidate's Guide book to
provide an illustration of the term to the class. Emphasise the presentation to the class: it
is very important that the class should adopt the format shown in the solution. Advise
the class that the examiner will award marks for both the correct ®gures and the use of
correct wording within a Manufacturing Account.
5
In the case of the ``Cost of Raw Materials Used'' it is important that the class arrange
their ®gures in such a way that the net purchases ®gure is shown as part of the ®gure for
the cost of the raw materials used.
Advise the class that it would be possible to obtain the correct ®gure for the cost of the
raw materials used, but by adopting a form of presentation that does not show the ®gure
for the net purchases. This is likely to cause the loss of marks.
6
Explain the double entries that will have taken place when a Manufacturing Account
has been prepared. Your explanation will be assisted by showing the following
Manufacturing Account to the class:
Portway Manufacturing Ltd
Manufacturing Account for the year ended 31 May Year 6
Raw materials stock (1 May Year 6)
Purchases
Carriage on purchases
£
71,000
138,000
6,200
215,200
Cost of raw materials used b/d
86
148,850
£
Returns outwards
Raw materials stock (31 May Year 6)
Cost of raw materials used c/d
1,350
65,000
148,850
215,200
Manufacturing accounts
Advise the class of the corresponding entries for each of the items that appear in the
above Manufacturing Account.
7
Advise the class that the above form of presentation is not recommended; the vertical
form of presentation should be used. Explain to the class that the example is only used
here to explain the double entries.
8
Explain the meaning of direct labour cost and use the examples on page 191 of the
Candidate's Guide book. Contrast these examples with those for indirect labour on
page 192 of the Candidate's Guide book.
9
Use Example 2 on page 192 of the Candidate's Guide book and ask the class to prepare
the Direct Wages Accrued Account and to determine from the account the amount of
direct labour cost to charge to the Manufacturing Account. Then show the class how
the direct labour cost is shown in the Manufacturing Account by using the solution and
its related notes on pages 192 and 193 of the Candidate's Guide book.
10 Explain to the class the meaning of the term ``Direct expenses''. Use the section on page
193 of the Candidate's Guide book in your explanation. Another example of direct
expense that the class may understand is the cost of painting the product, if another
company carries this out.
11 Explain to the class the term ``Prime cost of production'', using the section on page 193
of the Candidate's Guide book that is given to this topic. Emphasise that this term
should always be used when preparing manufacturing accounts; if the term is used and
the value is correctly calculated it will earn marks.
12 Involve the class by asking them to prepare an answer to Example 3 on page 194 of
the Candidate's Guide book. Explain the solution to the class emphasising the format
of presentation used to allow the ®gures for net purchases, cost of raw materials used,
direct wages earned and the prime cost of production to be shown in the account. In
explaining the solution, advise the class of the reason for omitting the ®gure relating
to the purchases of furniture for re-sale; the reason is given in the Notes to the
solution.
13 Explain to the class the meaning of the term ``Overheads'' and provide examples of this
type of cost, eg rent, business rates, insurances, indirect materials and indirect labour.
Explain to the class that overheads are classi®ed by function, eg production, selling,
administration etc. Explain that an item of overhead cost is classi®ed by its function
means that, for example, one overhead cost can be classi®ed as a production overhead
while another overhead cost could be classi®ed as an administration cost. Explain to the
class that there are times when overhead costs will be apportioned to the various
functions and an example of this is provided in Example 4 on pages 196 and 197 of the
Candidate's Guide book.
14 Explain to the class that it is only production overheads that are charged into a
Manufacturing Account, all of the other overheads incurred are charged into the Pro®t
and Loss Account.
87
Lesson 10
15 Explain to the class that the various production overheads appear in the Manufacturing
Account after the calculation of the prime cost of production. Explain that the prime
cost of production plus the production overheads equals the production cost. Please
emphasise to the class that the production overheads should be added to the prime cost
of production. Many candidates lose marks by deducting the production overheads
from the prime cost of production.
16 Advise the class that in many manufacturing organisations there is likely to be
production that has been started but is not yet in a condition to be placed in the ®nished
goods warehouse; this is known as work in progress stock. Advise the class that as with
the other types of stock, this needs to be valued. The section on page 197 of the
Candidate's Guide book advises of the valuation methods for work in progress, so use
this to explain the valuation of work in progress to the class.
17 Use Example 5 on page 198 of the Candidate's Guide book as an illustration of work in
progress stocks being valued at production cost. Ask the class to value the 620 products
completed by department X at prime cost, ie direct costs. The answer is £141,980,
6206£229. Note the prime cost is found by adding the direct material cost of £200 to
the direct labour cost of £29.
18 Advise the class that the valuation method adopted for work in progress will in¯uence
the positioning of the adjustment for the work in progress stocks in the manufacturing
account. Emphasise that if the work in progress stocks are valued at prime cost, then
the adjustment for the difference between the opening and closing work in progress
stocks should be shown immediately after the prime cost of production ®gure is
shown.
Explain that if the work in progress stocks are valued at production cost, then the
adjustment for the difference between the opening and closing work in progress stocks
should be shown immediately after the cost of production ®gure is shown.
19 Advise the class that the positioning of the work in progress adjustment in the
Manufacturing Account is very important. The marks given for this adjustment will be
awarded only if the ®gure is correct and the positioning of the adjustment is also
correct. Advise the class that the format used for the presentation of the Manufacturing
Account is very important. Tell the class that it is possible that a candidate could obtain
the correct ®gure for the cost of production, but due to an incorrect form of
presentation then all of the available marks will not be awarded.
20 Advise the class that an adjustment for the increase or decrease in the valuation of the
opening and closing work in progress stocks will need to be made in the Manufacturing
Account. Advise the class that this means that if there has been an increase in the
valuation of the work in progress stocks, then this should be deducted from the prime
cost of production or the cost of production, depending upon the valuation method
used.
88
Manufacturing accounts
Use this example as an illustration of this point to the class:
Work in progress stocks valued at production cost
Work in progress stocks:
1 January
31 December
£3,500
£3,720
The adjustment required is a reduction in the production cost of £220: £3,720 less
£3,500.
21 Explain to the class that if there has been a decrease in the difference in the
valuations of the work in progress stocks, then this decrease should be added to the
prime cost of production or the cost of production depending upon the valuation
method used.
Use this example as an illustration of this point to the class:
Work in progress stocks valued at production cost
Work in progress stocks:
1 January
31 December
£5,200
£4,900
The adjustment required is an increase in the production cost of £300: £5,200 less
£4,900.
22 Introduce the class to the meaning of pro®t in the Manufacturing Account. Use the
explanation on page 201 of the Candidate's Guide book. Advise the class that a transfer
price is an internal selling price. Now use Example 7 on pages 201, 202, 203 and 204 of
the Candidate's Guide book to illustrate the pro®t in the Manufacturing Account. Also
use the example to illustrate the transfer of the value of the goods to the Trading
Account.
23 Before showing the solution to this example, involve the class by asking the students to
prepare the Manufacturing Account before the manufacturing pro®t is determined.
When the class has completed this, explain the solution and then show the entry to
determine the manufacturing pro®t. In this example in the Candidate's Guide book,
10% is added to the production cost to determine the value of the goods that are
transferred to the Trading Account. Explain to the class that the 10% added to the
production cost of the ®nished output is the manufacturing pro®t; this is sometimes
referred to as the pro®t made on manufacture.
24 Explain to the class that questions are set that advise how the pro®t is determined. In
this example in the Candidate's Guide book, 10% is added to the production cost.
Advise the class that this is referred to as a pro®t mark up, ie production cost is increased
or marked up by 10%.
89
Lesson 10
25 Explain that questions are also set that refer to the pro®t made on manufacture as a
pro®t margin. This means that the pro®t margin is a percentage, or fraction, of the value
transferred to the Trading Account. It is usual for the pro®t mark up and the pro®t
margin to be expressed in percentage terms.
26 Advise the class that if this example had stated ``Finished goods are transferred from
the factory to ®nished stock to achieve a 10% pro®t margin'', then this would have
resulted in the value of the goods transferred from the factory to the Trading
Account being £1,811. Advise the class that this ®gure has been rounded to the
nearest £.
Now explain to the class how this ®gure has been obtained. The pro®t margin is
10%. Ask the class to recognise that as we are trying to calculate the transfer value,
ie the internal selling price, they should regard this as being 100%. This will mean
that:
Cost (90%) plus pro®t (10%) equals transfer value (100%)
Ask the class to recognise that the cost is £1,630.
Therefore the transfer value is calculated as:
£1,6306100%
= £1,811 ( rounded)
90%
27 Advise the students that they should be familiar with the distinction between mark up
and margin and also be able to apply both of these terms in any situation. Advise the
class that the terms do not have the same meaning and show the class the results of the
above example. Show the class, again, that an item with a 10% mark up will have a
different selling price than an item with a 10% margin. Advise the class that these terms
are used in other areas of the syllabus; the importance of understanding these terms
cannot be over-emphasised.
28 Now show the class the solution to Example 7 on pages 201 and 202 of the Candidate's
Guide book relating to the Trading Account and use the Notes to the solution in your
explanation. Show the class the entries from the manufacturing and the trading
accounts into the Pro®t and Loss Account.
Explain to the class that when the credit entry relating to the pro®t on the
manufactured goods has been made in the Pro®t and Loss Account, it is assumed that all
of the goods have been sold. This may not always be the case; all of the products may
not have been sold.
29 Explain to the class that if all of the manufactured goods have not been sold, then it is
not correct to take credit for the pro®t on the unsold goods. Explain, therefore, that an
adjustment will need to be made. Advise the class that the pro®t on the unsold goods is
referred to as ``unrealised pro®t''.
90
Manufacturing accounts
An example of unrealised pro®t appears on pages 206, 207 and 208 of the Candidate's
Guide book. Use this example to illustrate and explain this area of the syllabus to the
class. Explain to the class that there are 550 units of the product in ®nished stock at the
end of the ®nancial year. Advise the class that this had arisen due to 6,400 units of the
product being manufactured and 5,850 units of the product being sold. So the stock of
550 units is determined as 6,400 units less 5,850 units.
30 Explain to the class that the value of the stock of ®nished goods is calculated as: 550
units6£44 = £24,200.
Advise the class that there has been a mark up of 10%. The cost of each product was
£40, so the mark up was £4 per unit; £40610%.
Tell the class that this means that the valuation of the ®nished goods stocks at the
end of the year contains an unrealised pro®t of £4 per unit. The unrealised pro®t in
the stock valuation of the ®nished goods at the end of the year is £2,200; £46550
units.
31 Explain to the class that this calculation is the basis for the preparation of the Provision
for Unrealised Pro®t Account. Advise the students that the pro®t on all of the products
manufactured has been credited to the Pro®t and Loss Account; refer the class to the
credit entry of £25,600 in the Pro®t and Loss Account. This is shown in the illustration
on page 207 of the Candidate's Guide book. Explain to the class that this pro®t has been
calculated as 6,400 units manufactured6£4 pro®t per unit. Now advise the class that
the Pro®t and Loss Account should be debited with the amount of unrealised pro®t that
remains in the ®nished stocks.
Show the following account to the students:
Provision for Unrealised Pro®t Account
Balance c/d
£
2,200
Pro®t & Loss Account
£
2,200
Balance b/d
2,200
Advise the class that the double entry procedures in preparing the Provision for
Unrealised Pro®t Account are as follows:
1
2
3
4
Credit
Debit
Debit
Credit
Provision for Unrealised Pro®t Account
Pro®t and Loss Account
Provision for Unrealised Pro®t Account (this is the balance carried down)
Provision for Unrealised Pro®t Account (this is the balance brought down)
£
2,200
2,200
2,200
2,200
32 Involve the class by asking them to prepare an answer to Example 8 on page 208 of the
Candidate's Guide book. This example builds on the previous illustration and involves a
decrease in the stocks of the ®nished goods.
91
Lesson 10
Ask the class to note that Example 8 in the Candidate's Guide relates to the next
®nancial year, and to remember that there is an opening stock of 550 units of the
product in ®nished goods.
Explain to the class that during the year 6,100 units of the product were manufactured
and 6,180 units of the product were sold. Ask the class to calculate the number of units
of the product that remain in stock at the end of this particular ®nancial year. The
answer is 470 units of the product; 550 + 6,10076,180.
33 Explain to the class that the valuation of the closing stocks of ®nished goods will, again,
include the pro®t mark up of £4 per unit. The total value of the pro®t mark up
included in the valuation of the ®nished stocks is £1,880; £46470 units. Advise the
class that this ®gure represents the balance to be shown in the Provision for Unrealised
Pro®t Account at the end of the ®nancial year. Remind the class that the balance shown
on the account at the moment is £2,200.
Explain to the class that an adjustment needs to be made in the Provision for Unrealised
Pro®t Account to adjust the balance to £1,880.
Show the class the Provision for Unrealised Pro®t Account that appears on page 208 of
the Candidate's Guide book.
34 Explain to the class that the quantity in the ®nished goods stocks has decreased by 80
units; opening stocks 550 units, closing stocks 470 units. This has arisen due to the sales
of the product exceeding the production of the product by 80 units; sales 6,180 units,
production 6,100 units. Explain to the class that this means that the company is now
justi®ed in taking the pro®t for the sale of the additional 80 units. Explain that the
additional 80 units sold have been sold from the quantity in opening stocks, and that the
company is now able to take the pro®t on these 80 units.
35 Explain to the class that pro®t on the 80 units is re¯ected in the credit entry to the
Pro®t and Loss Account of £320, £4680 units.
Refer the class to this entry as it appears in the Provision for Unrealised Pro®t Account.
Ask the class to recognise that the balance brought down in the Provision for Unrealised
Pro®t Account is £1,880; this represents the unrealised pro®t in the quantity of ®nished
goods in stock held at the end of the ®nancial year; £46470 units.
92
Manufacturing accounts
QUESTIONS FOR CLASS PRACTICE
Question 10.1
The following balances were extracted from the books of Jason Manufacturing Co. Ltd, at
31 December Year 10:
£
Stock of raw materials at 1 January Year 10
Selling and distribution expenses
Purchases of raw materials
Sales of ®nished goods
Administrative expenses
Factory director wages
Stock of ®nished goods at 1 January Year 10
Interim preference dividend paid
Factory indirecy wages
Pro®t & Loss Account at 1 January Year 10
Factory indirect expenses
Work in progress at 1 January Year 10 (factory cost)
Financial expenses
Interim Ordinary share dividend paid
Investment
8% preference shares of £1 each, fully paid
Ordinary shares of £1 each, fully paid
Freehold premises at cost
Plant and machinery at cost
Motor vehicles at cost
Fixtures and ®ttings at cost
Debtors
Creditors
Provision for depreciation at 1 January Year 10:
Plant and machinery
Motor vehicles
Fixtures and ®ttings
Bank balance (DR)
15,000
28,250
284,050
904,294
173,900
176,380
45,765
12,000
37,628
392,286
23,285
10,070
24,125
20,000
300,000
300,000
1,000,000
850,000
236,100
45,000
62,000
49,150
21,706
80,000
17,000
28,000
350,583
Additional information:
1
Depreciation to be charged on cost:
Plant and machinery
Motor vehicles
Fixtures and ®ttings
at 20% per annum (factory expense)
at 20% per annum (selling expense)
at 15% per annum (administrative expenses)
93
Lesson 10
2
Stocks at 31 December Year 10:
£
18,420
50,240
8,950
Raw materials
Finished goods
Work in progress (factory cost)
3
At 31 December Year 10:
Accrued selling and distribution expenses
Prepaid administrative expenses
4
£
1,795
3,200
The directors agreed to recommend the following dividends:
Preference share ®nal
Ordinary share ®nal of £0.03 per share
5
The investments are all due for repayment before 30 June Year 11
6
Authorised capital:
500,000 8% preference shares of £1 each
1,250,000 Ordinary shares of £1 each
Required
Prepare, for Jason Manufacturing Co Ltd, in vertical form:
(a) (i) Manufacturing Account for the year ended 31 December Year 10.
(ii) Trading, Pro®t and Loss and Appropriation Account for the year ended 31
December Year 10
(b) Balance Sheet at 31 December Year 10.
(25 marks)
(LCCIEB 1997)
Question 10.2
J Davenport extracted the following Trial Balance from his books at the end of the ®nancial
year, 31 March Year 12:
Purchase of raw materials
Heating and lighting
Factory wages
Repairs to plant and machinery
Rent and rates
Administration salaries
Selling expenses
Sales
94
£
262,000
16,500
85,000
8,700
20,000
14,000
6,000
£
496,000
Manufacturing accounts
Returns inwards
General of®ce expenses
Carriage outwards
Stocks at 1 April Year 11:
Raw materials (at cost)
Work in progress (at production cost)
Finished goods (at market value)
Provision for unrealised pro®t
Capital
Freehold premises at cost
Plant and machinery at cost
Provision for depreciation on plant and machinery
at 1 April Year 11
Debtors
Creditors
Balance at bank
5,000
7,400
1,600
23,000
15,000
24,500
3,000
476,000
420,000
86,000
18,000
21,000
35,500
12,800
1,028,500
1,028,500
In addition, the following information was available:
£
1
Stocks at 31 March Year 12
Raw materials (at cost)
Work in progress (at production cost)
Finished goods (at market value)
26,000
11,600
25,800
2
The provision for unrealised pro®t is to be adjusted to £3,200.
3
Depreciation is to be provided on plant and machinery at 15% on cost.
4
Rent and rates prepaid £4,000.
5
Accrued due for heating and lighting £2,000.
6
75% of rent and rates, 80% of heating and lighting, and 20% of general of®ce expenses
are to be charged to manufacturing.
7
The market value of goods produced during the year ended 31 March Year 12 is £413,500.
Required
(a) Prepare, for J Davenport the:
(i) Manufacturing Account for the year ended 31 March Year 12.
(ii) Trading, Pro®t and Loss Account for the year ended 31 March
Year 12.
(b) Prepare, for J Davenport, a Balance Sheet at 31 March Year 12.
(19 marks)
(6 marks)
(Total 25 marks)
95
Lesson 10
Solution to Question 10.1
(a) (i)
Jason Manufacturing Co Ltd
Manufacturing Account for the year ended
31 December Year 10
Raw materials
Stock 1 January
£
£
15,000
284,050
Purchases
less Stock 31 December
299,050
18,420
Raw materials consumed
Direct factory wages
280,630
176,380
Prime cost
457,010
Factory overheads
Indirect factory wages
Indirect factory expenses
Depreciation plant and machinery
37,628
23,284
47,220
add Work in progress 1 January
less Work in progress 31 December
10,070
8,950
108,133
565,143
Factory cost of production
(ii)
Trading, Pro®t & Loss and Appropriation Account
for the year ended 31 December Year 10
£
£
Sales
less Cost of goods sold
Stock of ®nished goods 1 January
Factory cost of production
45,765
566,263
less Stock of ®nished goods 31 December
612,028
50,240
Gross pro®t
less expenses
Selling and distributive (£28,250 + £1,795 + £9,000)
Administrative (£173,900 7 £3,200 + £9,300)
Financial
Net pro®t for year
less Appropriations
Dividends ± preference interim
± preference ®nal
± Ordinary interim
± Ordinary ®nal
Retained pro®ts for the year
96
1,120
566,263
£
904,294
561,788
342,506
39,045
180,000
24,125
243,170
99,336
12,000
12,000
24,000
20,000
30,000
50,000
74,000
25,336
Manufacturing accounts
(b)
Jason Manufacturing Co Ltd
Balance Sheet at 31 December Year 10
Cost
£
Freehold premises
Plant and machinery
Fixtures and ®ttings
Motor vehicles
Net current assets:
Current assets
Stock of raw materials
work in progress
®nished goods
850,000
236,100
62,000
45,000
1,193,100
Accumulated
depreciation
£
±
127,220
37,300
26,000
190,520
Net book
value
£
850,000
108,880
24,700
19,000
1,002,580
18,420
8,950
50,240
77,610
Investment in government stock
300,000
Debtors and prepayments (£49,150 + £3,200) 52,350
Bank
less Amounts due under one year:
Creditors and accruals (£21,706 + £1,795)
Proposed dividends: preference
Ordinary
Share capital
8% preference shares of £1 each fully paid
Ordinary shares of £1 each fully paid
Reserves:
Pro®t & Loss Account (£392,286 + £25,336)
Shareholders' capital and reserves
350,583
780,543
23,501
12,000
30,000
65,501
Authorised
£
500,000
1,250,000
1,750,000
715,042
1,717,622
Called up
£
300,000
1,000,000
1,300,000
417,622
1,717,622
97
Lesson 10
Solution to Question 10.2
(a) (i) and (ii)
J Davenport
Manufacturing, Trading and Pro®t & Loss Accounts
for the year ended 31 March Year 12
Raw materials
Opening stock
Purchases
£
£
23,000
262,000
285,000
26,000
less Closing stock
Direct labour ± factory wages
Prime cost
Production overheads:
Repairs to plant and machinery
Rent and rates
Heating and lighting
General of®ce expenses
Depreciation of plant and machinery
8,700
12,000
14,800
1,480
12,900
add Adjustment for work in progress stocks
Opening stock
Closing stock
Manufacturing cost of goods produced
Manufacturing pro®t
15,000
11,600
259,000
85,000
344,000
49,880
393,880
3,400
397,280
16,220
Market value of goods produced
413,500
Sales
less Returns
496,000
5,000
491,000
Cost of sales:
Opening stocks ± ®nished goods
Market value of goods produced
add Stock of ®nished goods at 1/4/11
413,500
24,500
438,000
25,800
less Closing stocks ± ®nished goods
Gross pro®t
add Manufacturing pro®t
Administration overheads
Heating and lighting
Rent and rates
Salaries
General of®ce expenses
Increase in provision for unrealised pro®t
Net pro®t
412,200
78,800
16,220
95,020
less
Selling and distribution expenses
Selling expenses
Carriage outwards
98
£
6,000
1,600
7,600
3,700
4,000
14,000
5,920
27,620
200
35,420
59,600
Manufacturing accounts
(b)
J Davenport
Balance Sheet at 31 March Year 12
Cost
£
Fixed assets
Freehold premises
Plant and machinery
Current assets
Stocks
Raw materials
Work in progress
Finished goods
less Provision for unrealised pro®t
420,000
86,000
506,000
Aggregate
depreciation
£
30,900
30,900
Net
book value
£
420,000
55,100
475,100
26,000
11,600
25,800
3,200
22,600
60,200
21,000
4,000
12,800
Debtors
Prepaid ± rent and rates
Bank
98,000
less Amounts due within one year
Creditors
Accrued heating and lighting
Net current assets
Financed by:
Capital and reserves
Capital at 1 April Year 11
Net pro®t
Capital (31 March Year 12)
35,500
2,000
37,500
60,500
535,600
476,000
59,600
535,600
99
Lesson 11: Stocks, stock valuations
and stock losses
Lesson topics
.
.
.
.
.
Reasons for stocks being held by businesses
The valuation of stock
Adjustments to stock valuations for gross mark up and gross margin
Adjustments to stock valuation at the end of ®nancial periods
Stock losses
Extended Syllabus references
13.1
13.2
The importance of stock valuation in the measurement of trading pro®t
Stock as a current asset on the Balance Sheet
13.3.2 The effect upon stock valuation of goods purchased at different prices, and
differing methods of charging goods sold to the trading account ± use of
FIFO, LIFO, weighted average
13.3.3 Understanding the consequent effect upon reported pro®ts, of the pricing
method chosen
13.4.3 Valuing stock when a choice has to be made between cost and net realisable
value
13.5.1 Adjusting a stock valuation to the ®nancial year end, when the physical
stocktaking occurs after the actual year end
13.5.4 The effect on stock valuation of goods in customers' hands, eg on sale or
return, and of customers' goods on our premises
13.6.1 Calculation of the cost of goods stolen from stock
13.6.2 Calculation of the loss of stock arising from ®re, ¯ood, etc
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
.
100
Apply the concept of ``Lower of cost and net realisable value'' to determine the
valuation of stock
Apply different pricing methods in the calculation of pro®t ®gures and stock
valuations
Calculate a gross pro®t mark-up percentage and a gross margin percentage
Stocks, stock valuations and stock losses
The lesson
1
Begin the lesson by explaining to the class the meaning and importance of stocks; this is
explained on pages 213 and 214 of the Candidate's Guide book. The explanation refers
to a ``Just in Time'' procedure. Advise the class that ``Just in Time'' means the delivery
of the goods when the consumer requires them. Advise the class that they will not be
examined on this technique in this examination.
2
Advise the class of the need to value stocks at the end of ®nancial periods. Explain that
the valuation is necessary to assist in the calculation of pro®t and also to record the value
of the stock as a current asset in the Balance Sheet.
3
Advise the class that it is important that they know the principle of stock valuation:
``Stocks should be valued at the lower of cost and net realisable value''. Advise the class
that this principle needs to be observed in the valuation of stocks and that the topic is
examined regularly. Provide the class with this illustration, which has been taken from
page 214 of the Candidate's Guide book:
Purchased item
Purchase price
£
180
Selling price
£
210
Replacement price
£
190
The stock valuation for the item is the purchase price of £180, as this is the lower of the
cost and net realisable value.
4
Provide the class with another example that has also been taken from the Candidate's
Guide book (page 215):
Purchased item
Purchase price
£
180
Selling price
£
105
Replacement price
£
190
The stock valuation for the item is the selling price of £105, as this is the lower of cost
and net realisable value.
5
Advise the students that the replacement price has not been used in either of the
examples. For Second Level studies, advise your students that the replacement price will
not be examined as a basis for stock valuation.
6
Advise the class that in the UK it is traditional for many retail stores to reduce their
selling prices in the month of January. This is the background to the reference to the
January sales in the Candidate's Guide book.
7
Refer the class back to the above example and advise the students that if the retailer felt
that he would also need to spend £8 to put the item into a saleable condition, then the
stock valuation would reduce to £97. Explain to the class that this is because the net
realisable value is calculated as: £105 less £8 = £97.
101
Lesson 11
8
Involve the class and ask the students to prepare an answer to Example 1 on page 215 of
the Candidate's Guide book.
9
Explain the solution to the class using the Notes to the solution, which are on pages 215
and 216 of the Candidate's Guide book. Ask the class to recognise the in¯uence that the
stock valuation has upon the calculation of the gross pro®t.
Note 2 of the Notes to the solution explains that Kathy has obtained a gross mark up of
50%. Explain to the class that this ®gure has been calculated as follows:
Gross pro®t
Cost of sales
6100
10 Refer the class to the solution to the Trading Account on page 216 of the Candidate's
Guide and use these ®gures to illustrate the calculation of the gross pro®t mark up:
£59,560
£119,120
6100 = 50%
11 Advise the class that the mark up percentage shows the relationship between the gross
pro®t and the cost of sales. As the cost of sales plus the gross pro®t equals the sales value,
then a percentage can be calculated that shows the relationship between the gross pro®t
and the sales value. Advise the class that this is referred to as the gross margin and is
calculated as follows:
Gross pro®t
Sales value
6100
Refer the class to the solution to the Trading Account and use these ®gures:
£59,560
£178,680
6100 = 331¤3 %
Advise the class that it is important that they are aware of the distinction between gross
mark up and gross margin.
12 Advise the class that it is important that they should be able to calculate the gross mark
up and gross margin, and to use them for other calculations. For example, if a question
provided the candidates with the ®gure for sales value and the gross margin percentage
achieved on the sales, then the candidates could be asked to calculate the ®gures for the
cost of the sales and gross pro®t.
13 Involve the class by asking them to complete the following calculations:
(a) A retailer has purchased goods costing £12,000 and wishes to achieve a 50% gross
mark up.
102
Stocks, stock valuations and stock losses
Calculate the sales value that the retailer should charge for the goods.
Answer:
Purchase cost
add 50%
£12,000
£6,000
Sales value
£18,000
(b) A retailer has purchased goods costing £12,000 and wishes to achieve a gross
margin of 331¤3 %. Calculate the sales value that the retailer should charge for the
goods.
Answer:
Purchase cost
£12,000
Gross margin is 331¤3 %
Therefore, as purchase cost plus gross pro®t = sales and the gross margin represents
a percentage of sales value, explain to the class that the purchase cost is 662¤3%, 100%
less 331¤3 % of the sales value.
Show the class that the sales value is calculated as:
£12,000
662¤3 %
6100 = £18,000
Ask the class to recognise that the answers to (a) and (b) are the same. Explain,
therefore, that a 50% gross mark up is identical to a 331¤3 % gross margin.
(c) A retailer has sold goods for £36,000. He always achieves a gross margin of 331¤3%.
Calculate the ®gures for cost of sales and gross pro®t.
Answer: Explain to the class that as the gross margin is expressed as a percentage of
the sales value, then the cost of sales will be 662¤3 %, 100% less 331¤3 %, of the sales
value.
Cost of sales: £36,0006662¤3 % = £24,000
Gross pro®t: £36,0006331¤3 % = £12,000
The gross pro®t can also be calculated as: £36,000 less £24,000 = £12,000.
(d) A retailer has sold goods for £36,000. He always achieves a gross mark up of 50%.
Calculate the ®gures for the cost of sales and gross pro®t.
Answer: Explain to the class that the gross mark up is expressed as a percentage of
the cost of sales. As cost of sales plus gross pro®t = sales, then explain to the class
that the gross pro®t is one-third of the sales value. This means that the gross
pro®t is £12,000; £36,000/3, and the cost of sales is £24,000, £36,000 less
£12,000.
103
Lesson 11
Now test these ®gures to prove the gross mark up percentage:
Sales
Cost of sales
£
36,000
24,000
Gross pro®t
12,000
Gross pro®t mark up =
Gross pro®t
Cost of sales
And so using the above ®gures,
6100
£12,000
£24,000
6100 = 50%
(e) A retailer has valued his stock on hand at 31 December Year 9 at the normal sales
value of £90,000. The retailer achieves a gross margin of 331¤3 %.
Calculate the cost value of the stock on hand at 31 December Year 9. What value
should be placed on the stock that appears in the retailer's Balance Sheet at 31
December Year 9?
Answer: With a gross margin of 331¤3%, then the cost of the stock is 662¤3% of its sales
value. Explain to the class that this means the cost of the stock is £60,000,
£90,0006662¤3%. Use these ®gures to see if the gross margin is 331¤3%: sales value of
the stock £90,000, cost value of the stock £60,000, so the gross pro®t that would
be achieved if the goods were sold is £30,000.
Therefore, the gross margin is calculated as:
Gross pro®t
Sales value
6100
And using the above ®gures:
£30,000
£90,000
6100 = 331¤3 %
The values of these goods are as follows: sales value £90,000, cost value £60,000.
Therefore, the goods should be valued at the lower of cost and net realisable value,
which in this case is £60,000. Explain to the class that the value of stock on the
retailer's Balance Sheet at 31 December Year 9 is therefore £60,000.
14 Involve the class again by asking the students to prepare an answer to Example 2 on
pages 216 and 217 of the Candidate's Guide book. In particular ask the class to
recognise that they will need to convert the stock valuation to its cost valuation and also
adjust it for the value of the goods that await collection by the customer.
Explain the solution on page 217 to the class and also use the Notes to the solution on
pages 217 and 218 of the Candidate's Guide book.
104
Stocks, stock valuations and stock losses
15 Explain to the class the problems that businesses may experience with annual physical
stocktaking, by using the details on pages 218 and 219 of the Candidate's Guide book.
16 Ask the class to attempt an answer to Example 3 on page 219 of the Candidate's Guide
book. Emphasise to the class the importance of understanding the gross pro®t mark up
as again it is required in this example and appears regularly in examination questions.
Also advise the class that the gross pro®t margin is also regularly examined, so this
should also be studied by the students in their preparation for the examination.
Explain the solution that is shown on page 220 of the Candidate's Guide book and also
use the Notes to the solution.
In explaining the solution, ask the class to tell you the cost value of the sales that were
made between 31 December Year 12 and 5 January Year 13. This is to provide further
practice for the calculation involving the gross pro®t mark up. Also ask the class to tell
you the ®gure for the cost value of the goods that were held by the customers on a sale
or return basis.
Ask the class to recognise why there has been a reduction in the value of the stocks by
£150; this appears as the last adjustment in the solution and is explained in Note 4 of
the Notes to the solution in the Candidate's Guide book. The class should be aware that
the adjustment has been made because of the need to apply the principle for stock
valuation of ``Lower of cost and net realisable value''.
17 Ask the class to attempt an answer to Example 4 on page 221 of the Candidate's Guide
book, and then explain its solution. The solution and its related Notes are on page 221.
Note that, although a Trading Account has not been requested, it may be helpful to
your students if you asked them to prepare a Trading Account in order to answer the
question. Advise the class that if this question had appeared in the examination, then
they would not have been penalised if they had prepared a Trading Account.
Advise the class that another way to calculate the cost of sales ®gure is to use the unit
cost of £310 and multiply this by the quantity sold. This would give the following:
Cost of sales 645 sets6£310 = £199,950
18 Explain the problem of both calculating a gross pro®t ®gure and valuing stock when the
purchase price ¯uctuates in the same ®nancial period. Advise the class that the problem
arises when the quantity purchased in the ®nancial period differs from the quantity sold.
The problem is determining how much of the purchase cost is charged to the cost of
sales and how much of the purchase cost is used as the valuation of the closing stock.
19 Refer the class to Example 5 on page 222 of the Candidate's Guide book and use this to
highlight to the class the problem of differing purchase prices. Use the example to
illustrate 3 differing methods of preparing the charge to the cost of sales in the Trading
Account. The 3 methods shown are: 1 ®rst in ®rst out (FIFO), 2 last in ®rst out (LIFO)
and 3 weighted average. The examples are shown on pages 222, 223 and 224 of the
Candidate's Guide book.
105
Lesson 11
Show the class the following Trading Accounts that have been prepared using the
differing pricing methods:
L Chilton
Trading Account
for the year ended 31 December Year 9
Pricing method
Sales
Cost of sales
Gross pro®t
FIFO
£
312,825
195,500
117,325
LIFO
£
312,825
195,350
117,475
Weighted average
£
312,825
195,489
117,336
20 Advise the class that the differing gross pro®t ®gures re¯ect the differing cost of sales
®gures. The differing ®gures are caused by the different pricing methods and these also
cause the closing stocks to be valued differently. Advise the class that the differing stock
valuations are as follows:
Pricing method
Purchases
less Cost of sales
Stock valuation
at 31 December Year 9
FIFO
£
206,000
195,500
LIFO
£
206,000
195,350
10,500
10,650
Weighted average
£
206,000
195,489
10,511
Refer to the Candidate's Guide book on pages 223 and 224 to explain the proof of
these stock valuations.
21 Explain to the class the importance of controlling stocks and use the illustrations on
page 224 of the Candidate's Guide book to explain how stock losses may occur.
Use Example 6 and its related solution on pages 224 and 225 to illustrate how the
calculation of the cost of goods stolen is made.
22 Emphasise to the class, again, of the importance for the class to understand how to treat
the 25% mark up. Note that in the solution a pro®t margin of 20% is used. Explain to
the class that a 25% mark up has the same effect as a 20% margin. Use this example to
illustrate this point to the class:
Example: Assume that a product has a unit purchase cost of £120.
Ask the class to calculate the selling price of the product if a 25% pro®t mark up
is required.
The answer should be shown as follows: £120 plus 25% = £150.
Ask the class to calculate the selling price of the product if a 20% pro®t margin is required.
In preparing the answer, advise the class that this means that the pro®t is 20% of the
selling price. Also explain that this means that the purchase price, the cost price, is 80%
of the selling price. Therefore the selling price is calculated as:
106
Stocks, stock valuations and stock losses
£120
80%
6100% = £150
Ask the class to recognise that the same unit selling price is determined and this shows
that a 25% pro®t mark up gives the same result as a 20% pro®t margin.
23 Involve the class by asking the students to prepare an answer to Example 7 on page 226
of the Candidate's Guide book.
To assist the class in preparing their answers, illustrate the calculation of the gross pro®t
margin. This is shown in the solution as 45%. Advise the class that this calculation will
be useful for them in preparing their answers.
Explain the solution to the class that is presented on pages 226 and 227 of the
Candidate's Guide book.
24 Ask the class to prepare an answer to Example 8 on page 227 of the Candidate's
Guide book. You may wish to partially assist the students in answering this example
by illustrating the Trading Account for the silver products; this is shown on page 228
of the Candidate's Guide book. Also advise the class how the sales value for the silver
products is obtained; this is explained on page 228 of the Candidate's Guide book
and this again refers to the use of the gross pro®t margin. Now ask the class to
complete the answer to the example by calculating the sales value of the gold
products stolen.
Explain the solution to the class and also use the Notes to the solution to assist your
explanation.
An alternative, and acceptable, approach to the answer is shown below:
The sales value of the gold products sold (obtained by deducting the
sales value of the silver products from the total sales value)
Gross pro®t margin
Cost of the gold products sold
£646,800
6 50% =
100%
£646,800
50%
£323,400
Gold products
Stock at 31 December Year 7
add Purchases
£
98,600
385,200
less Cost of gold products sold (see above)
483,800
323,400
Stock at 2 June Year 8 should be
Actual stock at 2 June Year 8
160,400
21,600
Cost value of gold products stolen
138,800
107
Lesson 11
QUESTIONS FOR CLASS PRACTICE
Question 11.1
Wintner Stores, whose ®nancial year ends on 31 March, took stock on 26 March Year 5.
The stock on that date was valued at cost RM64,670. Wintner added 25% to cost to obtain
the selling price in the year ended 31 March Year 5.
Between 25 March and 31 March Year 5, the following transactions took place:
RM
2,830
2,120
1,320
180
450
Goods purchased
Credit sales
Cash sales
Goods returned by customers, taken back into stock
Goods, purchased prior to 26 March Year 5, returned to supplier
Required
(a) (i) Prepare a statement showing the adjusted value of Wintner's stock
at 31 March Year 5.
(ii) If, at a later date, Wintner Stores learned that an item of stock
purchased for RM3,000 now had a realisable value of RM2,500,
how would this affect a subsequent stock valuation?
(10 marks)
(3 marks)
Summer's business premises were broken into on 20 June Year 6. Damage to the
premises was RM4,600 and stock was stolen. Records showed a stock of
RM68,200 (at cost) at 1 April Year 6 and purchases of RM184,300 at cost during
the period 1 April±20 June Year 6. Sales during the period 1 April±20 June were
RM252,800.
The mark up on cost price of goods for sale is 331¤3 %.
A physical stocktaking on 21 June Year 6 showed that the goods remaining after the
theft, valued at cost, were RM12,600.
The insurance policy covered Summer for both loss of stock and damage to premises
though Summer had agreed to pay the ®rst RM500 of damage to premises.
(b) Prepare a statement showing the calculation of the insurance claim
which Summer would submit.
(12 marks)
(Total 25 marks)
(LCCIEB 1996)
108
Stocks, stock valuations and stock losses
Question 11.2
Tom Moore owns a retail shop and his Balance Sheet at 31 May Year 5 showed his stock
valued at £15,320, at cost.
In establishing his selling prices he always achieves a pro®t margin of 20%.
For some months Moore has felt that goods were being stolen from his shop. At the end of
business on 5 July he valued his stock at the normal sales value of £12,600.
The business records showed that for the period from 1 June Year 5 to 5 July Year 5:
Purchases amounted to £24,300
Sales amounted to £31,560
Moore advised you that the sales ®gure included the sales of some goods for which he had
reduced the prices. The reduction in prices amounted to £440.
Also, Moore had agreed to allow a customer to take goods with a sales value of £1,400 on a
sale or return basis. These goods had not been included in the sales ®gure quoted above and
the goods remained with the customer on 5 July Year 5.
Required
(a) Prepare a statement which reveals the value of the goods stolen from
Moore's retail shop.
(13 marks)
Following a physical stocktake at the premises of John Hurst plc on 30 April Year 9, the
cost value of the stock was shown as £32,100. This valuation includes the following:
1
Stock Item A
Fifty items were in stock at their cost value of £10 each. Their selling price at 30
April Year 9 was £7 each.
2
Stock Item D
Forty items were in stock at their cost value of £5 each. These items were declared
obsolete on 30 April Year 9.
3
Stock Item G
Ten items were in stock at their cost price of £20 each. However, only 4 of the
items were in a suitable condition for sale at their normal selling price of £40 each.
The remaining items were to be scrapped.
4
Hurst had allowed goods with a sales value of £1,500 to be taken by a customer on
a sale or return basis. The goods remained with the customer on 30 April Year 9,
yet he had not given any indication whether he wished to retain the goods. The
mark up used for these items was 20%.
109
Lesson 11
(b) Prepare a statement which shows the value of stock that should be
included in Hurst's Balance Sheet at 30 April Year 9, starting with the
valuation on 30 April of £32,100.
(12 marks)
(Total 25 marks)
(LCCIEB 1998)
Solution to Question 11.1
(a) (i)
Wintner Stores: Statement of adjusted stock valuation at 31 March Year 5
RM
Stock, valued at cost, 26 March Year 5
Adjust for transactions between 26 March and 31 March:
Purchases
less Returns
2,830
450
RM
64,670
2,380
67,050
Sales ± credit
± cash
2,120
1,320
less Returns
3,440
180
less Pro®t margin, 20% on sales
3,260
652
Stock, valued at cost, 31 March Year 5
(ii)
(b)
2,608
64,442
The subsequent stock valuation would be reduced by RM500 because the realisable value of
the stock is less than its cost.
Summer: Calculation of insurance claim in respect of the break-in of 20 June Year 6
RM
Stock, valued at cost, 1 April Year 6
Adjust for transactions between 1 April and 20 June:
Purchases
RM
68,200
184,300
252,500
Sales
less Pro®t margin, 25% on sales
252,800
63,200
62,900
12,600
less Stock remaining after break-in, valued at cost
Stock stolen, at cost
Damage to premises
less Cost borne by Summer
Claim to be submitted to the insurance company
110
189,600
50,300
4,600
500
4,100
54,400
Stocks, stock valuations and stock losses
Solution to Question 11.2
(a)
Tom Moore
£
15,320
24,300
Stock at 31 May Year 5
add
Purchases
39,620
less
less
Cost of sales
(£31,560 + £440)680%
25,600
Goods on customer's premises (£1,400680%)
14,020
1,120
Stock in hand, at cost, 5 July (12,600680%)
Cost value of goods stolen
(b)
12,900
10,080
2,820
John Hurst
£
Stock, at cost, 30 April Year 9
less Stock Item a (506 (1077))
Stock Item D (4065)
Stock Item G (6620)
add
Goods with customer
(1,500683.33%)
Stock value, at cost, 30 April Year 9
£
32,100
7150
7200
7120
+ 1,250
+ 780
32,880
111
Lesson 12: Accounts of non-trading
organisations
Lesson topics
.
.
.
.
.
.
.
.
Understanding the meaning of a non-trading organisation
Preparation of a Receipts and Payments Account
Preparation of a club's Trading Account
Preparation of a Subscriptions Account
Calculation of subscriptions credited to the Income and Expenditure Account
Preparation of the Income and Expenditure Account
Calculation of the accumulated fund
Preparation of a club's Balance Sheet
Extended Syllabus references
4.1
Understanding of the need for accounts in a non-trading organisation
4.2.2 Capital and revenue items in the Receipts and Payments Account
4.3.1 The meaning of the accumulated fund
4.3.2 Causes of an increase or decrease in the accumulated fund
4.3.3 Calculation of the amount of the accumulated fund at the start of a ®nancial
year
4.3.4 Donations as a direct entry to the accumulated fund
4.4.1 Adjustments to cash paid and received to obtain purchases and sales
4.4.2 According for those expenses properly chargeable to the trading activity of the
non-trading organisation
4.4.3 Determining the trading pro®t
4.4.4 Understanding the treatment of the trading pro®t
4.5.1 Recognition of the nature and purpose of an Income and Expenditure Account
4.5.2 Accounting for subscriptions received during the ®nancial year
4.5.3 Accounting for subscriptions in arrear or in advance at the start of the ®nancial
year
4.5.4 Accounting for subscriptions in arrear or in advance at the end of the ®nancial
year
(continued)
112
Accounts of non-trading organisations
Extended Syllabus references (continued)
4.5.5 Accounting for lifetime subscriptions
4.5.7 Determining appropriate expenses to be debited to the Income and
Expenditure Account
4.5.8 Calculation of the balance of the Income and Expenditure Account
4.5.9 Identi®cation of the balance as either an excess of income over expenditure or
as an excess of expenditure over income
4.6.1 Presentation of the accumulated fund on the Balance Sheet
4.6.2 Lifetime subscriptions
4.6.3 Subscriptions in arrear and in advance at the Balance Sheet date
Aim of the lesson
At the end of the lesson the students will be able to prepare the Receipts and
Payments Account and the ®nal accounts of a non-trading organisation
The lesson
1
Begin the lesson by explaining to the class the meaning of a non-trading organisation.
Provide examples of them, eg sports clubs such as a golf club and clubs formed for other
social activities such as a bird watching group or a walking group. Ask the class to
provide examples of other such clubs; they may be members of clubs themselves.
2
Use the introduction to Chapter 10 on pages 234 and 235 of the Candidate's Guide
book to assist you in your explanation of non-trading organisations. Emphasise the
important role that is carried out by the club's treasurer; explain to the class that the
position is one that is very important in that this of®cer is responsible for the correct
recording and safeguarding of the club's ®nances.
3
Begin to introduce the class to the various types of accounting records and statements
that should be maintained and prepared by a non-trading organisation.
4
Explain the meaning of a Receipts and Payments Account and illustrate its preparation
by using Example 1 on pages 236 and 237 of the Candidate's Guide book. Advise the
class that it is usual for examination to provide a club's Receipt and Payments Account
and then to ask for other club accounts to be prepared. Therefore, advise the class that
they should understand the manner in which a Receipts and Payments Account is
prepared and also of its contents.
113
Lesson 12
5
Explain to the class that some clubs have a pro®t making activity; the most common
example of this is a restaurant providing refreshments for the club's members and their
guests.
Explain to the class that separate accounting records are maintained for the pro®t
making activities of the club. This will provide information to the club members of the
level of pro®tability of this activity.
6
Advise the class that a Trading Account is prepared for the pro®t making activity. This is
prepared in exactly the same manner as all trading accounts.
Now use Example 2 on pages 237 and 238 of the Candidate's Guide book. Illustrate the
solution to this example to the class and also use the Notes to the solution.
Ask the class to recognise that only expenditure that relates to the restaurant is charged
to the restaurant's Trading Account. For example, this golf club is likely to incur wages
costs for a number of reasons: wages paid to employees who maintain the golf course,
clean the club's premises and perform duties in the restaurant, such as cooking and
serving customers. It is only the wages of the restaurant staff that are charged to the
Trading Account, the other types of wages are charged to the club's Income and
Expenditure Account.
7
Explain the contents of Note 1 of the Notes to the solution; this refers to other
expenses being charged to the restaurant's Trading Account. Provide this example to
show the class an illustration of this point:
The buildings insurance cost details for a club for the year ended 31 December
Year 7 are as follows:
The buildings insurance is payable annually in advance on 1 October.
The costs incurred for the past 2 years are as follows:
For the year ended:
30 October Year 7
30 October Year 8
£
16,800 (paid on 1 October Year 6)
18,000 (paid on 1 October Year 7)
The buildings of the club are occupied as follows:
Restaurant 30%
Changing rooms and general facilities 70%
These occupancy percentages re¯ect the amount of buildings insurance that is
chargeable to the Trading Account and the Income and Expenditure Account.
The club's ®nancial year ends on 31 December
Required
Prepare workings to show the amount of buildings insurance chargeable to:
(a) The restaurant's Trading Account.
114
Accounts of non-trading organisations
(b) The Income and Expenditure Account for the year ended 31 December Year 7.
Solution
Buildings insurance:
Prepaid amount at 1 January Year 7
£
£16,800
69 months)
12,600 (
12 months
add Payment on 1 October Year 7
18,000
30,600
less Prepaid amount at
31 December Year 7
13,500
Amount chargeable between restaurant's Trading
Account and Income and Expenditure Account
17,100
Chargeable to:
Restaurant Trading Account
Income and Expenditure Account
8
%
30
70
£
5,130
11,970
100
17,100
In order to provide the class with some practice of ledger account preparation and
prepayments, ask the students to prepare the buildings insurance ledger account. The
solution is as follows:
Buildings Insurance Account
Year 7
1 Jan Balance b/d
1 Oct Bank
£
12,600
18,000
30,600
Year 8
1 Jan Balance b/d
9
Year 7
31 Dec Income and Expenditure Account
31 Dec Balance c/d
£
17,100
13,500
30,600
13,500
Explain to the class the meaning of an Income and Expenditure Account. Advise the
class of the confusion experienced by some candidates in the manner in which they
prepare this account. Some candidates present the account in an acceptable horizontal
format, but in the wrong way; this means that items that should appear on the credit
side of the account are shown on the debit side of the account and vice versa. This
approach results in the loss of the marks for the Income and Expenditure Account.
Advise the class that one way of overcoming this dif®culty is to prepare the account in a
vertical format. This is an acceptable form of presentation so long as the income items
are shown ®rst in the account.
10 Advise the class that an Income and Expenditure Account is prepared in the same way
as a Pro®t and loss Account; items of income are credited and items of expenditure are
debited. Also advise the class that items such as prepayments, accruals and the need to
distinguish between capital and revenue expenditure will arise in the preparation of
Income and Expenditure Accounts.
115
Lesson 12
11 Emphasise to the class that the organisations being discussed are non-pro®t making
organisations. Therefore, the terms pro®t, or loss, are not used in the Income and
Expenditure Account. Advise the class that the terms that should be used are:
(a) In the case of the income exceeding the expenditure, the term that should be used
is ``Excess of income over expenditure''.
(b) In the case of the expenditure exceeding the income, the term that should be used
is ``Excess of expenditure over income''.
Advise the class that when the incorrect terms of pro®t (or loss) are used, then this
results in the loss of the marks that may be available for the correct wording.
12 As an introduction to the preparation of an Income and Expenditure Account, ask the
class to prepare an answer to Example 3 on pages 239 and 240 of the Candidate's Guide
book.
Explain the solution to the example to the class also using the Notes to the solution;
these are provided on pages 240 and 241 of the Candidate's Guide book.
13 Explain to the class the meaning of members' subscriptions; advise the class that this will
often relate to the largest portion of income that a club receives.
14 Explain to the class that the amount of subscriptions that should be credited to the
Income and Expenditure Account will need to take into account the subscriptions paid,
the subscriptions in arrear and the subscriptions paid in advance. Advise the class that
they should understand the application of the accruals concept in calculating the
amount of subscriptions to be credited to the Income and Expenditure Account.
15 Illustrate Example 4 on page 242 of the Candidate's Guide book to the class. Explain
the solution to the preparation of the Subscriptions Account, and show the class that
the account has been prepared using information obtained from the Receipts and
Payments Account and also details of the subscriptions in arrear and paid in advance at
31 December Year 6.
Advise the class that the details of the accruals and prepayments will be obtained from
the records prepared by the club's treasurer or, in cases of the larger clubs, the
subscriptions secretary. Each of these of®cers will keep records of the payments
received from the members and details of those members who have paid their
subscriptions in advance and details of those members whose subscriptions are in
arrears.
16 Involve the class by asking them to prepare a solution to Example 5 on pages 243 and
244 of the Candidate's Guide book.
Explain the solution to the class using the Notes to the solution on pages 244 and 245
of the Candidate's Guide book. Advise the class, again, of the importance to show all of
their workings. It is possible that a question could be asked that requires the calculation
of the amount of subscriptions to be credited to the Income and Expenditure Account.
116
Accounts of non-trading organisations
The examiner will award marks for partially correct answers, as long as the workings
used to obtain the answer are shown.
17 Advise the class that a variety of answers to Example 5 in the Candidate's Guide book
could be provided; some fully correct answers, some with items incorrectly omitted,
some with items incorrectly added when they should have been deducted, some with
items deducted when they should have been added. Advise the class that the examiner
will award partial marks for those parts of the answer that have been completed
correctly. However, advise the class that the examiner will only do this if the workings
have been included with the candidates' answers. Stress to the class, therefore, that if the
workings are not included with the answers then the examiner will not award the marks
for the partially correct answers. Tell the class that this advice about workings is not
restricted to this area of the syllabus: it applies to the whole syllabus.
18 Involve the class by asking the students to prepare an answer to Example 6 on pages
245 and 246 of the Candidate's Guide book. Again advise the class to show all of
their workings in arriving at the ®gure to credit to the Income and Expenditure
Account. Show the class the solution; this appears on page 246 of the Candidate's
Guide book.
19 Explain to the class the meaning and treatment of life subscriptions and entrance fees.
Explain to the class that entrance fees are payable by the new members to the club and
these fees often re¯ect the popularity of the club. The management of such clubs,
often referred to as the club committee, regard the payment of entrance fees as a
payment by the new members to enjoy the existing facilities that have been created by
the efforts of the existing members. Explain to the class that this is particularly the case
with golf clubs in the UK. Use the explanation of these terms that is provided on pages
246 and 247 of the Candidate's Guide book. Now illustrate the terms by the use of
Example 7 and its related solution on pages 247 and 248 of the Candidate's Guide
book.
20 Explain to the class that a club's Balance Sheet is prepared in the same way as that of any
organisation. Explain to the class that a club is likely to have ®xed assets, current assets,
current liabilities (amounts falling due within one year) and possibly items falling due in
more than one year. Explain to the class that an item that is exclusive to a non-trading
organisation's Balance Sheet is the accumulated fund.
21 Use the explanation provided on pages 248 and 249 of the Candidate's Guide book to
advise the class of the meaning of the accumulated fund.
Use Example 8 on page 249 to illustrate how the accumulated fund can be calculated.
In explaining the solution, advise the class that the accumulated fund ®gure represents
the difference between the value of the club's assets less the value of the club's liabilities.
Also emphasise point 4 of the Notes to the solution; the omission of the cash and bank
balances in the calculation of the accumulated fund.
22 Advise the class that questions can be set which show the Receipts and Payments
Account, but without showing the closing balances for the ®gures for the cash and bank
117
Lesson 12
balances. This means that the candidate is expected to calculate these balances and
include them in the calculation of the accumulated fund. Also advise the class that the
examiner would expect to see these balances in the club's Balance Sheet.
23 Advise the class that a club may not always maintain proper accounting records. This
may result in the accounts for the club being prepared from incomplete records. The
principles outlined in Lesson 9 would also apply to a club situation.
Advise the class that the ®gures in Example 8 on page 249 of the Candidate's Guide
book could be interpreted as ®gures derived for a club that does not keep proper
accounting records. Some of the ®gures could be actual ®gures, such as the accrued staff
wages, amounts owed to suppliers and the balance outstanding on the loan. However,
some of the other ®gures could be estimated ®gures; these include the valuations of the
premises and the sports and ®tness equipment. Therefore, from the use of a
combination of actual and estimated ®gures, a ®gure for the club's accumulated fund at
a particular date can be calculated. This, in turn, allows the preparation of the club's
Balance Sheet.
24 Advise the class that the calculation of the accumulated fund at the beginning and the
end of the ®nancial period will also allow the calculation of the surplus of income over
expenditure or the surplus of expenditure over income. Explain to the class that
without the presence of life subscriptions or entrance fees, then the change in the
valuation of the accumulated fund will be explained by the surplus of income over
expenditure or surplus of expenditure over income.
Advise the class that the use of such information to determine the ®gures for inclusion
in the club's ®nal accounts is unlikely to be welcomed by the club's members. They are
likely to require that any surplus or de®cit reported to them is explained and supported
by the presence of accurate accounting records.
25 Involve the class by asking the students to prepare an answer to Example 9 on page 251
of the Candidate's Guide book.
Advise the class that the example provides a strong hint that the bank balance at
30 September Year 9 needs to be calculated; the question shows ``????'' against the cash
at bank entry for September 30 Year 9. This hint will not always appear in examination
questions; the candidates will often be expected to realise that this balance needs to be
calculated and included in the club's Balance Sheet.
26 Emphasise to the class, again, that the preparation of their solutions will be assisted by
the presentation of all of their workings. Advise the class that the workings to the
solution are shown in the Candidate's Guide book. Explain the solution to the class also
using the Notes to the solution to assist your explanation. These appear on pages 252,
253 and 254 of the Candidate's Guide book.
118
Accounts of non-trading organisations
QUESTIONS FOR CLASS PRACTICE
Question 12.1
The Treasurer of the GB Cricket Club has prepared the following summarised Receipts and
Payments Account for the year ended 31 December Year 19:
$
Opening balance
Subscriptions:
Year 18
Year 19
Year 20
8,610
1,100
31,400
700
$
7,800
8,250
625
278
3,780
1,377
15,400
268
4,032
Purchases of pavilion ®ttings
Groundsman's wages
Heat and light
Printing and stationery
Rent
Repairs to machinery
Purchases of new machinery
Telephone
Closing balance
41,810
41,810
Additional information:
Fixed assets at valuation:
Pavilion and ®ttings
Machinery
1 January
$
18,510
31,720
31 December
$
24,200
42,310
Subscriptions:
Outstanding Year 18
Outstanding Year 19
Prepaid Year 19
1,500
±
300
?
350
±
Creditors:
Rent
Heat and light
Telephone
Accrued wages
1,130
52
30
150
1,150
63
41
190
No disposals of any ®xed assets took place during the year.
Required
Showing all your workings, prepare for the GB Cricket Club, the:
(a) Income and Expenditure Account for the year ended 31 December
Year 19.
(13 marks)
(b) Balance Sheet at 31 December Year 19.
(12 marks)
(Total 25 marks)
(LCCIEB 1997)
119
Lesson 12
Question 12.2
The following Receipts and Payments Account has been prepared for the Goodhope Social
Club:
Receipts and Payments Account
for the year ended 30 June Year 9
£
Balance at bank at
1 July Year 8
Subscriptions for the year ended:
30 June Year 8
30 June Year 9
30 June Year 10
Members' visits by
coach
Annual dinner-dance
Sale of old
television set
Catering takings
£
5,190
260
10,380
120
10,760
620
1,020
40
20,060
New games equipment
Rent of club premises
Catering supplies
Wages ± catering staff
Wages ± other staff
Insurance
Lighting and heating
Annual dinner-dance
New television set
Printing and stationery
Hiring of coaches for visits
General expenses
Repairs and maintenance
Balance at bank at
30 June Year 9
37,690
£
2,500
4,500
9,160
6,250
3,080
600
675
840
360
565
750
310
550
7,550
37,690
The following additional information is available:
Furniture and ®ttings (including old television set valued at £60)
Games equipment
Catering stock
Insurance prepaid
Creditors for catering supplies
Lighting and heating accured due
Subscriptions: in arrears
in advance
1 July
Year 8
£
3,600
1,200
2,025
65
320
180
290
140
30 June
Year 9
£
?
?
1,850
75
565
210
190
120
Of the subscriptions in arrears at 1 July Year 8, the balance owing is to be written off as irrecoverable.
Depreciation is calculated t 20% on furniture and ®ttings, 25% on games equipment; both based on the
book values at 30 June Year 9.
Required
Prepare, for the Goodhope social Club:
(a) A statement of the accumulated fund at 1 July Year 8.
120
(2 marks)
Accounts of non-trading organisations
(b) The Catering Account for the year ended 30 June Year 9.
(3 marks)
(c) The Income and Expenditure Account for the year ended
30 June Year 9.
(14 marks)
(d) The Balance Sheet at 30 June Year 9.
(6 marks)
(Total 25 marks)
(LCCIEB 1997)
Solution to Question 12.1
Workings
Accumulated fund
Subscriptions
Year 19
$
50,230 (18,510 + 31,720)
+1,500
71,362
7300
+8,610
$
31,400
+300
+350
Depreciation:
pavilion and
®ttings
$
18,510
+7,800
724,200
32,050
2,110
Depreciation:
machinery
Rent
$
31,720
+15,400
742,310
$
3,780
+1,150
71,130
4,810
3,800
58,678
Heat and light
$
625
+63
752
636
(a)
Telephone
$
268
+41
730
Wages
$
8,250
+190
7150
279
8,290
GB Cricket Club
Income and Expenditure Account for the
Year ended 31 December Year 19
$
Depreciation:
Pavilion and ®ttings
Machinery
Rent
Heat and light
Telephone
Wages
Printing and stationery
Repairs
Excess of income over expenditure
2,110
4,810
3,800
636
279
8,290
278
1,377
10,470
32,050
$
Subscriptions
32,050
32,050
121
Lesson 12
(b)
GB Cricket Club
Balance Sheet at 31 December Year 19
Accumulated fund
Fixed assets
$
$
58,678
Opening balance
add Excess of income
over expenditure
$
24,200
42,310
10,470
69,148
Current liabilities
Creditors
Subscriptions
$
Pavilion and ®ttings
Machinery
1,444
700
66,510
Current assets
Cash
Subscriptions
4,032
750
2,144
71,292
Creditors:
$
1,150
63
41
190
4,782
71,292
Subscriptions:
$
Year 18 ($1,500 7 $1,100)
Year 19
400
350
750
1,444
Solution to Question 12.2
(a)
Goodhope Social Club
accumulated fund at 1 July Year 8
Furniture and ®ttings
Games equipment
Stock of catering supplies
Bank
Insurance prepaid
Subscriptions in arrears
Subscriptions in advance
Creditors for catering supplies
Lighting and heating accrued due
Accumulated fund
£
3,600
1,200
2,025
5,190
65
290
12,370
122
£
140
320
180
11,730
12,370
Accounts of non-trading organisations
(b)
Catering Account
for year ended 30 June Year 9
Opening stock
Purchases
£
2,025
9,405
less Closing stock
11,430
1,850
£
20,060
Takings
9,580
6,250
Wages ± catering staff
Pro®t to Income and Expenditure Account
15,830
4,230
20,060
20,060
Workings
Purchases: £9,160 7 320 + 565 = £9,405.
(c)
Goodhope Social Club
Income and Expenditure Account
for the year ended 30 June Year 9
£
Rent of club premises
Coach hire
750
620
less Receipts
Staff wages
Insurance (£600 + £65 7 £75)
Lighting and heating
(£675 7 £180 + £210)
Printing and stationery
General expenses
Repairs and maintenance
Depreciation:
old television set
20
furniture/®ttings
780
games equipment
925
Surplus for year
£
£
4,500
130
3,080
590
705
565
310
550
1,725
2,935
15,090
Pro®t on catering
* Subscriptions for year
less w/o
£
4,230
10,710
30{
10,680
Annual dinner-dance
income
less Expenses
1,020
840
180
*10,380
140
10,520
190
10,710
15,090
{ Could be on debit side
* Workings depreciation: furniture and ®ttings £3,600 7 £60 + £360 = book value 30 June Year 9 £3,900
at 20% = £780; games equipment £1,200 + £2,500 = £3,700 at 25% = £925
123
Lesson 12
(d)
Goodhope Social Club
Balance Sheet at 30 June Year 9
£
£
Fixed assets
Furniture/®ttings
less Depreciation
3,900
780
3,120
Games equipment
less Depreciation
3,700
925
2,775
Current assets
Stock of catering supplies
Prepaid insurance
Subs in arrears
Bank
124
Accumulated fund
1 July Year 8
add Surplus
£
11,730
2,935
14,665
5,895
1,850
75
190
7,550
£
9,665
15,560
Amounts due under
12 months:
creditors for catering supplies 565
Lighting and heating
210
120
Subs in advance
895
15,560
Lesson 13: Branch accounts (1)
Lesson topics
.
.
.
.
.
The meaning of a branch
The treatment of goods sent to branch(es) at cost
Preparation of the branch accounts in the Head Of®ce ledger
Preparation of a branch account, goods to branch account, branch cash account,
branch debtors' account, branch Pro®t and Loss Account
Preparation of the Head Of®ce Trading Account
Extended Syllabus references
7.1
The meaning of a ``branch''
7.2
The importance of controlling cash at branch, stock at branch and the selling
price of goods at the branch
7.3
Recording branch transactions in the Head Of®ce ledger (questions will not
be asked involving the maintenance of a double entry ledger by the branch)
7.4.1 The use of a branch (stock) account. Entries for goods to branch, sales, and
opening and closing stocks. The source of the stock ®gures. Gross pro®t.
7.4.3 The use of a goods to branch account
7.4.4 The branch debtors' control account, branch cash control account and the
branch Pro®t and Loss Account
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
Prepare the ledger accounts of a branch, when the goods are sent to the branch
from the Head Of®ce at cost
Prepare the Trading Account of the Head Of®ce
The lesson
1
Begin the lesson by explaining the meaning of a branch. Use the explanation provided
on page 260 of the Candidate's Guide book and illustrate your introduction by advising
125
Lesson 13
the class that one of the leading high street retail stores in the UK began trading in
Leeds over 100 years ago and has gradually opened stores throughout the UK and the
world. Advise the class that the stores throughout the UK and overseas are all to be
regarded as branches.
2
Use the Candidate's Guide book to explain the following branch activities: how
purchases are likely to be made, how selling prices are determined, how stocks are
controlled and how cash is remitted to the Head Of®ce. The Candidate's Guide book
provides these explanations on pages 261, 262 and 263.
3
Advise the class that the Second Level syllabus relates to the recording of branch
transactions in the Head Of®ce ledger; the students will not be expected, therefore, to
record transactions in the branch ledger.
4
Advise the class that the Head Of®ce will often send goods to the branch that are
required to be subsequently sold by the branch. In addition, advise the class that the
Head Of®ce can choose from a number of methods to charge the branch for these
goods.
5
Explain to the class that this lesson will cover the topic that relates to the goods sent to
the branch from the Head Of®ce at cost.
6
Refer the class to the main entries that will appear in the Head Of®ce ledger that relate
to goods sent to the branch from the Head Of®ce, goods returned to the Head Of®ce
from the branch, goods transferred between branches, cash and credit sales made by the
branch and expenses incurred by the branch. An illustration of the entries to be made in
the Head Of®ce ledger relating to these transactions appears on pages 264 and 265 of
the Candidate's Guide book.
7
Advise the class to remember that all of the entries are made in the Head Of®ce ledger;
there are no entries that span the Head Of®ce ledger and the branch ledger.
8
Advise the class that the branch account is the same as the branch stock account.
Explain to the class that this account is very similar to a Trading Account, and will be
the account where the gross pro®t for the branch is calculated.
9
Refer the class to Example 1 on page 265 of the Candidate's Guide book and show the
students the solution. Illustrate the preparation of the ledger accounts with references to
the earlier example of the main entries that will appear in the Head Of®ce ledger.
However, ask the class to recognise that not all of the main entries are covered in
Example 1: there are no transfers between any branches and also there are no credit
sales. Also ask the class to notice that the cash sales of the branch are banked into a
branch cash account, rather than the money being paid into the Head Of®ce Bank
Account as discussed earlier in this lesson.
10 Explain the solution to the class and use the Notes to the solution; these appear on
pages 266 and 267 of the Candidate's Guide book.
126
Branch accounts (1)
Note 1 of the Notes to the solution shows the gross margin, 47.13%, achieved on the
branch sales. Ask the class to calculate the gross mark up for the branch sales.
In explaining the solution to this calculation, advise the class that the cost of sales can be
calculated as sales less gross pro®t, £54,100 less £25,500 = £28,600.
The gross pro®t mark up is calculated as:
Gross pro®t
Cost of sales
6100
and using the ®gures from above:
£25,500
£28,600
6100 = 89.16%
11 Involve the class by asking the students to prepare an answer to Example 2 on pages 267
and 268 of the Candidate's Guide book. Before the students begin their answers,
explain that although you have not shown an example of a Head Of®ce Trading
Account, this should not cause a problem to the students.
12 Advise the class that the Head Of®ce Trading Account should be prepared in a similar
manner to one prepared for a sole trader, partnership, limited company or pro®t making
area of a non-trading organisation. Advise the class that the preparation of these Trading
Accounts has been dealt with in earlier lessons.
13 Advise the class that the only additional entry is that which credits the Trading Account
with the cost of the goods sent to the branch. Remind the class of the double entry
required in the Trading Account from this entry made in the ledger:
Debit:
Credit:
Goods sent to branch account
Head Of®ce Trading Account
14 Show the solution to the example to the class and use the Notes to the solution to assist
your explanation. These appear on pages 268, 269 and 270 of the Candidate's Guide
book.
15 Show the class the alternative and acceptable presentation of the Head Of®ce Trading
Account; this appears as Note 2 of the Notes to the solution.
Advise the class that this alternative form of presentation provides more information
than the answer shown on page 268 of the Candidate's Guide book. The alternative
answer shows ®gures for the net purchases and the cost of sales.
16 Ask the class to recognise that the ®gures used to calculate the gross pro®t mark up %
are readily available from the alternative presentation. Illustrate this point to the class by
showing how the ®gures used to calculate the gross pro®t mark up appear in the
alternative form of presentation; gross pro®t £211,977 and cost of sales £494,613.
127
Lesson 13
17 Advise the class that a vertical presentation of the Trading Account would also be
acceptable. This would appear as:
Head Of®ce Trading Account
for the year ended 31 December Year 9
Cash sales
Credit sales
£
£
£
702,900
4,750
less Returns
707,650
1,060
706,590
Cost of sales:
Opening stock
Purchases
less Returns
585,400
3,067
Net purchases
less Goods to branch
582,333
101,550
48,460
less Closing stock
Gross pro®t c/d
480,783
529,243
34,630
494,613
211,977
Note that the gross pro®t is carried down to the Head Of®ce Pro®t and Loss
Account.
Note, again, that the gross pro®t mark up and gross pro®t margin are mentioned in the
Notes to the solution.
QUESTIONS FOR CLASS PRACTICE
Question 13.1
The ®rm of J Clark and Son trades from both a Head Of®ce and a branch depot.
All purchases are made by Head Of®ce and goods sent to the branch are invoiced at cost.
The branch sells goods on credit and for cash.
Branch debtors at 1 January Year 8 were £5,720 and branch stock, at cost, at 1 January Year
8 was £9,000.
128
Branch accounts (1)
The following information relates to the branch for the ®nancial year ended 31 December
Year 8:
£
40,480
420
20,100
36,000
210
330
360
29,520
1,080
3,600
780
8,340
Goods sent from Head Of®ce
Goods returned to Head Of®ce at cost
Cash sales
Credit sales
Discount allowed to credit customers
Returns from credit customers
Bad debts
Cash received from credit customers
Rates
Wages and expenses
Selling expenses
Stock at cost (31 December Year 8)
Required
Prepare the following accounts for the year ended 31 December Year 8:
(a)
(b)
(c)
(d)
Goods sent to branch account.
Branch stock account.
Branch debtors' account.
Branch Pro®t and Loss Account.
(LCCIEB 1992, amended)
Solution to Question 13.1
(a)
Goods Sent to Branch Account
Year 8
31 Dec
31 Dec
£
Branch stock
Head Of®ce Trading
Account
420
Year 8
31 Dec
Branch stock
40,060
40,480
(b)
£
40,480
40,480
Branch Stock Account
Year 8
1 Jan
31 Dec
31 Dec
31 Dec
Balance b/d
Goods sent to branch
Debtors
Gross pro®t to Pro®t
& Loss Account
£
9,000
40,480
330
Balance b/d
£
Goods sent to branch
Cash
Debtors
c/d
420
20,100
36,000
8,340
31 Dec
15,050
64,860
Year 9
1 Jan
Year 8
31 Dec
31 Dec
31 Dec
Balance
64,860
8,340
129
Lesson 13
(c)
Branch Debtors' Account
Year 8
1 Jan
31 Dec
£
5,720
36,000
Balance b/d
Branch stock
Year 8
31 Dec
31 Dec
31 Dec
31 Dec
31 Dec
£
Discount allowed
Branch stock
Bad debts
Bank
Balance c/d
41,720
Year 9
1 Jan
(d)
Balance b/d
41,720
11,300
Pro®t and Loss Account
for the year ended 31 December Year 8
£
Branch stock
less:
Discount allowed
Bad debts
Rates
Wages and expenses
Selling expenses
Net pro®t
130
210
330
360
29,520
11,300
210
360
1,080
3,600
780
£
15,050
6,030
9,020
Lesson 14: Branch accounts (2)
Lesson topics
.
.
.
.
.
.
.
Preparation of branch accounts when goods are sent to the branch:
± plus a handling charge
± at selling prices where there is not a constant margin
± at selling prices where there is a constant margin
Preparation of a single-column branch stock account
Preparation of a two-column branch stock account
Preparation of a branch stock adjustment account
Treatment of price reductions at a branch
Treatment of stock losses at a branch
Preparation of departmental accounts
Extended Syllabus references
7.5
Charging goods from Head Of®ce to branch at cost plus a handling charge
7.6
Charging goods from Head Of®ce to branch at selling price, where selling
prices are not set to give a consistent margin of gross pro®t
7.7.1 Use of a two-column branch account, including a memorandum column to
control goods at the branch
7.7.2 Authorised reductions of normal selling prices
7.7.3 Identi®cation and recording of stock losses, recognition of the different
treatment accorded to the pro®t margin as opposed to the cost
7.7.4 Use of a branch stock adjustment account
7.8.1 Purpose of departmental accounts
7.8.2 Preparation of columnar Trading and Pro®t and Loss Account, each column
representing a department or a product category
7.8.3 Calculation of the gross pro®t made by each department
7.8.4 Calculation of the net pro®t made by each department after apportioning the
total expenses to departments on various bases
131
Lesson 14
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
.
Prepare the accounts of a branch when the goods have been sent to the branch
from the Head Of®ce at cost plus a handling charge or at selling prices
Make entries to record price reductions and stock losses in the branch accounts
Prepare departmental accounts
The lesson
1
Begin the lesson by telling the class that there are occasions when a Head Of®ce will
send goods to its branches at a value higher than the purchase cost of the goods. Explain
to the class that this policy is adopted for a number of reasons. These may include: the
Head Of®ce will recover some its administration and distribution costs by charging the
branches a handling charge and the Head Of®ce is seen to be making a pro®t on its
internal transfers of goods to its branches.
2
Advise the class that the lesson will now deal with the area of the Head Of®ce charging
the branches with the cost of the goods plus a handling charge.
Tell the class that the handling charge is added to the purchase cost of the goods, in order
to charge the branches with a portion of the various administrative costs that the Head
Of®ce incurs. Advise the students that the justi®cation for this approach is that if the
branch operated as an independent organisation, then the branch would incur similar
types of administrative costs, so the branch pro®tability would be affected by such costs.
In addition, advise the class that further justi®cation for this method is that the Head
Of®ce should not bear the full amount of administrative costs when it is likely that their
level is in¯uenced by the amount of activity that is carried out on behalf of the
branches. Therefore it is regarded as reasonable to in¯ate the charges to the branches in
order to pass on some of these costs.
3
Explain the entries in the Head Of®ce ledger that are shown on page 270 of the
Candidate's Guide book; they relate to the goods being transferred from the Head
Of®ce to the branches at cost plus a handling charge. Advise the class that the entries
differ from those that are prepared when the goods are transferred to the branch at cost;
those entries were explained in the previous lesson.
4
Use Example 3 on page 271 of the Candidate's Guide book to illustrate this method of
branch accounts. Explain the solution to the class using the Notes to the solution; these
appear on pages 271, 272 and 273 of the Candidate's Guide book.
5
Explain to the class that goods may be transferred from the Head Of®ce to the branch at
the selling price of the goods. Introduce this method to the class by using the
132
Branch accounts (2)
explanation provided on pages 273 and 274 of the Candidate's Guide book. Please
remind the class, again, of the distinction between the terms ``margin'' and ``mark up''.
These terms are regularly used in this area of the syllabus and a good understanding of
them is required.
6
Explain to the class the reason for charging the goods to the branch at selling prices; the
explanation for this is provided on page 273 of the Candidate's Guide book. Use
Example 4 on page 274 to show the class the working of this method using some
®gures.
When explaining the solution to the class, ask the students to calculate the mark up %
and the margin % for the goods sent to the branch. When the students have made these
calculations ask them to prepare similar calculations for the goods returned to the Head
Of®ce and also for the stock in hand at 31 March Year 12.
The calculations are as follows:
Goods returned to Head Of®ce
£
Stock in hand at 31 March Year 12
£
Mark up:
Sales value
less Cost
1,970
1,485
29,275
23,070
Gross pro®t
485
6,205
Calculation:
£485
£1,485
Gross pro®t
Cost of sales
6100 = 32.7%
6100
£6,205
£23,070
6100 = 26.9%
Advise the class that both of the above calculations have been rounded to one decimal
place.
Margin:
Calculation:
£485
£1,970
Gross pro®t
Sales value
6100 = 24.6%
6100
£6,205
£29,275
6100 = 21.2%
Advise the class that both of the above calculations have been rounded to one decimal
place.
7
Now explain the solution to Part (a) of Example 4 and advise the class that this shows
that goods, with a sales value of £856, are unaccounted for.
Involve the class by asking them to suggest some possible reasons for this. Incorrect
stocktaking, reductions in selling prices, and theft are all possible reasons for this difference.
133
Lesson 14
8
Show the class the ledger accounts for the solution to Part (b) of the Example; these
appear on pages 275 and 276 of the Candidate's Guide book.
Explain to the class that although a stock loss has arisen, this is not included as part of
the double entry records. This means that the stock loss is not shown as a speci®c item
in the ledger accounts.
9
Advise the class that the stock loss will be re¯ected in the gross pro®t ®gure for the
Barn®eld branch. Advise the class that the gross pro®t for the branch is calculated in
the branch stock account and that this account has been debited with the cost of the
goods that were sent to the branch and credited with the sales value of the goods sold
by the branch. The account has also been credited with the cost of the goods that
were returned to the Head Of®ce by the branch. Also, the cost of the goods held by
the branch at the end of the accounting period is also credited to the branch stock
account.
Advise the class that this means that any stock loss will be re¯ected in the ®nal
calculation of the balancing ®gure in this account; the balancing ®gure will represent
the gross pro®t.
10 To explain this point further, tell the class that if the stock loss had been caused by the
reduction in the selling prices of some of the goods, then these reductions would have
been re¯ected in the sales value actually achieved by the branch.
Explain to the class that if the stock loss had been due to either incorrect stocktaking or
theft, then this would have been re¯ected in the valuation of the stocks of goods at the
branch at 31 March Year 12.
Explain to the class that the reduction in the ®gures for the sales value or the stock
®gures would, therefore, re¯ect on the ®gure calculated for the gross pro®t. The stock
loss would, therefore, be incorporated into this calculation for the gross pro®t.
11 Involve the class by asking them to refer to the branch stock account and to use the
®gures in the account to calculate the gross mark up % and the gross margin %. The
solutions are given in Note 2 in the Notes to the solution on page 276 of the
Candidate's Guide book.
12 Advise the class that the lesson will now consider the preparation of branch accounts
when the goods are sent from the Head Of®ce to the branch at their selling prices. The
selling prices are set to provide a margin and mark up which is constant.
This is an area of the syllabus that candidates appear to have dif®culties with, when
answering examinations on this topic.
Please advise your students, again, of the note relating to mark up and margin that
appears at the start of page 277 of the Candidate's Guide book; this item keeps
appearing in the syllabus!
134
Branch accounts (2)
13 Advise the class that the topic of branch accounts being maintained at selling prices with
a constant mark up/margin will involve the preparation of the branch stock account
using one the following two approaches:
(a) The branch stock account is prepared using a ``two-column'' format.
One of the columns is referred to as the ``memorandum column'' and does not
form part of the double entry system. This memorandum column is maintained at
sales value.
The other column records the following:
(i) The cost of the goods at the branch at the beginning and end of the ®nancial
period.
(ii) The cost of the goods sent to the branch from the Head Of®ce.
(iii) The cost of the goods returned to the Head Of®ce from the branch.
(iv) The sales value of the goods sold by the branch (both cash and credit
sales).
(v) The sales value of the goods returned to the branch by its customers.
(vi) The ``balancing ®gure'' in this column will represent the gross pro®t of the
branch for the particular ®nancial period.
(b) The branch stock account is maintained at sales value; this means that all of the
items in the account are valued at their sales values.
The items that will appear in the account are the items that are listed from (i) to (v)
above.
Advise the class that the gross pro®t does not appear in this account when this approach
is adopted for the preparation of the branch ledger accounts.
14 Advise the class that the gross pro®t is calculated in another account that is prepared
using this approach. The account is referred to as the ``branch stock adjustment
account''.
Advise the class that the account records the ``pro®t element'' of the following items
that appear in the branch stock account:
(a)
(b)
(c)
(d)
The goods at the branch at the beginning and end of the ®nancial period.
The goods sent to the branch from the Head Of®ce.
The goods returned to the Head Of®ce from the branch.
This will mean that the ``balancing ®gure'' in this account will be the gross pro®t
made by the branch in the ®nancial period.
15 Advise the class that the differing approaches will only relate to the preparation of the
branch stock account; all the other branch ledger accounts will be prepared in the same
manner.
Refer the class to Example 5 on page 277 of the Candidate's Guide book to illustrate
both of these approaches. Advise the class that it is unusual for examination questions to
ask for the two alternative approaches in the same question. It is done in this case to
illustrate both of the approaches using the same data.
135
Lesson 14
16 Advise the class that in the example the branch's selling prices are calculated by adding
25% to the cost of the goods.
Explain to the class, therefore, that if an item had cost £100, then this means that its
selling price is £125; £100 plus 25%. Remind the class that the 25% is referred to as
the mark up percentage.
Further explain that the margin percentage is calculated as:
£25
£125
6100 = 20%
Explain to the class that with a margin of 20%, this means that the cost of the goods
represents 80% of their sales value.
17 Advise the class that the calculation of the margin percentage allows the cost value of
the goods sent to the branch, and the returns from the branch to the Head Of®ce to be
calculated:
Goods sent to the branch £136,800 6 80% = £109,440
Returns to Head Of®ce from the branch £2,700 6 80% = £2,160
Advise the class that, in this example, the sales value of the closing stocks is the
``balancing ®gure'' in the ``memorandum column'' of the branch stock account.
In this case the closing stock, at sales value, is calculated as:
£
Goods sent to branch
less Goods returned to Head Of®ce
£
136,800
2,700
134,100
less:
Credit sales
Cash sales
4,640
108,600
Closing stock at sales value
113,240
20,860
Advise the class that the cost value of the closing stock is calculated as:
£20,860680% = £16,688
18 Provide the class with the explanation of a ``two-column branch stock account'' that
appears on page 278 of the Candidate's Guide book. Advise the class of the need to
bring the balances for the values (sales and cost) of the closing stocks down at 1
September Year 10.
Show the class the solution to Example 5 Part (a) in the Candidate's Guide which
related to the ``two-column branch stock account''.
136
Branch accounts (2)
19 Emphasise to the class the importance, once again, of the need to be able to calculate
costs and selling prices from the use of a mark up percentage and the use of a margin
percentage. This was essential in this example; advise the class that the example gave the
details of the goods sent to the branch from the Head Of®ce and the goods returned to
the Head Of®ce from the branch at sales value. These ®gures had to be converted to
their cost value to be shown in the appropriate column in the branch stock account;
therefore the conversion from their sales value to their cost value required a good
understanding of the application of the margin percentage and the mark up percentage.
20 Advise the class that in this example the sales value of the goods was obtained by adding
25% to the cost of the goods. Remind the class (yet again!), that this means that if an
item cost £100, then its sales value will be £125; £100 plus 25%. This means that the
pro®t in the sales value represents 20% of the sales value; £25/£1256100; so this
means that the cost value of the goods is 80% of the sales value of the goods.
Advise the class that the cost values of the items appearing in the branch stock account
are calculated as follows:
Goods sent to branch at expected selling prices £136,800680% = £109,440
Goods returned to Head Of®ce from the branch at their expected selling prices
£2,700680% = £2,160
21 Advise the class that questions can be set for this examination where the goods sent to
the branch from the Head Of®ce, the goods returned from the branch to the Head
Of®ce, and the goods at the branch at the beginning and end of the ®nancial period are
all given at their sales values. This will mean that candidates will need to convert these
items to their cost values for their inclusion in the branch stock account. Yet another
reminder to the class of their need to fully understand the calculation and application of
the margin and mark up percentages!
22 Advise the class that the ``balancing ®gure'' in the column that includes some of the
items at their cost values will be the gross pro®t made by the branch in that particular
®nancial period.
Advise the class that the gross pro®t can be checked in this example. The total sales
of the branch amount to £113,240 and the gross pro®t represents 20% of this
®gure. This is calculated as: £113,240620% = £22,648. This is the ®gure that
should appear in the branch stock account; a typographical error has occurred in
the branch stock account that appears on page 278 of the Candidate's Guide book.
The ®gure that appears in the branch stock account for the gross pro®t is £22,640;
it should be £22,648 (this is the ®gure shown in Note 3 of the Notes to the
solution).
Advise the class that this check on the accuracy of the calculation of the gross pro®t is
able to be done because:
(a) The goods all have the same mark up (or margin).
(b) There have not been any price reductions.
137
Lesson 14
Advise the class that they may be able to use this check in a future examination,
provided that the two conditions mentioned above are applicable.
23 Explain the solution to Part (a) of Example 5 on page 279 of the Candidate's Guide
book in full to the class, also using the Notes to the solution to assist your explanation.
24 Explain the solution to Part (b) of Example 5 on page 281 of the Candidate's Guide
book. This section of the example relates to the preparation of a branch stock account
and a branch stock adjustment account.
25 Explain to the class that if an examination question refers to the presence of a branch
stock adjustment account, then this means that the branch stock account is a single
column account. The account is maintained at selling prices and there is not a
``memorandum column''.
26 Explain the entries in the branch stock account by making reference to the related
double entries that appear in the goods sent to branch account, the branch stock
adjustment account and the branch debtors' and branch, or head of®ce, cash account.
For example, explain how entries relating to the goods sent to the branch from the
Head Of®ce are made.
The sales value of the goods sent to the branch from the Head Of®ce is £136,800.
Explain to the class that the journal entries for this transaction are as follows:
Dr
£
Goods sent to branch account
Branch stock account
Branch stock adjustment account
Cr
£
109,440
136,800
27,360
27 Explain to the class that the basis of these entries is as follows. The goods sent to branch
account is credited with the cost of the goods, whereas the branch stock account is
debited with the sales value of the goods. Explain to the class that this means that an
adjusting entry is required to be made that accounts for the difference between the cost
and the sales value of the goods. The credit entry to the branch stock adjustment
account shown in this illustration is the adjusting entry required for this situation.
Explain to the class that the adjusting entry is the pro®t mark up on these goods that
have been sent to the branch from the Head Of®ce.
The ®gure is calculated as follows:
£109,440625% = £27,360
This ®gure represents the mark up that is added to the cost of the goods.
28 Explain to the class that the debit entry in the branch stock account for this item is shown
on page 282 of the Candidate's Guide book as two entries: £109,440 and £27,360.
138
Branch accounts (2)
Advise the class that the sum of these two items is £136,800 and represents the sales value
of the goods. Advise the class that these two entries are an acceptable alternative to the
single entry, which is shown in the illustration of the journal entries above.
29 Advise the class that the entries will be reversed to those shown in the above illustration
for the goods that are returned to the Head Of®ce from the branch. These journal
entries are as follows:
Goods to branch account
Branch stock account
Branch stock adjustment account
Dr
£
2,160
Cr
£
2,700
540
Explain to the class that the adjusting entry for the branch stock adjustment account is
the pro®t mark up for the returned goods and it is calculated as follows:
£2,160625% = £540
This ®gure represents the mark up that is added to the cost of the goods.
30 Explain to the class that the credit entry in the branch stock account for this item is
shown on page 282 of the Candidate's Guide book as two entries: £2,160 and £540.
Advise the class that the sum of these two items is £2,700 and represents the sales value
of the goods. Advise the class that these two entries are an acceptable alternative to the
single entry, which is shown in the illustration of the journal entries above.
31 Explain the entries in the branch stock account that relate to the sales achieved by the
branch. Explain that the credit entry of £108,600 represents the cash sales made by the
branch, so the double entry for this item is a debit to the Head Of®ce cash account. Advise
the class that an alternative to debiting the Head Of®ce cash account is to debit the branch
Bank Account. This would apply if the branch banked all of its cash sales into the branch
Bank Account instead of paying the money into a cash account in the Head Of®ce's name.
Explain that the credit entry in the branch stock account of £4,640 represents the
credit sales achieved by the branch, so the double entry for this item is to debit the
branch debtors' account.
32 Explain to the class that the ``balancing'' ®gure in the branch stock account will be the sales
value of the goods on hand at the branch at the end of the ®nancial period. Advise the class
that this ®gure can be used for stock control purposes. The account has been debited with
the sales value of the goods received from the Head Of®ce, and credited with the sales
value of the following items: goods returned to the Head Of®ce, cash sales and credit sales.
This should mean, therefore, that the balance, if any, in the branch stock account is the
sales value of the goods that remain in the branch at the end of the ®nancial period.
Advise the class that the accuracy of this ®gure can be checked by undertaking a
physical stocktake and valuing the goods at their selling prices. The ®gures obtained
139
Lesson 14
from the stocktake and from the branch stock account can then be compared; any
differences should be investigated to establish the reasons for the differences.
33 Advise the class that the pro®t included in the valuation of the closing stock will require
an entry to be made in the branch stock adjustment account. The pro®t element in the
closing stock is calculated as follows:
£20,860620% = £4,172
Ask the class to recall that these goods have a mark up of 25%, so this means that they
have a margin of 20%.
Advise the class that the branch stock adjustment account is debited with the pro®t
element of the closing stocks of the branch.
Advise the class that carrying these ®gures down at the beginning of the next ®nancial
period completes the double entries for the closing stocks in the branch stock account
and the branch stock adjustment account.
34 Advise the class of the ``balancing ®gure'' in the branch stock adjustment account. The
``balancing ®gure'', £22,648, is the gross pro®t made by the branch.
Explain to the class that the ®gure can be explained by referring to the other ®gures in
the branch stock adjustment account as follows:
£
Pro®t on the goods:
Sent to the branch from the Head Of®ce
less Returned to the Head Of®ce from the branch
27,360
540
Remaining at the branch at the end of the ®nancial period
26,820
4,172
Gross pro®t made by the branch
22,648
Advise the class that this gross pro®t ®gure is con®rmed by the branch stock adjustment
account.
35 Advise the class that another way to con®rm the gross pro®t ®gure is to use the total
sales of the branch and apply this calculation:
Total sales (£)6Gross margin %
In this example this will be shown as:
£113,240620% = £22,648
Advise the class, again, that this ®gure is con®rmed in the branch stock adjustment
account.
140
Branch accounts (2)
Advise the class that these calculations are possible because all of the goods sold are sold
at a constant mark up, or a constant margin.
36 Explain the full solution to Part (b) of Example 5 also using the Notes to the solution to
assist your explanation. These appear on pages 281, 282 and 283 of the Candidate's
Guide book.
37 Refer the class to the possibility that branches may, at times, reduce their normal selling
prices.
Use Example 6 on pages 283 and 284 of the Candidate's Guide book to illustrate this
area of the syllabus.
Note, again, that this example uses a usual mark up of 331¤3%. Ask the class to calculate
the margin when a mark up of 331¤3% is used. When you show the answer to the class,
provide the students with the example that if the cost of an item is £120, then the
selling price is calculated as:
£120 plus 331¤3 % = Selling price
£120 plus £40 = £160
The margin is calculated as:
Gross pro®t
Selling price
£40
£160
6100
6100 = 25%
38 Explain to the class that the gross pro®t expected in Example 6 on pages 283 and 284 of
the Candidate's Guide book can be calculated as follows:
Opening stocks (1 April Year 5)
Goods sent to branch
£
26,300
106,000
132,300
less Closing stocks
(31 December Year 6)
Sales at normal selling prices
Margin
32,080
100,220
25%
Expected gross pro®t
less Price reductions
25,055
1,820
Actual gross pro®t
23,235
Advise the class that this gross pro®t is con®rmed by the ®gure shown in the branch
stock account, which is shown in the solution to the example on page 284 of the
Candidate's Guide book.
141
Lesson 14
Explain the solution to the class and use the Notes to the solution in your explanation.
39 Involve the class by asking them to prepare an alternative solution to Example 6 by
preparing a branch stock account and a branch stock adjustment account. Before the
class begin their answers, advise the students of the advice that you gave earlier in the
lesson: if a question asks for the preparation of a branch stock adjustment account, then
the branch stock account is maintained at sales value.
The solution is as follows:
Branch stock account
£
Balance b/d
Goods to branch
Branch stock adjustment
26,300
79,500
26,500
Cash sales
Branch stock adjustment
Balance c/d
132,300
Balance b/d
£
98,400
1,820
32,080
132,300
32,080
Branch stock adjustment account
Branch stock
Gross pro®t
Balance c/d
£
1,820
23,235
8,020
£
Balance b/d
Branch stock adjustment
33,075
6,575
26,500
33,075
Balance b/d
8,020
Explain this solution to the class, noting that the price reductions are a decrease in the
gross pro®t and so the ®gure is charged to the branch stock adjustment account.
40 Refer the class to the possibility of stock losses arising at a branch.
Use the examples made on page 262 of the Candidate's Guide book again to illustrate
possible reasons why stock losses may arise.
41 Use Example 7 on page 285 of the Candidate's Guide book to illustrate this area of the
syllabus.
Remind the class that a 25% mark up is the same as a 20% margin.
Before showing the solution in the form of the ledger accounts, show the class Note 2
in the Notes to the solution. Note 2 calculates the value of the stock loss and represents
the ``balancing ®gure'' in the branch stock account. Advise the class that the stock loss is
shown in the branch stock account as £334 (the pro®t element of the stock loss) and
£1,336 (the cost of the goods lost).
Ask the class to recognise that the sum of these two ®gures, £1,670, is the sales value of the
stock loss and con®rms the ®gure computed by the Note 2 in the Notes to the solution.
142
Branch accounts (2)
42 Show the solution to the class and also use the Notes to the solution; these appear on
pages 286 and 287 of the Candidate's Guide book. Please emphasise Notes 3 and 6;
these relate to the analysis of the stock loss. Advise the class that the pro®t element of
the stock loss is charged to the branch stock adjustment account and so affects the gross
pro®t and the cost of the stock loss is charged to the Pro®t and Loss Account.
43 Involve the class by asking the students to refer to Example 7 on page 285 of the
Candidate's Guide book and prepare for the branch the two-column branch stock
account.
The solution is as follows:
Branch stock account
Balance b/d
Goods to branch
Gross pro®t
Balance b/d
Memo SP
£
£
36,400
29,120
162,500 130,000
33,692
198,900
192,812
19,170
15,336
Cash sales
Credit sales
Price reductions
Stock loss to Pro®t
& Loss Account
Balance c/d
Memo SP
£
£
173,200 173,200
2,940
2,940
1,920
1,670
19,170
1,336
15,336
198,900
192,812
44 Explain to the class the meaning of departmental accounts and use the explanation on
page 287 of the Candidate's Guide book.
45 Use Example 8 on page 288 of the Candidate's Guide book to illustrate this section of
the syllabus.
When explaining the solution to the class, advise the students that a vertical
presentation for the answer would be an alternative and acceptable presentation.
Provide the class with illustrations of how the expenses have been apportioned between
the two departments. For example: advertising costs were apportioned between the
departments on the basis of sales value. The sales totalled £750,000 and was
apportioned between the departments X and Y in the ratio of 45% and 55%
respectively.
Therefore, the advertising costs would be apportioned in the same ratio as the sales
value. The advertising costs of £67,500 would be apportioned as follows:
Department X 45%6£67,500 = £30,375
Department Y 55%6£67,500 = £37,125
£67,500
143
Lesson 14
Motor vehicle running expenses were apportioned in accordance with the number of
salesmen:
Department
Number of salesmen
X
Y
3
2
Motor vehicle expenses
£
3,600
2,400
5
6,000
Advise the class that these ®gures have been obtained as follows:
Department X
3
6 £6,000 = £3,600
5
Department Y
2
6 £6,000 = £2,400
5
46 Advise the class that these approaches should be adopted for the apportionment of the
other items in the example.
Explain the solution in full for the example.
QUESTIONS FOR CLASS PRACTICE
Question 14.1
Colin Wells, whose Head Of®ce is in Bristol, has a branch in Reading. All goods are
purchased by Head Of®ce and invoiced to and sold by the branch at cost plus 50%. All
accounts are kept in Bristol. The following information in respect of the Reading Branch
applies to the year ended 30 September Year 8:
Stock, 1 October Year 7, at invoice price
Debtors, 1 October Year 7
Goods sent to branch, at invoice price
Cash sales
Credit sales
Returns from customers to branch, at invoice prices
Cash received from debtors
Returns to Head Of®ce, at invoice price
Discount allowed to debtors
Bad debts written off
Wages
Expenses
Stock, 30 September Year 8, at invoice price
144
£
15,000
12,170
255,000
152,010
103,080
1,680
98,400
690
2,630
470
43,200
17,460
15,900
Branch accounts (2)
Required
In the Head Of®ce books, prepare the following accounts of the Reading Branch for the
year ended 30 September Year 8:
(a) Branch stock account (using a memorandum selling value column).
(9 marks)
(b) Goods sent to branch account.
(4 marks)
(c) Branch debtors' account.
(7 marks)
(d) Branch Pro®t and Loss Account.
(5 marks)
(Total 25 marks)
(LCCIEB 1998)
Question 14.2
Chipley Limited has a Head Of®ce at Melchester and a branch at Tipford. All records of
branch trading are maintained in the Head Of®ce ledger.
All purchases are made by Head Of®ce, and normal selling prices are determined for both
Head Of®ce and Branch, by adding a ®xed % to the purchase cost of the goods. Normal
selling prices can be reduced, eg to sell perishable goods, but such reductions are
recorded.
Goods are transferred from Head Of®ce to the Tipford Branch at normal selling prices. A
branch stock account is used to control branch stock, and the gross pro®t is determined in a
branch stock adjustment account.
At 31 December Year 10, the following are some of the balances remaining in the Head
Of®ce ledger:
Purchases
Stocks at 1 January Year 10:
Head Of®ce, valued at cost
Branch, valued at normal selling prices
Branch stock adjustment
Cash sales:
Head Of®ce
Branch
Credit sales:
Head Of®ce
Branch
$
864,200
$
74,390
29,640
4,940
573,020
356,460
100,200
13,140
145
Lesson 14
On 31 December Year 10, stock was checked, both at Head Of®ce and at the Tipford
Branch, and was valued:
$
51,890
36,360
Head Of®ce stock valued at cost
Branch stock valued at normal selling prices
All of the stock in hand at the branch, both at 31 December Year 9 and at 31 December
Year 10, was expected to be sold at normal selling prices.
Recorded price reductions for Year 10 were Head Of®ce $6,100 and the Tipford Branch
$8,400. No stock losses have occurred during the year.
Required
For the year ended 31 December Year 10, prepare:
(a) The Tipford Branch Stock Account.
(10 marks)
(b) The Tipford Branch Stock Adjustment Account.
(7 marks)
(c) The Head Of®ce Trading Account.
(8 marks)
(Total 25 marks)
(LCCIEB 1997)
Question 14.3
J Stewart operates 2 departments, A and B, from which he sells goods that he has purchased.
The departments incur their own speci®c costs as well as sharing costs that have been
incurred for the business as a whole.
The following information is available for the year ended 31 December Year 7:
Sales
Purchases:
Department A
Department B
Business rates
Sales staff salaries
Insurances
Motor vehicle running expenses
Advertising
Administration
Depreciation of ®xtures and ®ttings
146
£
900,000
160,000
240,000
81,000
84,000
36,000
7,000
60,000
12,000
9,900
Branch accounts (2)
Stocks, valued at costs were:
Department
1 January Year 7
31 December Year 7
A
£
12,000
14,000
B
£
22,000
18,000
Additional information is provided as follows:
1
The number of salesmen employed by each department is: Department A ± 3,
Department B ± 4.
2
The area occupied by each of the departments is as follows:
Department A
Department B
3
The sales were divided between the departments as follows:
Department A
Department B
4
5,000 square metres
4,000 square metres
60%
40%
The following bases are used for apportioning the expenses between the departments:
Expenses
Business rates
Sales staff salaries
Insurances
Motor vehicle running expenses
Advertising
Depreciation of ®xtures and ®ttings
Administration
Basis of apportionment
Area occupied
Number of salesmen
Area occupied
Sales value
Sales value
Area occupied
Purchases
Required
Prepare for J Stewart a columnar Trading and Pro®t and Loss Account for the
year ended 31 December Year 7. Columns are required for Department A,
Department B and for the total.
(25 marks)
(LCCIEB 1998)
147
Lesson 14
Solution to Question 14.1
COLIN WELLS
(a)
Reading Branch Stock Account
Memo SP
Year 7
£
1 Oct
Balance b/d
Memo SP
£
Year 8
£
15,000
10,000
30 Sep
Goods to branch
255,000
170,000
30 Sep
Cash sales
30 Sep
Branch debtors
Year 8
460
152,010
152,010
103,080
103,080
15,900
10,600
271,680
266,150
Reading Branch stock
£
170,000
(returns)
30 Sep
Goods to branch
30 Sep
Branch debtors
(returns)
30 Sep
1,680
1,680
Branch Pro®t & Loss
1 Oct
Balance b/d
(b)
(credit sales)
30 Sep
Account
Balance c/d
84,470
271,680
266,150
15,900
10,600
Goods Sent to Branch Account
Year 8
30 Sep
30 Sep
£
Branch stock (returns)
Head Of®ce Purchases
Account or Head Of®ce
Trading Account
(c)
460
Year 8
30 Sep
169,540
170,000
170,000
Reading Branch Debtors' Account
Year 7
1 Oct
Year 8
30 Sep
Balance b/d
£
12,170
Branch stock (credit saes)
103,080
Year 8
30 Sep
30 Sep
30 Sep
30 Sep
30 Sep
£
Branch stock (returns)
Bank/cash
Discount allowed
Bad debts
Balance c/d
115,250
1 Oct
£
690
Balance b/d
(d)
1,680
98,400
2,630
470
12,070
115,250
12,070
Reading Branch Pro®t & Loss Account
for the year ended 30 September Year 8
Discount allowed
Bad debts
Branch wages
Branch expenses
£
2,630
470
43,200
17,460
Branch stock account
£
84,470
63,760
Branch net pro®t to Head Of®ce
Pro®t & Loss Account
148
20,710
84,470
84,470
Branch accounts (2)
Solution to Question 14.2
(a)
Tipford Branch Stock Account
Balance brought forward
Goods to branch
$
29,640
384,720
Cash sales
Debtors ± sales
Branch stock adjustment ±
price reductions
Balance c/d
414,360
Balance b/d
(b)
$
356,460
13,140
8,400
36,360
414,360
36,360
Tipford Branch Stock Adjustment Account
Branch stock ± price reductions
Gross pro®t to pro®t and loss
Balance c/d
$
8,400
54,600
6,060
$
Balance brought forward
Branch stock
69,060
69,060
Balance b/d
(c)
4,940
64,120
6,060
Head Of®ce Trading Account
for the year ended 31 December Year 10
Opening stock
Purchases
$
74,390
864,200
Closing stock
938,590
51,890
Goods to branch
886,700
320,600
Cost of sales
Gross pro®t
566,100
107,120
673,220
Sales: cash
credit
$
573,020
100,200
673,220
673,220
Workings
1
Rate of gross pro®t worked out from opening balances, ie 4,940/29,640 = 1/6, ie
16.66% on selling price or 20% on cost.
2
Goods to branch $384,720 is the balancing ®gure in the branch stock account.
149
Lesson 14
Solution to Question 14.3
J Stewart
Trading and Pro®t & Loss Account
for the year ended 31 December Year 7
WA
B
Total
A
B
Total
£
£
£
£
£
£
Sales
540,000
360,000
900,000
540,000
360,000
900,000
Gross pro®t b/d
382,000
116,000
498,000
22,400
22,400
138,400
520,400
Opening stocks
Purchases
12,000
22,000
34,000
160,000
240,000
400,000
172,000
262,000
434,000
less Closing stock
14,000
18,000
32,000
Cost of sales
158,000
244,000
402,000
Gross pro®t c/d
382,000
116,000
498,000
540,000
360,000
900,000
Business rates
45,000
36,000
81,000
Sales staff salaries
36,000
48,000
84,000
Insurances
20,000
16,000
36,000
Motor vehicle running expenses
4,200
2,800
7,000
36,000
24,000
60,000
Administration
4,800
7,200
12,000
Depreciation
5,500
4,400
9,900
151,500
138,400
289,900
Advertising
Net pro®t
230,500
382,000
150
Net loss
230,500
138,400
520,400
382,000
Lesson 15: Bills of exchange
Lesson topics
.
.
.
.
.
Understanding the meaning of a Bill of Exchange
Preparing the ledger accounts in the ledgers of the drawer and the drawee to
account for the bills receivable and the bills payable
Accounting for discount charges, when the bill receivable is not held to its
maturity
Accounting for a Bill of Exchange that has been negotiated to a third party
Accounting for Bills of Exchange that have been dishonoured, including the
related charges
Extended Syllabus references
11.1
Understanding the de®nition of a Bill of Exchange
11.2
Parties to a Bill of Exchange ± drawer, drawee and payee
11.3
Understanding the procedure upon the maturity of a Bill of Exchange, and
the actions to be taken by each of the parties to the bill
11.4.1 Transfers between the Debtors' Account and the Bills Receivable Account
11.4.2 Showing bills receivable in the Balance Sheet
11.4.3 Entries needed on the maturity of a bill receivable
11.4.4 Negotiation of a bill receivable to a creditor
11.4.5 Discounting a bill receivable for immediate cash
11.4.6 Meaning and treatment of the discount
11.4.7 Contingent liability under a discounted bill receivable
11.4.8 Entries necessary upon the dishonour of a bill receivable, whether or not it
has been negotiated or discounted prior to maturity
11.4.9 Recording a replacement bill
11.5.1 Understanding the meaning of acceptance in respect of a Bill of Exchange
11.5.2 Transfer between the Creditors' Account and Bills Payable Account
11.5.3 Showing bills payable in the Balance Sheet
(continued)
151
Lesson 15
Extended Syllabus references (continued)
11.5.4 Entries needed on the maturity of a bill payable
11.5.5 The indifference of the drawee as to whether the bill is held to maturity by
the drawer, or discounted, or negotiated
11.5.6 Entries needed if the drawee is unable to meet the bill on maturity
Aim of the lesson
At the end of the lesson the students will be able to prepare journal entries and
ledger accounts that involve bills receivable and bills payable that are held to
maturity. The entries made will also relate to Bills of Exchange that are not
held to maturity, have been negotiated to a third party and those that are
dishonoured
The lesson
1
Begin the lesson by explaining to the class the meaning of a Bill of Exchange. An
explanation is provided on page 295 of the Candidate's Guide book.
2
Show the class the illustration on page 296 of the Candidate's Guide book. The
illustration shows how a Bill of Exchange comes into being.
3
Explain to the class that in the books of James Sutton Ltd the balance in the Bills
Receivable Account replaces the balance in the personal account of Li Chen when the
Bill of Exchange is accepted by Li Chen.
Explain to the class that in the books of Li Chen, the balance in the Bills Payable
Account replaces the balance in the personal account of James Sutton Ltd, when the
Bill of Exchange is accepted by Li Chen.
Explain to the class that, in this illustration, the drawer is James Sutton Ltd and the
drawee is Li Chen.
4
Use Example 1 on page 297 of the Candidate's Guide book as an illustration of the
accounting treatment of a bill receivable.
5
Show the class the answer to the example, using both the journal entries and the
ledger account solutions. Also use the Notes to the solution in explaining the answer
and, in particular, emphasise the treatment of the Bills Receivable Account in a
Balance Sheet.
152
Bills of exchange
6
Show the class how the Bill of Exchange would be accounted for in the books of M
Boyce. Advise the class that the bill in these books will now be referred to as a ``bill
payable''. Show the class the entries in the accounts of M Boyce in both the journal and
ledger account formats.
7
Use the Notes to the solution in explaining the answer and, in particular, emphasise
the treatment of the Bills Payable Account in a Balance Sheet. The solution to
Example 1 and its related Notes appears on pages 297, 298 and 299 of the Candidate's
Guide book.
8
Advise the class that as M Boyce had accepted the bill, he acknowledged the amount to
be paid on a speci®ed date, then he should try to ensure that he will have suf®cient
funds in his bank account to meet this liability on the date that the bill matures. Explain
to the class that the term ``the date the bill matures'' means the date when the bill
becomes payable.
9
Advise the class that N Nerris could decide to use the bill before its maturity date; this
means before the bill is presented for payment. Explain to the class that N Nerris could
try to use the bill before its maturity date in one of the following ways:
(a) He could discount the bill with a bank and so realise a large proportion of the
bill.
(b) He could negotiate the bill with one of his creditors. This means that he can offer
to one of his creditors the Bill of Exchange, and so the creditor will receive the
money when the bill matures.
10 Explain to the class that whatever N Nerris decides to do with the bill, ie retain it,
discount it to a bank or negotiate it to a creditor, he will not have to tell M Boyce what
he has done. Explain that the terms of the bill will not have changed: M Boyce has
agreed to pay a speci®ed amount on a speci®ed date. This situation remains, no matter
which party is in possession of the bill; N Nerris, the bank or one of N Nerris's
creditors.
11 Explain to the class the meaning of the discounting of a Bill of Exchange. An
explanation of this appears on pages 299 and 300 of the Candidate's Guide book. Use
Example 2 on page 300 of the Candidate's Guide book as an illustration of this topic.
12 Show the class the solution using both the journal entries and ledger account formats.
Also use the Notes to the solution, particularly emphasising Point 4 which relates to a
contingent liability; these appear on pages 300, 301 and 302 of the Candidate's Guide
book.
13 The class may ®nd it strange that N Nerris is prepared to lose £15 of the bill
receivable, rather than wait until the bill matures when he will receive the full amount
of £1,500.
Advise the class that N Nerris may be experiencing a cash shortage and could be, for
example, under pressure to pay his creditors. N Nerris is unlikely to want to upset his
153
Lesson 15
creditors; they may refuse to supply him with any further goods or services, unless
payment is received. This could be a suf®cient prompt to N Nerris to discount the
bill receivable and so allow him to obtain funds that will allow him to pay his
creditors.
14 Advise the class, again, that M Boyce would not know, or need to know, that N Nerris
had discounted the Bill of Exchange with the bank.
Advise the class that the action taken by N Nerris in discounting the bill will require no
entries in the books of M Boyce.
15 Now explain to the class the meaning of the term ``Negotiating a Bill of
Exchange''. An explanation of this appears on page 302 of the Candidate's Guide
book.
16 Use Example 3 on page 302 of the Candidate's Guide book as an illustration of this area
of the syllabus.
Explain the solution to the Example also using the Notes to the solution to assist
your explanation; these appear on pages 303, 304 and 305 of the Candidate's Guide
book.
17 Advise the class, again, that M Boyce would not know, or need to know, that N Nerris
had negotiated the Bill of Exchange with L Maree. M Boyce will regard the bill payable
on 1 June for £1,800 as relating to N Nerris and will try to ensure that this amount is in
his bank account on that date. When the due date arrives, M Boyce's bank statement
will show £1,800 as a payment; he does not need to know that the funds have been
transferred into the bank account of L Maree.
18 Ask the class to recognise that as the bill has been negotiated to L Maree, then a Bills
Receivable Account will appear in the books of L Maree. However, advise the class that
if the only bill receivable by N Nerris was the bill he has negotiated to L Maree, then
the negotiating of the bill will mean that the balance on the Bills Receivable Account in
the ledger of N Nerris has been removed.
19 Explain to the class the meaning of the term ``dishonoured Bills of Exchange''. An
explanation of this term appears on page 306 of the Candidate's Guide book.
20 Use Example 4 on page 306 of the Candidate's Guide book to illustrate this area of the
syllabus. Show the class the solution to this example also using the Notes to the solution
to assist your explanation; these appear on pages 306 and 307 of the Candidate's Guide
book.
21 Ask the class to recognise that the original debt was £800, but this increased by £22.
The increase was caused by legal charges being incurred due to the Bill of Exchange
being dishonoured.
154
Bills of exchange
22 Advise the class that the Bill of Exchange was due to mature on 1 September; this
means that N Nerris should have received the money on that date. However, the
money was not received on 1 September; the bill was not honoured. C Tromans did
not have suf®cient funds in his bank account on 1 September to be able to meet the
liability of the bill.
23 Advise the class that any delay in paying N Nerris will cause him to lose the
opportunity of investing the money and so receive interest from it. Therefore, it
would be reasonable for N Nerris to charge C Tromans for the loss of the interest
that would otherwise have been received from investing the money from 1
September.
N Nerris has charged C Tromans £18 for the loss of interest. The result is that the
amount owed by C Tromans has now increased from the original debt of £800 to
£840. Advise the class that the increase of £40 is due to the legal charges of £22 and
the loss of interest of £18.
24 Advise the class that the arrangements made to pay N Nerris were as follows:
Immediate payment
New Bill of Exchange
£
250
590
Total amount owed
840
25 Refer the class to Example 5 on page 307 of the Candidate's Guide book. This example
deals with the following items:
(a)
(b)
(c)
(d)
The drawing of a Bill of Exchange.
The discounting of a Bill of Exchange with a bank.
The Bill of Exchange being dishonoured.
Legal costs and interest being charged to the drawee.
26 Explain the solution to the class and use the Notes to the solution to assist your
explanation.
Advise the class that a similar question could appear in the examination and the
candidates could be asked to prepare a solution using journal entries rather than prepare
the ledger accounts.
27 Involve the class by asking the students to prepare a solution using journal entries,
without narrations, for all of the transactions in the books of N Nerris.
155
Lesson 15
The solution is as follows:
Journal
Date
3 July
10 July
10 July
6 Oct
6 Oct
6 Oct
15 Oct
15 Oct
15 Oct
Bills receivable
A Magee
Bank
Bills receivable
Bill discounting charges
Bank
Bill receivable
Bank
A Magee
Bills receivable
A Magee
Bank
A Magee
Interest received
Bank
A Magee
Bill receivable
A Magee
Dr
£
1,900
Cr
£
1,900
1,900
1,900
57
57
1,900
1,900
1,900
1,900
31
31
59
59
550
550
1,440
1,440
28 Please advise the class that if a question requires the answer to be prepared using journal
entries, then the candidates must use journal entries and not use a ledger account format.
Advise the students that if a ledger account format is used, then no marks will be
awarded.
Advise the students that if an answer is required in a ledger account format, then ledger
accounts must be used. If journal entries are used, then no marks will be awarded.
QUESTION FOR CLASS PRACTICE
Question 15.1
On 1 May Year 4, D Babcock had the following balances in his sales ledger:
F Grace
S Winslow
£4,000 Dr
£6,200 Dr
On the same date, D Babcock had the following balance in his purchases ledger:
T Fallwood
156
£2,560 Cr
Bills of exchange
The balance of his Bank Account at 1 May Year 4 was £4,698 Dr.
D Babcock drew 4 Bills of Exchange as follows:
Bill
No
Date
Year 4
Debtor
Period
1
2
3
4
1
1
5
5
F Grace
F Grace
S Winslow
S Winslow
2
3
2
4
May
May
May
May
months
months
months
months
from
from
from
from
date
date
date
date
Amount
£
2,000
2,000
3,200
3,000
The bills were duly accepted by F Grace and S Winslow on 4 May and 7 May respectively
and returned to D Babcock.
On 5 May Year 4, Babcock endorsed bill No 1 from F Grace in favour of T Fallwood and
sent a cheque for the outstanding balance.
On 5 May Year 4, Babcock discounted bill No 2 at his bank, for £1,920.
On 8 May Year 4, he discounted bill No 3 at his bank, for £3,072. Babcock kept bill No 4
to maturity.
All bills, except No 2, were honoured at maturity. F Grace dishonoured bill No 2 when
due, and the bank debited Babcock's account on 1 August with £2,000 plus £15 noting
charges.
On 3 August Year 4, F Grace accepted a one month bill (No 5) to cover the full amount
owed to Babcock.
Required
Record the above transactions, in the following accounts in the books of D Babcock, up to
and including 7 September Year 4:
(a)
(b)
(c)
(d)
(e)
(f)
F Grace Account.
S Winslow Account.
T Fallwood Account.
Bank Account.
Bills Receivable Account.
Bills Discounting Charges Account.
(25 marks)
(LCCIEB 1996)
157
Lesson 15
Solution to Question 15.1
(a)
Year 4
1 May
F Grace Account
£
4,000
Balance b/f
Year 4
4 May
4 May
Bills receivable (1)
Bills receivable (2)
£
2,000
2,000
4,000
3 Aug
Bills receivable (5)
2,015
4,000
1 Aug
1 Aug
Bank (dishonoured bill) (2)
Bank (noting charges)
(b)
Year 4
1 May
2,000
15
2,015
2,015
S Winslow Account
£
6,200
Balance b/f
Year 4
7 May
7 May
Bills receivable (3)
Bills receivable (4)
6,200
(c)
Year 4
5 May
5 May
T Fallwood Account
£
2,000
560
2,560
Bills receivable (1)
Bank
(d)
Year 4
1 May
5 May
8 May
5 Sep
1 Aug
Balance b/f
Bills receivable (2)
Bills receivable (3)
Bills receivable (4)
Bank (dishonoured bill) (2)
Balance b/f
Bills receivable (2)
£
2,560
2,560
£
4,686
2,000
3,200
3,000
2,000
Year 4
5 May
5 May
8 May
1 Aug
1 Aug
£
Bills discount charges
T Fallwood
Bills discount charges
F Grace (dishonoured bill) (2)
F Grace (noting charges)
80
560
128
2,000
15
Bills Receivable Account
F Grace (1)
F Grace (2)
S Winslow (3)
S Winslow (4)
F Grace (5)
(f)
Year 4
5 May
Bank (2)
8 May Bank (3)
158
Year 4
1 May
4 May
Bank Account
(e)
Year 4
4 May
4 May
7 May
7 May
3 Aug
£
3,200
3,000
6,200
£
2,000
2,000
3,200
3,000
2,015
Year 4
5 May
5 May
8 May
5 Sep
T Fallwood (1)
Bank (2)
Bank (3)
Bank (4)
£
2,000
2,000
3,200
3,000
Bills Discounting Charges Account
£
80
128
Year 4
£
Bills of exchange
Note
The use of bill numbers and dates.
Alternative solution for Bank, Bills Receivable and Bills Discounting Charges Accounts:
(d)
Year 4
1 May
5 May
8 May
5 Sep
Bank Account
Balance b/f
Bills receivable (2)
Bills receivable (3)
Bills receivable (4)
(e)
Year 4
4 May
4 May
7 May
7 May
3 Aug
Year 4
5 May
1 Aug
1 Aug
£
T Fallwood
F Grace (discount bill)
F Grace (noting charges)
560
2,000
15
Bills Receivable Account
F Grace (1)
F Grace (2)
S Winslow (3)
S Winslow (4)
F Grace (5)
(f)
Year 4
5 May
8 May
£
4,686
1,920
3,072
3,000
£
2,000
2,000
3,200
3,000
2,015
Year
5 May
5 May
5 May
8 May
8 May
5 Sep
T Fallwood (1)
Bank (2)
Bills discounting charges
Bank (3)
Bills discounting charges
Bank (4)
£
2,000
1,920
80
3,072
128
3,000
Bills Discounting Charges Account
Bills receivable (2)
Bills receivable (3)
£
80
128
Year 4
£
Note
Credit was given for using this alternative method but the preferred method is that shown in
the main answer.
159
Lesson 16: Consignment accounts
Lesson topics
.
.
.
.
.
.
.
Preparation of consignment accounts in the books of the consignor
Calculation of the pro®t or loss from a consignment
Calculation of the valuation of the stocks of unsold goods with the consignee at
the end of a ®nancial period
The treatment of the return of unsold goods
The treatment of expenses incurred by the consignor and the consignee
The treatment and distinction of the basic and del credere forms of commission
The Balance Sheet entries in relation to consignments
Extended Syllabus references
6.1
Understanding of the meaning of a consignment
6.2
Explanation of the difference between a consignor and a consignee
6.3.1
Distinguishing the consignment account from the goods on the consignment
account
6.3.2
Accounting for expenses incurred by the consignee on behalf of the
consignor
6.3.4
Calculation of the value of unsold consignment stock in the possession of the
consignee or in transit
6.3.5
Accounting for returns of unsold goods from the consignee
6.3.6
Preparation of a consignment account to calculate the pro®t or loss on the
consignment for a particular accounting period
6.3.7
The effect of goods on consignment on the preparation of the general
Trading Account
6.3.8
Making the corresponding entry for the consignment pro®t
6.3.9
Preparation of the account of the consignee
6.3.10 Balance Sheet entries in respect of a consignment
6.3.11 Preparation of a consignment account for a second period, where there is an
opening stock brought forward to the consignment account
6.4.1
Entries in the consignor's account
(continued)
160
Consignment accounts
Extended Syllabus references (continued)
6.4.2
Expenses incurred on behalf of the consignor
6.4.4
Entries in the commission account
6.4.5
Informing the consignor; the account sales
Aim of the lesson
At the end of the lesson the students will be able to prepare ledger accounts relating to
a consignment in the accounts of the consignor and the consignee
The lesson
1
Begin the lesson by explaining to the class when consignment accounts will be prepared
by a business. Explain the relationship between the person who sends the goods (the
consignor) to the agent (the consignee). These explanations appear on page 313 of the
Candidate's Guide book.
2
Advise the class that the consignor could be a business in your country and the
consignee could be located in the UK.
3
Explain to the class that the consignor wishes to achieve a pro®t from the sale of the
goods that he has sent to the consignee. The consignor requires the consignee to sell the
goods on his behalf and will reward the consignee by paying an agreed rate of
commission on the sales value of the goods.
4
Explain to the class that the consignor will prepare a consignment account that will be
used to determine the pro®t or loss achieved. Advise the students that the consignment
account will be debited with the cost of the goods sent to the consignor, the expenses
incurred by the consignor for items such as the transportation and insurance on the
goods and any expenses incurred by the consignee in relation to the receipt and sale of
the goods. Also advise the students that the consignment account will also be debited
with the commission earned by the consignee for selling the goods.
5
Explain to the class that the consignment account will be credited with the sales value of
the goods sold and the valuation of any stock that remains unsold at the end of the
consignor's ®nancial period.
6
Explain to the class that other ledger accounts that are prepared in relation to a
consignment in the books of the consignor are as follows:
(a) Goods on consignment account.
161
Lesson 16
(b) The personal account of the consignee. If the consignee is T Wong of Malaysia,
then the account would be referred to as ``T Wong of Malaysia''.
7
Explain to the class that the entries relating to the goods on consignment account are as
follows:
Debit
Credit
Debit
Credit
Consignment account
Goods on consignment account
Goods on consignment account
Trading Account
Explain to the class of the importance of these initial entries; they relate to the cost of
the goods that are sent on consignment. Ask the class to recognise that the Trading
Account is credited with the cost of the goods that are sent on the consignment, and
that this cost is then debited to the goods on consignment account.
Explain to the class that then the goods on consignment account is credited with the
cost of the goods sent on consignment and this cost is then debited to the consignment
account.
Advise the class that these entries show the procedure for charging the cost of the goods
sent on consignment into the consignment account. Also advise the class that other
entries will be made in the consignment account before the pro®t or loss on the
consignment can be calculated.
8
Explain to the class that the personal account of the consignee, in the above
illustration, T Wong of Malaysia, is similar to the account of a debtor in the ledger of
the consignor. This account will be debited with value of the sales achieved by the
consignee and credited with the commission earned by the consignee on the sale of
the goods and also credited with the expenses incurred by the consignee. Advise the
class that the balance on the account will be cleared when the consignee pays the
consignor.
9
Refer the class to Example 1 on page 315 of the Candidate's Guide book, and show the
class the preparation of the ledger accounts as the solution. The solution and its related
Notes to the solution appear on page 315 and 316 of the Candidate's Guide book.
10 Ask the class to recognise that a separate consignment account is prepared for each of
the locations the goods have been despatched to; this allows the pro®t or loss to be
calculated for each of the consignments.
11 Involve the class by asking the students to prepare an answer to Example 2 on page
316 of the Candidate's Guide book. Advise the class that the example does not
involve any calculations of a pro®t or loss made on the consignment; the example
only relates to the cost of the goods that have been sent on consignment. Explain that
the example will require the preparation of accounts that relate to the consignment:
goods on consignment account and the Consignment to Chi Leng (Hong Kong)
Account.
162
Consignment accounts
12 Show the class the solution and use the Notes to the solution to assist your explanation;
these appear on pages 317 and 318 of the Candidate's Guide book. Emphasise to the
class that the corresponding entries to those made in the goods on consignment account
are made in the Consignment to Chi Leng Account and the Trading Account. Advise
the class that if a question appears in the examination involving a consignment and
requires the preparation of a Trading Account then the candidates will be expected to
show the cost of the goods sent on consignment as a deduction from the purchases in
the account.
13 Advise the class to recognise that the balance in the Consignment to Chi Leng (Hong
Kong) Account will appear in the Balance Sheet of R Bruton (the consignor) as a
current asset; the account represents the value of R Bruton's goods that are in Hong
Kong.
Ask the class to recognise that sales have yet to be achieved in Hong Kong, therefore an
account has still to be opened for the consignee as he has yet to earn any commission or
incur any expenses that are chargeable to the consignor. Therefore neither of the parties
owes money to each other at 31 March Year 12.
14 Involve the class, again, by asking the students to prepare an answer to Example 3 on
page 318 of the Candidate's Guide book.
15 Show the class the solution and use the Notes to the solution to assist your explanation:
these appear on pages 319 and 320 of the Candidate's Guide book.
Ask the class to adopt the presentation for the Trading Account that appears in the
solution rather than the alternative shown in Point 3 of the Notes to the solution.
16 Now explain to the class that expenses will be incurred in relation to the consignment.
Explain to the class that the expenses will be incurred by both the consignor and the
consignee. Advise the class that the expenses will be debited to the consignment account
and will, therefore, in¯uence the calculation of the pro®t or loss on the consignment.
17 Advise the class that if the consignor incurs the expenses, then the double entries will
be made in the consignment account and the appropriate creditor or Bank Account.
Explain that if the consignee incurs the expenses then the personal account of the
consignee will be credited and the consignment account debited; this acknowledges
that the consignor has accepted responsibility for these expenses and so owes the
consignee the amount of these expenses. Advise the class that these expenses will be
offset against the sales achieved by the consignee. Explain that this means that when the
consignee pays the consignor, then the amount remitted will be the sales value achieved
by the consignee less the expenses incurred by the consignee.
18 A further explanation of the expenses incurred in relation to the consignment appears
on page 320 of the Candidate's Guide book. Use this to explain this topic to the class.
19 Illustrate the treatment of expenses by using Example 4 on pages 320 and 321 of the
Candidate's Guide book.
163
Lesson 16
20 Explain the solution to the example by using the solution and the Notes to the solution;
these appear on pages 321, 322 and 323 of the Candidate's Guide book. Advise the class
that in addition to the fax form of communication mentioned in Point 2, other forms
of communication, such as e-mail, can be used to transmit information between the
consignor and the consignee. Also advise the class that the information sent by the
consignee to the consignor informing him of the state of the consignment, eg the sales
value achieved to date, the expenses incurred on behalf of the consignor and the
amount of unsold goods at the end of a ®nancial period is referred to as the ``Account
Sales''.
21 Ask the class to recognise that the consignor (S Rodger of London) and the consignee
(B Wong of Singapore) have incurred expenses. Also ask the class to recognise that there
is an agreement between the consignor and the consignee of the rate of commission
payable on the sales value achieved by the consignee.
22 Please emphasise to the class of the importance of the use of correct descriptions to be
used in the ledger accounts. In examinations on consignment accounts, candidates
frequently adopt the use of incorrect descriptions and this can cause the loss of marks.
For example, a common mistake is to credit the consignment account with the
description of ``Sales'', yet the sales account is not the account that is the corresponding
account for this entry. The account that is debited is the account of the consignee; in
this example it is B Wong. Therefore the entry on the credit side of the consignment
account should read as ``B Wong''. Advise the class that the entry of ``B Wong ± sales'' is
an acceptable alternative.
23 Advise the class that the entries relating to the expenses incurred on the consignment
should also be described correctly. For example, the consignor could pay, by cheque, for
the insurance of the goods while they are being transported to the consignee. The entry
in the consignment account should read ``Bank'' and not ``Insurance''. Also the
expenses that are incurred by the consignee should also be described correctly in the
consignment account. For example, if the consignor is B Wong, and he incurs landing
charges when the goods arrive at their intended location, then the description in the
consignment account should be ``B Wong'' and not ``Landing charges''. Ask the class to
recognise that alternative and acceptable descriptions for these examples of expenses
are: ``Bank ± insurance'' and ``B Wong ± landing charges''.
24 To encourage the class to use the correct account references in order to emphasise the
use of the correct descriptions in the accounts, involve the class by asking them to
prepare the journal entries, without narrations, for Example 4 on pages 320 and 321 of
the Candidate's Guide book. The journal entries should appear as follows:
164
Consignment accounts
Journal
Date
2 Jan
2 Jan
2 Jan
2 Jan
4 Jan
31 March
31 March
31 March
31 March
Consignment to B Wong Account
Goods on consignment account
Consignment to B Wong Account
Bank
Consignment to B Wong Account
Bank
Consignment to B Wong Account
Bank
Consignment to B Wong Account
B Wong
Consignment to B Wong Account
B Wong
B Wong
Consignment to B Wong Account
Consignment to B Wong Account
Pro®t and Loss Account
Goods on consignment account
Trading Account
Dr
£
102,000
Cr
£
102,000
2,100
2,100
1,480
1,480
2,950
2,950
3,170
3,170
15,280
15,280
152,800
152,800
25,820
25,820
102,000
102,000
25 Explain to the class that there will be occasions when the consignee will have stocks of
unsold goods on hand at the end of the consignor's ®nancial period. Explain to the class
that in order to calculate a pro®t or loss on the consignment, then a valuation should be
made for the unsold stock. Advise the students that it would not be correct to
acknowledge this point in the accounts of the consignee.
26 Use Example 5 on page 323 of the Candidate's Guide book to illustrate the presence of
unsold goods with the consignee at the end of the consignor's ®nancial period.
Advise the class that this example expands on the information provided in Example 4 in
the Candidate's Guide book and shows that there are 80 units of unsold goods with the
agent at 31 March.
27 Advise the class of how these stocks of goods are valued. The calculation for the
valuation is shown on pages 323 and 324 of the Candidate's Guide book.
Advise the class that in addition to the purchase cost of the goods, the packing,
insurance, air freight and landing charges are included in the calculation of the stock
valuation.
These costs are those incurred to put the goods into their condition and location at 31
March, and so are used to value the 80 unsold units at that date.
28 Advise the class that the commission cost is not included in the valuation of the stocks;
it is a cost that is incurred on the sale of the products and so will not form part of the
165
Lesson 16
stock valuation. Explain that costs that are incurred on the sale of the units are incurred
because the consignee no longer holds the units, and so should not be included in the
valuation of any units that remain with the consignee.
29 Show the solution with its related Notes to the solution to the class; these appear on
pages 323, 324 and 325 of the Candidate's Guide book.
Advise the class that the valuation of the unsold goods is credited to the consignment
account and this balance is brought down in the account at the start of the next ®nancial
period.
30 Ask the class to recognise that the balance on the consignee's account is a debit
balance; this means that B Wong owed S Rodger £120,598. This balance represents
the difference between the sales value of the goods sold by B Wong and the total of
the expenses incurred on behalf of the consignment by B Wong and the commission
earned by B Wong in achieving the sales for S Rodger. Now show the class how the
balance on the consignee's account may be settled. Examples 6, 7 and 8 on pages
325, 326 and 327 of the Candidate's Guide book show differing ways in which this
may arise: cash payment, Bill of Exchange and a contra entry. Show the class each of
these examples and explain the solutions using the Notes to the solution to assist
your explanations. These appear on pages 325, 326 and 327 after each of the
examples.
31 Advise the class that it is possible for an examination question to be set that covers more
than one syllabus topic area. Example 7 on page 326 of the Candidate's Guide book
provides an illustration of this; a consignment account question contains the use of a Bill
of Exchange to settle the debt owed by the consignee to the consignor. This example is
also advice to the students that they should study all areas of the syllabus; not selected
parts of it. A question could be set covering more than one syllabus area; one of the
areas may have been studied by a particular student but not the other area. It is likely
with such an approach to his or her studies that this student would not gain a pass
standard for this particular question.
32 Advise the class that there may be occasions when the consignee is unable to sell all of
the goods sent to him and so he decides to return the goods to the consignor.
Advise the class that when this occurs, entries will need to be made in the consignment
accounts to acknowledge this. Illustrate this topic to the class by using Example 9 on
page 328 of the Candidate's Guide book.
33 Show the class the solution together with its related Notes; these appear on pages 328
and 329 of the Candidate's Guide book.
34 Advise the class of the manner in which the returned goods have been valued. In this
case the goods have been valued at their original cost, this means they have been valued
at their purchase cost of £127.50 per product (20 products6£127.50 = £2550.00).
Advise the class that if this situation is included in an examination question, then the
candidates will be advised of the basis to value the returned goods.
166
Consignment accounts
35 Advise the class how the commission earned by the consignee is calculated. Use the
explanation of commission that is provided on page 329 of the Candidate's Guide book.
It is important that the class is able to distinguish between basic and del credere
commission.
36 Emphasise to the class that the del credere form of commission means that the consignee
is responsible for the collection of the money from the customers. If the customers are
unable to pay their debts, then this does not affect the amount owed by the consignee to
the consignor.
37 Contrast this type of commission with the basic type of commission. The basic form of
commission means that if any of the customers are unable to settle their debts, then the
debt is written off as a bad debt and is credited to the consignee's account in the
consignor's ledger.
38 Use Example 10 on page 330 of the Candidate's Guide book to illustrate the two forms
of commission.
39 Show both of the solutions to the class also using the Notes to the solution to assist
your explanation. These are provided on pages 330 and 331 of the Candidate's Guide
book.
Advise the class that the consignee receives a higher rate of commission (8%) for the del
credere type of commission than for the basic type of commission (5%). Explain to the
class that the higher rate of commission re¯ects the larger amount of work that the
consignee will be doing to achieve the del credere commission. Explain to the class that
with this form of commission the consignee will not only be selling the goods, but he
will also be responsible for the collection of the debts. Explain to the class that with the
basic form of commission, the consignee will earn this by selling the goods but he will
not be responsible for the collection of the debts from the customers.
40 Ask the class to recognise the increased amounts of commission that are shown in Part
(b) of the solution for Example 10 on page 330 of the Candidate's Guide book.
Ask the class to recognise that the bad debts are credited to the consignee's account in
Part (a) of the solution. This entry acknowledges the fact that the consignee is not held
responsible for the collection of these amounts, so the consignor suffers the bad debt.
Contrast this with the approach shown in Part (b) of the solution. In this case the bad
debts are not credited to the consignee's account. Explain to the class that despite
some debtors not being able to pay for the goods, the consignee still owes the
consignor for these debts. The consignor has paid an increased amount of
commission to the consignee to include the collection of all monies from all of
the debtors. This arrangement is likely to mean that the consignee is very careful as to
the customers he sells the goods to. If he sells to customers who subsequently are
unable to pay for the goods, then the consignee will have to pay for them; this should
make the consignor very careful of which customers he is prepared to sell to on credit
terms!
167
Lesson 16
41 Advise the class that the difference between the balances in Section (a) and Section (b)
of the solution to Example 10 is £11,077 at 1 October Year 5; the balance in (a) is
£76,305 and the balance in (b) is £65,228. Explain to the class that the difference is
caused by:
(a) An increase in the rate of commission. The account in (a) is prepared on the basis of
the commission is 5%, whereas the rate in Section (b) is 8%.
(b) There has been a change in the basis of the commission. In Section (a) the basic type
of commission is used, whereas the del credere basis is used in Section (b). This means
that the consignee is responsible for all of the debts when the del credere basis is used.
42 The difference in the balances between each of the ledger accounts can be explained as
follows:
3 months ended:
Total sales
Bad debts written off
31 March
£
176,700
900
Balance as per solution to Section (a)
add Back bad debts written off in (a)
less Increased commission in (b)
Balance as per solution to Section (b)
30 June
£
201,500
2,700
30 September
£
217,700
3,200
£
£
76,305
6,800
17,877
Total
£
595,900
6,800
11,077
65,228
43 Explain to the class that examination questions can require accounts to be prepared in
the ledger of the consignee.
Use the explanation of the entries that appear in the consignee's ledger, which is on
page 332 of the Candidate's Guide book.
Explain to the class that it is a common requirement in examination questions for the
consignor's account to be prepared in the consignee's ledger.
44 Use Example 11 on page 332 to illustrate this area of the syllabus.
45 Show the class the solution also using the Notes to the solution to assist in your
explanation; these appear on pages 332 and 333 of the Candidate's Guide book.
Emphasise Point 2 of the Notes to the solution; this relates to bad debts and their
treatment will be dependent upon the type of commission that is paid to the consignee.
Remind the class of the differences in the types of commission that were discussed
earlier in the lesson.
46 Finally, advise the class that the purchase cost of the goods sent to the consignee by the
consignor will not appear in the books of the consignee. The consignee will not own the
goods; he will receive them from the consignor and try to sell them for him. The
consignee will therefore record in his ledger: the sales of the goods; the expenses he has
incurred; the commission he has earned; and the payments he has made to the consignor.
168
Consignment accounts
QUESTION FOR CLASS PRACTICE
Question 16.1
On 8 September Year 9, Taylor of London consigned 1,000 boxes of goods to S Wong of
Singapore. Taylor had purchased the goods for £50 per box.
On the same day the goods had been consigned to Singapore, Taylor paid the following by
cheque:
Freight charges
Insurance charges
£1,200
£630
S Wong received the goods on 1 October Year 9 and immediately paid landing charges of
£350 by cheque. S Wong also arranged for the storage of the goods in a local warehouse
and paid £820 by cheque for this service.
S Wong had been requested by Taylor to sell the goods at a selling price of £120 per box.
To assist his attempts to sell the goods, S Wong incurred advertising expenses of £1,500 on
12 October paid by cheque.
Taylor had agreed to regard this as an expense of the consignment.
Taylor had agreed to pay S Wong a basic commission of 5% and a further 2% del credere
commission on the sales value.
The ®nancial year end of both the consignor and the consignee was 31 December. By the
®nancial year end, S Wong had sold on credit 700 boxes of the goods at the selling price
requested by Taylor and 80% of the debts had been settled in cash.
At 31 December S Wong submitted an account sales and a remittance of £62,000 to Taylor
of London.
Required
(a) Prepare the following accounts in the books of the consignor:
(i) Consignment to S Wong, Singapore.
(13 marks)
(ii) Goods on consignment.
(2 marks)
(iii) S Wong, Singapore.
(4 marks)
(b) Prepare the following accounts in the books of the consignee:
(i) Taylor of London.
(ii) the consignment Debtors' Account.
(4 marks)
(2 marks)
(Total 25 marks)
(LCCIEB 1997)
169
Lesson 16
Solution to Question 16.1
(a) In the books of the consignor
(i)
Year 9
8 Sep
8 Sep
8 Sep
31 Dec
31 Dec
31 Dec
31 Dec
31 Dec
Consignment to S Wong, Singapore Account
Goods on consignment
Bank ± freight
Bank ± insurance
S Wong ± landing charges
S Wong ± warehouse charges
S Wong ± advertising
S Wong ± commission
Pro®t and loss ± consignment
pro®t
£
50,000
1,200
630
350
820
1,500
5,880
Year 9
31 Dec
31 Dec
Wong ± sales
Stock c/d
4,200)
1,680) *
39,520
99,900
Year 10
1 Jan Stock b/d
(ii)
Year 9
31 Dec
99,900
15,900
Goods on consignment account
Trading Account
(iii)
Year 9
31 Dec
£
50,000
Year 9
8 Sep
Consignment to S Wong
£
50,000
S Wong, Singapore Account
Consignment to S Wong
£
84,000
Year 9
31 Dec
31 Dec
31 Dec
84,000
Year 10
1 Jan Balance b/d
170
£
84,000
15,900
13,450
£
Consignment to S Wong:
Landing charges
350
Warehouse charges
820
Advertising
1,500
Commission
5,880
Bank
62,000
Balance c/d
13,450
84,000
Consignment accounts
(b) In the books of the consignee
(i)
Year 9
1 Oct
1 Oct
31 Dec
31 Dec
31 Dec
31 Dec
Taylor of London Account
£
Bank ± landing charges
Bank ± warehouse
Bank ± advertising
Commission
Bank
Balance c/d
350
820
1,500
5,880
62,000
13,450
Year 9
31 Dec
Debtors
84,000
84,000
Year 10
1 Jan Balance b/d
(ii)
Year 9
31 Dec
£
84,000
13,450
Debtors' Account
Taylor of London
£
84,000
84,000
Year 10
1 Jan Balance b/d
Workings for stock valuation:
Cost of goods consigned
Freight
Insurance
Landing charges
Warehouse
Year 9
31 Dec
31 Dec
Bank
Balance c/d
£
67,200
16,800
84,000
16,800
50,000
1,200
630
350
820
53,000
Valuation:
£53,000
100
630 = £15,900
171
Lesson 17: Sales and purchases ledger
control accounts
Lesson topics
.
.
.
.
.
The
The
The
The
The
preparation of a sales ledger control account
preparation of a purchase ledger control account
treatment of contra entries
treatment of debit balances in the purchase ledger control account
treatment of credit balances in the sales ledger control account
Extended Syllabus references
5.2
The purpose of control accounts
5.3
The importance of control accounts with reference to the preparation of a trial
balance and a Balance Sheet
5.5
Understanding of the items most likely to appear in a sales ledger control
account
5.6
Understanding of the items most likely to appear in a purchases ledger control
account
5.7
Transfers between the purchases ledger and the sales ledger
5.8
Preparation of control accounts from given balances and summary transactions
for a period
5.9
Interpretation of the balances on the sales ledger control account and, in
particular, the meaning of credit balances in the sales ledger
5.10 Interpretation of the balances on the purchases ledger control account and, in
particular, the meaning of debit balances in the purchases ledger
5.12 Reconciliation of differences between the balance on the control account and
the total of the list of balances in the subsidiary ledger
Aim of the lesson
At the end of the lesson the students will be able to prepare a sales ledger control
account and a purchase ledger control account
172
Sales and purchases ledger control accounts
The lesson
1
Begin the lesson by explaining to the class that control accounts are summaries of any
number of individual accounts of the same classi®cation. For example, the sales ledger
control account is a summary of the individual debtors' accounts and the purchase
ledger control account is a summary of the individual creditors' accounts.
2
Advise the class that the use of control accounts will be useful for the preparation of a
trial balance. The balances for these two control accounts will appear in the trial
balance, rather than all of the balances for each of the debtors and creditors.
3
Advise the class that the balances on the sales ledger control account and the purchase
ledger control account must agree with the totals of the individual balances for the
debtors and the creditors.
Advise the class that the exercise of reconciling the balances on the control accounts and the
individual accounts should be completed regularly, preferably at least on a monthly basis.
If the balances do not agree, then an investigation should be made in order to
determine the reasons for the differences.
Advise the class of the possible reasons for the differences; these appear on page 346 of
the Candidate's Guide book.
4
Advise the class that when a business prepares control accounts for its debtors and
creditors, then it will maintain a sales ledger and a purchase ledger. Advise the class that
these two ledgers are separate from the nominal ledger; the nominal ledger will contain
the control accounts for the purchase ledger and the sales ledger.
5
Advise the class that the sales ledger will contain the accounts for each of the business
debtors and that the purchase ledger will contain the accounts for each of the business
creditors. The control accounts will contain the summarised transactions for each
particular ®nancial period that appears in the individual debtor and creditor accounts.
For example, the credit sales for a particular month are likely to arise on various days in
the month, yet the sales ledger control account will show one entry for the total credit
sales made in the particular month. This exercise is repeated for all of the items in the
purchase and sales ledgers.
6
Advise the class of the items that can be expected to appear in the sales ledger control
account. These appear on page 339 of the Candidate's Guide book. Also advise the class
of the items that can be expected to appear in the purchase ledger control account;
these appear on page 341 of the Candidate's Guide book.
7
Refer the class to Example 1 on page 341 of the Candidate's Guide book. Advise the
class that the total of credit sales made for the three months ended 31 March Year 10 is
£35,919, and that the total of the cash received from the debtors for the same period is
£27,010. Explain to the class that these totals are entered in the sales ledger control
account in the nominal ledger.
173
Lesson 17
8
Advise the class that the individual ®gures for sales and receipts are entered in the
individual debtors' accounts in the sales ledger.
9
Explain to the class that the sales ledger control account re¯ects the total for each type
of entry that appears in the individual debtors' accounts in the sales ledger. Also explain
to the class that there will never be an entry in the individual debtor accounts that does
not also appear in the sales ledger control account and vice versa.
10 Show the class the solution to the example, also using the Notes to the solution to assist
your explanation; these appear on pages 341, 342 and 343 of the Candidate's Guide
book.
Advise the class that the example related to 3 credit customers, but the same principles
would apply to the preparation of the sales ledger control account in the nominal ledger
and the individual debtors' accounts in the sales ledger if there had been 30 or 300
credit customers!
11 Refer the class to Example 2 on page 343 of the Candidate's Guide book. This example
relates to suppliers. Tell the class that the following totals apply:
Balances outstanding to suppliers at 31 December Year 9
Purchases on credit
Payments to suppliers
Discount received from suppliers
Bill payable
£
36,200
36,120
23,900
224
10,000
12 Explain to the class that the purchase ledger control account re¯ects the total for each
type of entry that appears in the individual suppliers' accounts in the purchase ledger.
Advise the class that there will never be any item that appears in the individual suppliers'
accounts in the purchase ledger that will not appear in the purchase ledger control
account in the nominal ledger and vice versa.
Advise the class, again, that this example relates to 5 suppliers and that the same
principles would apply to the preparation of the purchase ledger control account in the
nominal ledger and the individual suppliers' accounts in the purchase ledger if there had
been 50 or 500 suppliers!
13 Explain the meaning of the term ``contra entries'' to the class. An explanation of the
term appears on page 347 of the Candidate's Guide book. Refer the class to Example 3
on the same page.
14 Before showing the class the solution to the example, explain that the net effect of the
two transactions is that R Anthony owes £300 to J Cooper. This means that a contra
entry of £900 needs to be made in both of the control accounts in the nominal
ledger and also in both of the personal accounts that appear in the sales and purchase
ledgers.
174
Sales and purchases ledger control accounts
15 Show the class the solution again using the Notes to the solution to assist in your
explanation; these appear on pages 347 and 348 of the Candidate's Guide book.
16 Explain to the class that there are occasions when there is a closing debit balance on the
purchase ledger control account in the nominal ledger and therefore closing debit
balances in the individual suppliers' accounts in the purchase ledger.
Explain to the class that this means that the supplier owes money to customers.
Advise the class that this may arise due to the customer having paid for the goods
supplied to him or her and then, because of dissatisfaction with the goods, they are
returned to the supplier. The supplier then issues a credit note to the customer,
and acknowledges the fact that he or she now owes the customer an amount of
money.
17 Advise the class that when this situation arises the debit balances should not be netted
off against the credit balances in the purchase ledger control account. The control
account should re¯ect all of the entries that appear in the individual suppliers' accounts
in the purchase ledger. Therefore, when there is a closing debit balance in the purchase
ledger control account, there will be a number of closing debit balances on suppliers'
accounts in the purchase ledger that will total the closing debit balance that appears on
the purchase ledger control account. The total of the debit balances shown in the
purchase ledger control account will be known when the individual balances for each of
the creditors has been established.
18 Explain to the class that there are occasions when there is a closing credit balance on the
sales ledger control account in the nominal ledger and therefore closing credit balances
in the individual customers' accounts in the sales ledger.
Explain to the class that this means that the supplier owes money to customers.
Explain that this situation could arise when a customer has overpaid his account. For
example, if goods were supplied to a customer for £1,000 but the customer paid
£1,100, so the supplier has received £100 too much. Explain to the class that this over
payment will be re¯ected by a credit balance of £100 in the sales ledger control account
and the individual debtor account in the sales ledger.
19 Advise the class that the closing credit balance should not be netted off against the
closing debit balance in the sales ledger control account. The control account should
re¯ect all of the entries that appear in the individual customers' accounts in the sales
ledger. Therefore, when there is a closing credit balance in the sales ledger control
account, there will be a number of closing credit balances on customers' accounts in the
sales ledger that will total the closing credit balance that appears on the sales ledger
control account.
The total of the credit balances shown in the sales ledger control account will be known
when the individual balances for each of the debtors has been established.
175
Lesson 17
20 Involve the class by asking them to prepare a solution to Example 5 on pages 349 and
350 of the Candidate's Guide book.
21 Show the class the solution, also using the Notes to the solution to assist your
explanation; these appear on pages 350 and 351 of the Candidate's Guide book.
Advise the class of the importance of showing both of the closing balances, debit and
credit, at the beginning and end of May Year 6 in both the sales ledger control account
and the purchase ledger control account.
22 Explain to the class that in this example the closing credit balance in the sales ledger
control account was provided. This meant that the closing debit balance in the sales
ledger control account, £147,041, was the last ®gure to be calculated.
Advise the class that the example also provided the closing debit balance in the purchase
ledger control account. This meant that the closing credit balance in the purchase
ledger control account, £41,460, was the last ®gure to be calculated.
23 Advise the class that questions sometimes appear in the examination on this syllabus
topic that show entries that have been incorrectly posted in the control accounts. For
example, the entry for the credit purchases could be shown as a debit item in the sales
ledger control account, when the correct entry would be a credit in the purchase ledger
control account. The question would require candidates to adjust the given control
accounts and to prepare them in the correct format. Contrast this type of question to
one where a list of transactions are presented to the candidates and they are required to
prepare the control accounts from the data provided.
QUESTIONS FOR CLASS PRACTICE
Question 17.1
Anthony Thaxton keeps control accounts for his purchases and sales ledgers. He extracted
the following balances from his books of account:
Balances, 1 April Year 8:
Purchases ledger
Sales ledger
Provision for doubtful debts
176
£
372
35,890
56,460
490
2,115
Dr
Cr
Dr
Cr
Sales and purchases ledger control accounts
The following information was available for April Year 8:
£
Purchases on credit
98,430
Sales on credit
126,270
Discount allowed
3,670
Legal expenses charged to customers
715
Cash purchases
9,630
Returns inwards
3,280
Discount received
2,095
Cheque received from customer returned by bank dishonoured
640
Bad debts written off
375
Sales ledger debit balances transferred to purchases ledger per contra
930
Returns outwards
2,040
Cash sales
12,570
Payments by cheque to suppliers
94,630
Receipts by cheque from credit customers
130,890
Balances, 30 April Year 8:
Purchases ledger
536 Dr
Sales ledger
468 Cr
Provision for doubtful debts
1,680
Required
(a) Prepare purchases ledger and sales ledger control accounts for April
Year 8, bringing down the balances at 1 May Year 8.
(20 marks)
(b) Show, as a Balance Sheet extract, how debtors and creditors would
appear at 30 April Year 8.
(5 marks)
(Total 25 marks)
(LCCIEB 1997)
Question 17.2
Douglas Highland purchases and sells goods on credit. He has prepared the following
incomplete and incorrect sales ledger control and purchase ledger control accounts for the
month of May Year 5:
Sales Ledger Control Account
Year 5
31 May
31 May
31 May
31 May
£
Bad debts
520
Discount received
720
Cheques received from debtors 321,490
Contra
320
Year 5
31 May
31 May
Credit sales
Returns outwards
£
344,250
480
177
Lesson 17
Purchase Ledger Control Account
Year 5
31 May
31 May
£
1,690
530
Discount allowed
Returns inwards
Year 5
31 May
31 May
31 May
£
Credit purchases
154,330
Cheques paid to creditors 152,780
Contra
320
Highland has asked you to assist him to complete the control accounts for May Year 5.
You ascertain that the individual customer and supplier accounts have the following total balances:
Purchase ledger control
Sales ledger control
1 May Year 5
£340
£29,270
£61,320
£750
(Dr)
(Cr)
(Dr)
(Cr)
31 Mar Year 5
£430
?
?
£650
Required
Prepare for the month of May Year 5:
(a) The sales ledger control account.
(13 marks)
(b) The purchase ledger control account.
(12 marks)
(Total 25 marks)
(LCCIEB 1998)
Solution to Question 17.1
(a)
Year 8
1 Apr
30 Apr
30 Apr
30 Apr
30 Apr
30 Apr
1 May
178
In the books of Anthony Thaxton
Purchases ledger control
£
Balance b/forward
Discount received
Returns outwards
Bank
Sales ledger contras
Balance c/d
Balance b/d
372
2,095
2,040
94,630
930
34,789
134,856
536
Year 8
1 Apr
30 Apr
30 Apr
Balance b/forward
Purchases
Balance c/d
£
35,890
98,430
536
134,856
1 May
Balance b/d
34,789
Sales and purchases ledger control accounts
Sales ledger control
Year 8
1 Apr
30 Apr
30 Apr
30 Apr
30 Apr
Balance b/forward
Sales
Legal expenses
Bank (dishonoured cheque)
Balance c/d
£
56,460
126,270
715
640
468
Year 8
1 Apr
30 Apr
30 Apr
30 Apr
30 Apr
30 Apr
30 Apr
£
Balance b/forward
Discount allowed
Returns inwards
Bad debts
Bank
Purchases ledger contras
Balance c/d
184,553
1 May
Balance b/d
(b)
44,918
1 May
490
3,670
3,280
375
130,890
930
44,918
184,553
balance b/d
468
Anthony Thaxton
Balance Sheet (extract) at 30 April Year 8
Current assets
Debtors (£44,918 + £536)
less Provision for d/debts
£
45,454
1,680
Amounts due within one year
Creditors (£34,789 + £468)
£
35,257
43,774
Solution to Question 17.2
DOUGLAS HIGHLAND
(a)
Year 5
1 May
31 May
31 May
Balance b/d
Sales
Balance c/d
Sales ledger control account
£
61,320
344,250
650
Year 5
1 May
31 May
31 May
31 May
31 May
31 May
31 May
£
Balance b/d
Bad debts
Bank
Contra
Discount allowed
Returns inwards
Balance c/d
406,220
1 June Balance b/d
(b)
Year 5
1 May
31 May
31 May
31 May
31 May
31 May
80,920
750
520
321,490
320
1,690
530
80,920
406,220
1 June
Balance b/d
650
Purchase ledger control account
£
Balance b/d
Discount received
Returns outwards
Bank
Contra
Balance c/d
340
720
480
152,780
320
29,390
Year 5
1 May
31 May
31 May
Balance b/d
Purchases
Balance c/d
184,030
1 June Balance b/d
430
£
29,270
154,330
430
184,030
1 June Balance b/d
29,390
179
Lesson 18: Errors and the use of suspense accounts
Lesson topics
.
.
.
.
.
.
The treatment of errors that do not prevent the Trial Balance being balanced
The treatment of errors that prevent the Trial Balance being balanced
The preparation of a suspense account
The calculation of the opening balance in the suspense account
The adjustment of a provisional pro®t by the correction of errors and omissions
The treatment of differences between control accounts in the nominal ledger and
individual accounts in a plant, purchase or sales ledger.
Extended Syllabus references
10.1 Ability to explain different types of error
10.2 Understanding which errors will prevent the Trial Balance from balancing and
which errors will not
10.4 Where control accounts are in use, understanding the effect of errors made in
the sales ledger, as opposed to errors made in the sales ledger control account
10.5 Where control accounts are in use, understanding the effect of errors made in the
purchases ledger, as opposed to errors made in the purchases ledger control account
10.6 Use of the suspense account as a temporary measure to balance the Trial Balance
10.7 Correction of errors through the journal, where the suspense account is
unaffected
10.8 Correction of errors through the journal, where the suspense account is
affected
10.9 Preparation of the suspense account to arrive at the opening difference in the
trial balance where this is not given by the Examiner
Aims of the lesson
At the end of the lesson the students will be able to:
.
.
180
Prepare journal entries to correct errors and omissions
Prepare a suspense account and a statement of revised pro®t to re¯ect the
correction of the errors and omissions
Errors and the use of suspense accounts
The lesson
1
Begin the lesson by advising the class that there are occasions when errors are made in
maintaining the accounting records of organisations.
Explain that the errors could be made by treating incorrectly an item or omitting the
item from the organisation's ledger.
2
Advise the class that there are some errors that will not prevent the Trial Balance being
balanced. Use this illustration to explain this to the class:
A company has incurred some travelling expenses amounting to £125. The bank account
had been correctly credited with the payment for these expenses, but the telephone
account has been incorrectly debited. Advise the class that the travelling expenses account
should have been debited.
Explain to the class that this error would not prevent the Trial Balance being balanced.
The error, however, needs correcting; show the class the following journal entry that is
made to correct the error:
Journal
Travelling expenses account
Telephone account
3
Dr
£
125
Cr
£
125
Advise the class that there are some errors that will prevent the Trial Balance being
balanced. Use this illustration to explain this to the class:
A sole trader has sold goods, on credit, for £536. The sales ledger control account has
been correctly debited with £536 but the sales account has been credited with £563.
Explain to the class that this means that the Trial Balance total of the credit items will exceed
the total of the debit items by £27; £563 less £536.
4
Advise the class that it is in situations like this example that a suspense account is
prepared. Explain to the class that the suspense account is used as a temporary measure
to make the Trial Balance balance. This will mean that the ®nal accounts of the
organisation can be prepared and so a provisional net pro®t can be shown in the Pro®t
and Loss Account.
5
Advise the class that before any corrections are made, the suspense account will appear
in the Balance Sheet. If the balance is a debit balance, then the account will appear as a
current asset. If the balance is a credit balance, then the account will appear as a current
liability, or items falling due in less than one year.
6
Advise the class that questions are set in this examination that require the candidates to
prepare a suspense account. The preparation of the suspense account will require the
181
Lesson 18
individual entries to be posted in the account, and should eventually result in the errors
being corrected.
7
Advise the class that the examination question may provide the ®gure for the opening
balance in the suspense account, but there could be occasions when this balance is not
given in the question.
8
When the opening balance is not given in the question it will mean that the candidates
should know that the ®gure for the opening balance is the ``net ®gure'' of the
corrections made by the candidate. Advise the class that the ®gure is, therefore, the
balancing ®gure. Use this illustration as an example for the class:
A retailer has prepared a Trial Balance for his business at 31 March Year 5, the end of his
®nancial year. The Trial Balance did not balance and a suspense account was therefore
opened. The following errors have been found:
(a) A payment received from a customer for £354 has been posted correctly to the Bank
Account, but the entry in the personal account of the debtor has not been made. Ask the
class to assume that a sales ledger control account is not maintained.
(b) The business incurred advertising costs of £527, which were paid by cheque. The correct
entry has been made in the Bank Account, but the advertising account has been debited
with £472.
The suspense account will now be cleared by correcting the errors found. The reasons
for each of the entries are as follows:
(a) The personal debtor account should have been credited with £354. This means
that before the error was found, the suspense account would have been shown with
a credit entry of £354. This would also have been the balance if this item had been
the only error.
(b) The ledger account for advertising should have been debited with a further £55;
£527 less £472. This means that before the error was found, the suspense account
would have shown a debit entry of £55. This would also have been the balance if
this item was the only error.
9
Show the class the following journal entries that would be made to correct the
errors:
Journal
Suspense account
Debtor's account
Advertising account
Suspense account
Dr
£
354
Cr
£
354
55
55
Ask the class to recognise that the opening balance in the suspense account does not
need to be given in the question; in examinations at this level, it often will not be given.
182
Errors and the use of suspense accounts
Advise the students that the ®gure is calculated by using the ®gures that have been
posted to the suspense account, in order to correct the errors.
10 In this illustration the suspense account has been debited with £354 and credited with
£55. This has resulted in a net debit total of £299. Advise the class that the opening
balance will therefore be a credit entry balance of £299. Advise the class that the
opening balance is shown in the account together with the adjustments, then the
suspense account will be cleared. Show the class the suspense account:
Suspense account
Debtor's account
£
354
354
Balance
Advertising
£
299
55
354
11 Advise the class that their opening balance should be the ®rst entry shown in the
suspense account; either debit or credit entry. Also advise the class that the examiner
will give marks where the candidate has attempted to calculate an opening balance
®gure, but the ®gure is incorrect. If the candidate's own ®gure for the opening balance
means that the suspense account is cleared of any balance, then marks will be given for
this approach.
12 Refer the class to the classi®cations of errors and omissions that appear on pages 357 and
358 of the Candidate's Guide book.
Explain each of the classi®cations by using the illustrations provided on those pages.
13 Involve the class by asking the students to prepare an answer to Example 1 on pages 358
and 359 of the Candidate's Guide book.
14 Explain the solution to the class also using the Notes to the solution; these appear on
pages 359 and 360 of the Candidate's Guide book. Ask the class to recognise that not all
of the errors require the use of the suspense account to correct them. Also advise the class
that double entries are not always required; refer the class to Item 1 to illustrate this point.
15 Advise the class that errors and omissions can have an effect on the amount of pro®t or
loss that has been calculated before the errors have been corrected.
Use Example 2 on page 361 of the Candidate's Guide book to illustrate this item.
Advise the class that not all of the errors and omissions will have an effect on the pro®t
or loss that has been calculated before the items had been corrected. Explain to the class
that Items 1, 2 and 3 are examples of this.
16 Advise the class that if a question requires adjustments to the net pro®t to be shown and
there are some errors that have no effect on the pro®t, then the candidates should state
this in their answers. This approach will tell the examiner that the candidate
understands that some of the errors do not have any effect on the pro®t.
183
Lesson 18
17 Explain to the class the meaning of control accounts for ®xed assets; an explanation
appears on page 362 of the Candidate's Guide book. Emphasise to the class of the need
for additional records that need to be kept and that these are used to support the control
accounts in the nominal ledger. Remind the class of Lesson 17, which relates to control
accounts. The lesson explained that the accounts in the sales and purchase ledgers were
additional records that supported the sales ledger control account and the purchase
ledger control account in the nominal ledger.
18 Use Examples 3 and 4 on pages 362, 363 and 364 of the Candidate's Guide book to
illustrate how differences may occur between the control account in the nominal ledger
and the additional records in the supporting ledger. Advise the class that the supporting
ledger is sometimes known as the ``memorandum ledger''. Use the explanations, shown
after each of the examples in the Candidate's Guide book, to advise the class how the
differences are dealt with.
19 Explain to the class how the Cash Book would be summarised to assist the posting of
each of the types of cash expenses. An explanation of this is given on pages 364 and 365
of the Candidate's Guide book.
20 Explain to the class that errors could be made in the postings of the summarised
amounts to the ledger accounts. The error could be one of posting the incorrect
amount or even omitting the amount completely.
Use the illustration on page 365 of the Candidate's Guide book, relating to the
stationery expenses, to show the class how this type of error may arise and also how it is
corrected.
21 Explain how differences can arise between the balance in the purchase ledger control
account and the individual suppliers' accounts in the purchase ledger. An example of
this appears on page 366 of the Candidate's Guide book.
22 Explain to the class that all of the entries made in the individual customers' accounts in
the sales ledger should be summarised to appear in the sales ledger control account in
the nominal ledger.
Advise the class that if there are any entries in any of the individual customer accounts
in the sales ledger that are not re¯ected in the sales ledger control account, then
differences will arise between the balances in the two ledgers. Also advise the class that
if there are any entries in the sales ledger control account that are not in any of the
individual customers' accounts in the sales ledger then, again, differences will arise.
Refer the class to Example 5 on page 367 of the Candidate's Guide book. This example
is an illustration of a difference arising because of the incorrect treatment of discount
allowed.
Advise the class that the discounts account should have been debited with £8; it was
instead, credited with £8.
184
Errors and the use of suspense accounts
23 For the solution to Section (a) in Example 5 in the Candidate's Guide book, advise the
class that to correct the credit entry of £8 in the discount account then:
(a) The discount account should be debited with £8. This is to correct the initial
incorrect entry of £8 to this account.
(b) The discount account should be debited with £8. This is the correct entry that
should have been initially made.
Explain to the class that this means, in summary, that the discounts account should be
debited with £16, £8 plus £8, and the suspense account credited with £16. Explain to
the class that the opening balance on the suspense account has not been given in the
example; it is calculated as a debit balance of £16.
24 Explain the solution to Section (b) in Example 5 in the Candidate's Guide book to the
class. This means that:
(a) The discount received account should be debited with £8. This entry corrects the
initial incorrect credit posting of £8 to this account.
(b) The discount allowed account should be debited with £8. This is the entry that
should have been made.
25 Explain to the class that the suspense account is credited with each of these entries.
Advise the class, again, of the need to show the opening balance of the suspense
account, debit £16, even though this balance was not given in the example.
26 Show the class the solution and use the Notes to the solution to assist your explanation.
These are found on pages 367 and 368 of the Candidate's Guide book.
QUESTIONS FOR CLASS PRACTICE
Question 18.1
The Trial Balance of B Brown, a sole trader, did not balance at the ®nancial year end
at 31 December Year 6. The books balanced when the difference was posted to a
suspense account. Before the ®nal accounts were prepared, you discovered the
following items:
1
The purchase of a new motor vehicle, on credit for £15,000, had been posted correctly
to the purchases ledger control account but had been posted to the motor vehicles
running expenses account as £1,500. Brown does not depreciate assets in the year of
their purchase.
2
Cheque payments made to creditors on 31 December Year 6 totalling £820 had been
correctly entered in the Bank Account but shown as £520 in the purchases ledger
control account.
185
Lesson 18
3
Discounts allowed for the year amounted to £75. The entries for these discounts had
been made as follows:
Debit
Credit
Sales ledger control account
Discount received account
4
The cash sales for December, amounting to £3,750, had been entered correctly in the
Cash Book, but had not been posted to the sales account.
5
Discounts were received amounting to £125, but the only entry for this item had been
made in the purchases ledger control account.
6
The cost of heating and lighting, amounting to £532, had been entered in the heading
and lighting account as £523; the correct amount had been posted to the appropriate
creditor's account.
After the amendments had been made to the accounts, the suspense account balance had
been cleared.
The balances on the sales and purchases ledger control accounts are used when the Trial
Balance is prepared.
Required
(a) Prepare journal entries to make the entries relating to any amendments
that are required to the accounts.
(b) Prepare the suspense account.
(13 marks)
(5 marks)
(c) Prepare a statement to show the amount by which each adjustment would
affect the pro®t for the year ended 31 December Year 6.
(7 marks)
(Total 25 marks)
(LCCIEB 1997)
Question 18.2
The draft Trial Balance of Alice Root at 31 December Year 3, her ®nancial year end, did
not agree and the difference was posted to a suspense account. The Trial Balance includes
the totals of the individual debtors' and creditors' accounts. Alice Root does not use control
accounts.
Draft ®nal accounts were prepared. Later investigation of the accounts showed the following:
1 A return of goods, £200, by a customer, R Meadow, had been posted from the
Returns Inwards Day Book to the debit of his account.
2 A Standing Order payment to Fidelity Insurance, £55, had not been posted from the
Cash Book.
186
Errors and the use of suspense accounts
3 Alice Root had taken goods, £800, purchased during the year to 31 December Year 3,
from the business for her own use, but no entries had been made in the accounts.
4 A ®ling cabinet, £120, purchased for use in the business had been posted to the
purchases account.
5 An amount owing for electricity, £150, had been completely omitted from the accounts.
6 November's discount allowed total of £175 from the Cash Book had been posted to the
credit of Discount Received Account.
7 In the Sales Day Book, November's sales total was shown as £5,876 but should have
been £6,876.
8 An item relating to P Hancox, £340, from the Returns Outwards Day Book had not
been posted to his personal account.
9 No entries had been made for depreciation of motor vehicles for the year, £1,300.
10 The debit side of L Jones' account, a debtor, was over added by £20.
Note
After the necessary corrections were made, the suspense account was completely eliminated
from the accounts.
Required
(a) Prepare the suspense account, making such entries from the above
list of errors/omissions as you think necessary, to reveal the original
difference in the Trial Balance.
(13 marks)
The provisional net pro®t produced in the draft Pro®t and Loss Account was £26,424.
(b) Using the format shown below, show the effect, if any, of the correction of each error/
omission upon the provisional net pro®t of £26,424, arriving at a corrected net pro®t
for the year.
Correction of draft net pro®t for year ended 31 December Year 3
£
26,424
Draft net pro®t
Add
£
Deduct
£
Item No
Correct net pro®t for the year
(12 marks)
(Total 25 marks)
(LCCIEB 1997)
187
Lesson 18
Solution to Question 18.1
(a)
Journal entries
Year 6
31 Dec
31 Dec
31 Dec
31 Dec
31 Dec
31 Dec
Motor vehicles a/c
Motor vehicles running expenses
Suspense a/c
Purchase ledger control a/c
Suspense a/c
Discounts allowed a/c
Discounts received a/c
Sales ledger control a/c
Suspense a/c
Sales a/c
Suspense a/c
Discounts received a/c
Heat and light a/c
Suspense a/c
(b)
Dr
£
15,000
Cr
£
1,500
13,500
300
300
75
75
150
3,750
3,750
125
125
9
9
Suspense account
31 Dec
31 Dec
31 Dec
Balance
Sales
Discount received
£
9,934
3,750
125
31 Dec
31 Dec
31 Dec
£
13,500
300
9
Motor vehicles
Purchase ledger control
Heat and light
13,809
(c)
13,809
Pro®t
(1)
(2)
(3)
(4)
(5)
(6)
£
+1,500
0
7150
+3,750
+125
79
Solution to Question 18.2
(a)
Suspense account
Year 3
Dec 31
(1) R Meadow
(7) Sales
(10) L Jones
£
400
1,000
20
1,420
188
Year 3
Dec 31
Original error
(2) Fidelity insurance
(6) Discount allowed
Discount received
(8) P Hancox
£
£
675
55
175
175
350
340
1,420
Errors and the use of suspense accounts
Note
Same item on both sides ± lose mark for that item. Lose own ®gure mark if extraneous
items included.
(b)
Correction of draft net pro®t for year ended 31 December Year 3
£
26,424
Draft net pro®t
Add
£
Item
(2)
(3)
(4)
(5)
(6)
(7)
(9)
55
800
120
150
350
1,000
1,300
1,920
Corrected net pro®t for the year
Deduct
£
1,855
add
65
26,489
189
Lesson 19: Accounts interpretation
Lesson topics
.
.
.
.
.
Calculation of the stock turnover ratio
Calculation of the stockholding period
Calculation of ratios using information from the Trading, Pro®t and Loss Account
Calculation of ratios using information from the Balance Sheet
Preparation of ®nal accounts from the use of ratios
Extended Syllabus references
15.1
Ability to state formulae for ratios included in the syllabus
15.2.1
Calculation of pro®t as a percentage of capital employed
15.3.1
Calculation of ROCE where no funds are borrowed
15.3.2
Calculation of ROCE where funds are borrowed
15.4.1
Calculation of return on total shareholders' funds
15.4.3
Calculation of return on total capital employed, ie including borrowed funds
15.5.1
Calculation of gross pro®t as a percentage of sales (margin)
15.5.2
Calculation of net pro®t as a percentage of sales
15.6.2
Calculation of turnover of capital employed, ie sales divided by capital
employed
15.7
Understanding the relationship between ROCE, pro®t to sales and sales to
capital employed
15.9.2
Understanding the current ratio as being current assets : current liabilities or
creditors falling due within one year
15.9.3
Calculation of the current ratio
15.10.2 Calculation of the liquidity ratio
15.11.2 Calculation of average stocks
15.11.3 Calculation of annual rate of stock turnover
15.11.4 Calculation of average time that goods are carried in stock
15.13
190
Use of ratios to prepare simple, planned ®nancial statements, ie Trading,
Pro®t and Loss Account and Balance Sheet
Accounts interpretation
Aim of the lesson
At the end of the lesson the students will be able to calculate a number of measures ±
ratios and percentages, from information obtained from the ®nal accounts
The lesson
1
Begin the lesson by explaining to the class that the ®nal accounts of organisations are
used to calculate a variety of measures.
The measures calculated can relate to the performance of the organisation in past
accounting periods and how the current performance compares to them.
2
Explain to the class that the measures calculated from the ®nal accounts are referred to
as ratios. Explain that some of the calculations appear as ratios, such as 2 : 1, whereas
other measures are calculated as percentages (%).
3
Advise the class that questions set for this examination often will require the calculation
of ratios and percentages. However, the question may, at times, require comments on
the calculated measures, so candidates are advised to understand what the measures
mean and also be able to comment on them.
Advise the class that questions can be set when the ratios and percentages are given in
the question and the requirement is to prepare accounts from the measures provided.
4
Refer the class to the manufacturing account that appears on page 375 of the
Candidate's Guide book. Use this account to illustrate the calculations of the rate of
stock turnover and the average stockholding period.
Show the class how these two ratios are calculated by using the examples shown on
page 376 of the Candidate's Guide book.
Ask the class to be aware of the distinction between each of these ratios; the rate of
stock turnover calculates the number of times the average stock is consumed, whereas
the average stockholding period relates to the time the stock is held for.
5
Involve the class by asking the students to prepare an answer to Example 1 on page 377
of the Candidate's Guide book. Please note that the ratios for the year ended 31 March
Year 9 were calculated when the ratios were explained earlier to the class.
6
Explain the solution to the class and advise the students that the average stocks for the
years ended 31 March Year 7 and Year 8 are calculated as follows:
Opening stocks of raw materials plus closing stocks of raw materials
2
191
Lesson 19
The calculations are as follows:
For the year ended:
Year 7
Year 8
£13,800 + £11,800
2
£11,800 + £12,000
2
= £12,800
= £11,900
7
Advise the class of the trend shown by these ®gures. The stock turnover rate improves
from 10 times to 11 times and then falls to 8 times. This trend is also re¯ected by the
average stockholding period; it falls from 1.2 months to 1.09 months and then increases
to 1.5 months. Use the suggestions shown at the foot of page 377 of the Candidate's
Guide book to explain possible reasons for this trend.
8
Involve the class by asking the students to prepare an answer to Example 2 on page 378
of the Candidate's Guide book. Ask the class to recognise that questions requiring the
calculation of mark up and margin can appear in this area of the syllabus; the
calculations are not restricted to areas covered in earlier lessons.
9
Explain the solution to the class also using the Notes to the solution to assist your
explanation.
10 Refer the class to Example 3 on page 379 of the Candidate's Guide book and advise the
students that this example relates to the preparation of a planned Trading and Pro®t and
Loss Account by using a number of ratios and percentages.
11 Explain the solution to the example by using the approach, Points 1 to 6, shown on
page 380 of the Candidate's Guide book. Ask the class to recognise that information
relating to the opening stocks at the beginning of Year 8 also relates to the closing stocks
on hand at the end of Year 7 which were given in Example 2.
Expand on the explanation of Point 3 on page 380 of the Candidate's Guide book by
reminding the class that the stock turnover ratio is calculated as:
Cost of goods sold
Average stocks
12 Advise the class that the example provided the stock turnover ratio of 13 times and that
the total cost of goods sold have been calculated as £74,880. Therefore, the above
formulae now appears as:
£74,880
= 13 times
Average stocks
13 Advise the class that this will now allow the average stocks to be calculated as:
£74,880 = £5,760
13
192
Accounts interpretation
Expand upon the explanation in Point 4. Remind the class that the average stocks are
calculated as the formulae given earlier in the lesson. Explain to the class that in this
example the average stocks are £5,760 and that the opening stocks are £5,800.
Therefore, the formulae is used to appear as:
£5,800 + Closing stocks = £5,760
2
The formulae can be adapted to ®nd the value of the closing stocks:
£5,800 + Closing stocks = £5,76062
£5,800 + Closing stocks = £11,520
Closing stocks = £11,5207£5,800
Closing stocks = £5,720
14 Expand on the explanation in Point 5 to calculate the purchases. The example has
provided the ®gure for the opening stocks and calculations have been completed for the
closing stocks and cost of sales ®gures. Therefore the purchases ®gure is the missing
®gure in this presentation:
Opening stock
add Purchases
£
5,800 (provided)
74,800 (balancing ®gure)
less Closing stock
80,600 (closing stock + cost of sales)
5,720 (calculated)
Cost of sales
74,880 (calculated)
15 Explain the solution to the class, using the Notes to the solution. Note that the planned
margin and mark up ®gures have been calculated. You could ask the class to prepare
these ®gures, again!
16 Explain to the class that the Balance Sheet is also an area from which ratios and
percentages are calculated.
17 Use the explanations of the measures obtained from the Balance Sheet: owner's capital
to ®xed assets, current assets to current liabilities, and liquid assets to current liabilities.
These are provided on pages 381 and 382 of the Candidate's Guide book.
18 The solution explains that the Balance Sheet has not been presented in a good format.
To assist you in showing how the ratios are calculated, ask the class to prepare the
Balance Sheet in a vertical format that shows ®gures for ®xed assets, current assets,
amounts falling due within one year, amounts falling due in more than one year and the
owner's capital.
193
Lesson 19
The Balance Sheet should look like this:
Paul Lee
Balance Sheet at 31 December
Year 7
£
Fixed assets
Premises
Motor vehicle
Fixtures and ®ttings
Current assets
Stocks
Debtors
Bank
less Amounts due within
one year
Creditors
£
Year 8
£
68,900
9,800
2,950
79,900
8,800
2,680
81,650
91,380
6,580
960
890
7,800
880
340
8,430
9,020
1,760
1,840
Net current assets
Net assets
less Amounts due in more than one year
Loan from mother
Capital
£
6,670
7,180
88,320
98,560
20,000
29,000
68,320
69,560
68,320
69,560
19 Ask the class to recognise how these Balance Sheets allow the ®gures for the ratios to be
more readily obtained. For example, show the class how the ®gures for the current ratio
are obtained:
As at 31 December Year
These ®gures are netted down to these ratios
6
8,430 : 1,760
4.79 : 1
7
9,020 : 1,840
4.90 : 1
20 Explain the solution to the class and also use the Notes to the solution to assist your
explanation. Also give the class guidance as to the types of comments required; these are
provided on pages 383 and 384 of the Candidate's Guide book.
21 Involve the class by asking the students to prepare an answer to Example 5 on pages 384
and 385 of the Candidate's Guide book.
22 Explain the solution to the class and use the Notes to the solution to assist your
explanation. Advise the class that examination questions could be set that provide a
Balance Sheet and, unlike this example, do not classify the assets or the types of
liabilities.
194
Accounts interpretation
23 Advise the class that ratios can be prepared from information obtained from the Trading
and Pro®t and Loss Account and the Balance Sheet.
Use the explanation of the return on capital employed to provide the class with the ®rst
example of this ratio; information for the measure is obtained partially from the Pro®t
and Loss Account and partially from the Balance Sheet.
24 The explanation of this measure provides 3 possible calculations; these are explained as
follows:
Return on capital employed; pro®t/capital employed6100, based upon:
Capital employed at the beginning of the year:
£12,000
6100 = 15%
£80,000
Capital employed at the end of the year:
£12,000
6100 = 14.63%
£82,000
Average capital employed during the year:
£12,000
6100 = 14.81%
£81,000
25 Advise the class that if they are asked to calculate this measure in an examination, then
they should, unless instructed otherwise, use the capital employed at the end of the
year.
26 Explain that the return on capital employed measure can be in¯uenced by the business
borrowing funds. Use the example on page 387 of the Candidate's Guide book to
illustrate this item to the class.
Advise the class that the return on capital employed ratio can be calculated in two
ways:
(a) Using the total capital employed; owner's capital plus borrowings.
(b) Using only the owner's capital.
Advise the class that if the total capital employed is used, then the loan interest on the
borrowings should be added back to the net pro®t made before appropriation.
27 Explain the solutions to the calculations of the two ratios also using the reasoning for
how the calculations are made; these appear on pages 387 and 388 of the Candidate's
Guide book.
Advise the class that if the ratio is calculated for a company, then the ratio could relate to
the total capital employed and also the shareholders' funds.
195
Lesson 19
The shareholders' funds will include items such as: called up share capital, share
premium and the balance in the Pro®t and Loss Account.
28 Explain to the class the meaning and calculation of the measure of sales to capital
employed. Use the example of sales of £180,000 and capital employed of £100,000 to
illustrate the 3 ways in which the measure can be expressed. Show the class the
following ways to express the measure:
(a) As a percentage.
£180,000
6100 = 180%
£100,000
(b) As a ratio.
£180,000 : £100,000
This nets down to 1.8 : 1
29 Advise the class to always reduce the ratio to its lowest ®gure. This means that the right
hand side ®gure should be 1. For example, if the ®gures to be used in a ratio are 58 and
14, then the ratio is calculated as 58 divided by 14, this equals 4.14. Note that the
answer has been calculated to two decimal places. The ratio will be shown as 4.14 : 1.
(c) As a turnover rate.
£180,000
= 1.8 times
£100,000
30 Advise the class of the relationship between the return on capital employed ratio and
the pro®t to sales ratio.
Explain to the class that the relationship can be expressed as follows:
Pro®t to Sales Ratio6Sales to Capital Employed = Return on Capital Employed.
Explain that this relationship is based on:
Pro®t 6
Sales
=
Pro®t
Sales
Capital employed
Capital employed
Use the illustration on page 389 of the Candidate's Guide book to explain this
relationship.
31 Involve the class again, by asking the students to prepare an answer to Example 6 on
pages 390 and 391 of the Candidate's Guide book.
32 Explain the solution to the class and use the Notes to the solution in the Candidate's
Guide book to assist your explanation. Please emphasise Point 4 of the Notes. Advise
the students that if they are asked to comment on the ratios, then short answers will be
required.
33 Advise the class that questions can be set in this examination that require the
preparation of a Balance Sheet from information that includes accounting ratios.
196
Accounts interpretation
34 Use the following example to illustrate this item to the class.
A company, SA plc, has the following shareholders' funds at 31 December Year 9:
£'000
Called up share capital
6,000,000 Ordinary £1 shares
Share premium account
Pro®t and Loss Account
6,000
300
1,200
7,500
The following information relates to the year ended 31 December Year 9:
Shareholders' funds to ®xed asset ratio
Current ratio
1.25 : 1
1.5 : 1
The sales were all made on credit and amounted to £30 million. The debtors at
31 December Year 9 were an average of one month's sales for the year.
The stock of goods on hand at 31 December Year 9 also represents an average
of one month's sales for the year. The gross margin achieved in the year was 30%.
The current assets are made up of stocks, debtors and the bank balance.
The bank balance at 31 December Year 9 was £250,000.
The valuation of the ®xed assets at 31 December Year 9 is divided between
each of the classi®cations as follows:
Land and buildings 50%, ®xtures and ®ttings 30% and motor vehicles 20%.
Amounts falling due within one year consist of trade creditors only.
35 Ask the class to:
(a) Prepare the Balance Sheet for SA plc.
(b) Calculate the liquidity ratio at 31 December Year 9. Advise the class to calculate the
ratio to 2 decimal places.
36 Show the solution to the class and start by showing the students the following workings.
The shareholders' funds are 125% of the ®xed assets; refer the class to the shareholders'
funds to ®xed assets ratio. The ®xed assets are calculated as:
Shareholders' funds
6100%
125%
£7,500,000
6100% = £6,000,000
125%
197
Lesson 19
The calculation of the total value of the ®xed assets means that the valuation of each of the
classi®cations can be made:
Land and buildings £6,000,000650% = £3,000,000
Fixtures and ®ttings £6,000,000630% = £1,800,000
Motor vehicles £6,000,000620% = £1,200,000
The average monthly sales are calculated as:
Total sales
12 months
In this example this is calculated as:
£30 million
= £2,500,000
12 months
This ®gure also represents the debtors at 31 December Year 9.
The example quotes the gross margin as 30%. This means that the average monthly gross
pro®t is calculated as:
Average monthly sales6Gross margin
£2,500,000630% = £750,000
This means that the average monthly cost of sales is calculated as £2,500,000 less £750,000
= £1,750,000.
This is also the value of the stock on hand at 31 December Year 9.
The calculation of the ®gures for the debtors and stock means that the current assets are
made up as:
Stock
Debtors
Bank
£'000
1,750
2,500
250
4,500
The current ratio is given as 1.5 : 1, so the total of the current assets represents 1.5 in the
ratio. This means that the amount falling due within one year is calculated as:
£4,500,000
61 = £3,000,000
1.5
198
Accounts interpretation
The Balance Sheet can now be prepared:
SA plc
Balance Sheet at 31 December Year 9
£'000
£'000
Fixed assets
Land and buildings
Fixtures and ®ttings
Motor vehicles
£'000
3,000
1,800
1,200
6,000
Current assets
Stock
Debtors
Bank
Amount falling due within one year
Net current assets
1,750
2,500
250
4,500
3,000
1,500
7,500
Shareholders' funds
Called up share capital
6,000,000 Ordinary £1 shares
Share premium
Pro®t and loss
6,000
300
1,200
7,500
Advise the class that the liquidity ratio is calculated as:
Debtors plus Bank : Amounts due within one year
and is calculated by using the following ®gures (in £000s):
£2,500 plus £250 : £3,000
£2,750 : £3,000
0.92 : 1
QUESTIONS FOR CLASS PRACTICE
Question 19.1
The following information is available concerning the business of Henry Jackson, whose
®nancial year ends on 31 March:
1
The following applied at 31 March Year 8:
Current assets to amounts due within one year (current liabilities)
2:1
Liquid assets to amounts due within one year (current liabilities)
6:5
Debtors as a percentage of total sales for the year
15%
199
Lesson 19
2
The following applied:
Rate of stock turnover based on the average of opening and closing stocks
3
6 times
Mark up from cost of sales to selling price
30%
General expenses and depreciation together as a percentage of total sales
20%
Depreciation of ®xed assets is calculated each year at 15% on cost and the aggregate of
depreciation at 31 March Year 7 was £15,000. The cost of ®xed assets has remained
unchanged throughout the year to 31 March Year 8.
Required
In your Answer Book, set out the following outline for Trading and Pro®t and Loss
Accounts and the Balance Sheet of Henry Jackson.
Using the information given above, complete the accounts and Balance Sheet by calculating
the missing ®gures.
Note
All workings must be clearly shown.
Henry Jackson
Trading and Pro®t & Loss Account
for the year ended 31 March Year 8
Opening stock
Purchases
less Closing stock
?
?
Cost of goods sold
Gross pro®t c/d
?
?
General expenses
Depreciation of ®xed assets
Net pro®t
200
£
23,800
?
?
9,000
?
£
Sales
?
Gross pro®t b/d
?
Accounts interpretation
Balance Sheet at 31 March Year 8
£
£
Fixed assets
At cost
less depreciation to 31 March Year 8
?
?
Current assets
Stock
Debtors
Balance at bank
?
?
?
less Amounts due within one year
(current liabilities)
?
32,750
Net current assets (working capital)
Net assets
Financed by:
Capital at 1 April Year 7
add Net pro®t
less Drawings
Capital at 31 March Year 8
?
?
£
?
?
11,000
?
?
(Total 25 marks)
(LCCIEB 1997)
Question 19.2
James Tower owns a business for which the ®nancial year ends on 31 May.
On 31 May Year 8, the capital employed for the business was £150,000. The following
information relates to the year ended 31 May Year 8:
1
The sales to capital employed ratio was 150%.
2
The gross pro®t to sales ratio was 30%.
3
The stock turnover ratio was 15 times.
4
The cost value of the stock in hand at 1 June Year 7 was £9,000.
5
The net pro®t to sales ratio was 20%.
Required
(a) Using the above information, prepare a Trading and Pro®t and Loss Account
for James Tower for the year ended 31 May Year 8. Show all calculations. (12 marks)
201
Lesson 19
For the year ended 31 May Year 9, Tower wishes to increase the sales volume by 10%,
but feels he could only achieve this by reducing the selling prices by 2%.
He also wishes to maintain his stock turnover ratio at 15 times for the year. His suppliers
have indicated that they will keep the prices at the same levels as those incurred for the
year ended 31 May Year 8 for the goods purchased for re-sale.
Tower also wishes to maintain the same net pro®t to sales ratio that was achieved for the
year ended 31 May Year 8.
(b) Prepare the planned Trading and Pro®t and Loss Account for John Tower
for the year ended 31 May Year 9, in as much detail as possible.
Show all calculations.
(13 marks)
(Total 25 marks)
(LCCIEB 1998)
Question 19.3
The ®nancial accounts for Wenderby Supplies for Years 5 and 6 are summarised below:
Pro®t & Loss Accounts for the year to 31 December
£'000
Sales (all on credit)
less Cost of goods sold:
Opening stock
Purchases
50
1,100
less Closing stock
1,150
100
Gross pro®t
less Expenses
Overdraft interest
202
£'000
1,260
£'000
£'000
1,700
100
1,510
1,050
1,610
90
210
100
100
110
1,520
180
110
10
120
60
Accounts interpretation
Balance Sheets at 31 December
£'000
Fixed assets
Current assets:
Stocks (valued after physical stocktaking
at 31 December each year)
Trade debtors
Cash at bank
100
210
10
£'000
186
320
506
£'000
90
320
±
£'000
245
410
655
Financed by:
Capital
add Net pro®t for year
less Drawings
236
110
64
46
282
60
55
282
Amounts due within one year:
Creditors
Bank overdraft
224
±
224
506
5
287
280
88
368
655
Required
Showing your detailed workings, calculate the following ratios for each of Years 5 and 6,
correct to one decimal place:
(a)
(b)
(c)
(d)
(e)
Annual rate of stock turnover.
Net pro®t to sales (%).
Current ratio.
Liquidity ratio.
Return on capital employed (ROCE).
Note
You should set out your answer in the following format, showing your workings
underneath the statement:
Ratio
(a) Rate of stock turnover
(b) Net pro®t to sales (5)
(c) Current ratio
(d) Liquidity ratio
(e) Return on capital employed (ROCE)
Year 5
Year 6
(25 marks)
(LCCIEB 1996)
203
Lesson 19
Solution to Question 19.1
Henry Jackson
Trading and Pro®t & Loss Account
for the year ended 31 March Year 8
Opening stock
Purchases
£
23,800
152,400
less Closing stock
176,200
26,200
Cost of goods sold
Gross pro®t c/d
£
195,000
Sales
150,000
45,000
195,000
General expenses
Depreciation of ®xed assets
Net pro®t
30,000
9,000
6,000
45,000
195,000
Gross pro®t b/d
45,000
45,000
Balance Sheet at 31 March Year 8
Fixed assets
At cost
less Depreciation to 31 March Year 8
£
60,000
24,000
Current assets
Stock
Debtors
Balance at bank
26,200
29,250
10,050
£
36,000
65,500
less Amounts due within one year
(current liabilities)
Net current assets (working capital)
Financed by:
Capital at 1 April Year 7
add Net pro®t
less Drawings
Capital at 31 March Year 8
Workings
(a) Current assets = 26£32,750 = £65,500
(b) Liquid assets (Debtors + Bank): A/D 1 year = 6 : 5
; £32,75066/5 = £39,300
Stock = current assets 7 (Debtors + Bank)
= £65,500 7 £39,300 = £26,200
204
32,750
32,750
68,750
73,750
6,000
11,000
(5,000)
68,750
Accounts interpretation
(c) Working capital = CA 7 A/D 1 year
= £65,600 7 £32,750
= £32,750
(d) Rate of stock turnover = 6 times
; COGS = 66
(£23,800 + £26,200)
2
= £150,000
(e) Purchases
= Cost of goods available for sale less opening stock
ie (£150,000 + £26,200) 7 £23,800 = £152,400
(f)
= COGS6130/100
= £150,0006130/100
= £195,000
Sales
(g) General expenses + Depreciation
;General expenses
Net pro®t
=
=
=
=
£30% of £195,000
£39,000
£39,000 7 £9,000 = £30,000
£45,000 7 £39,000 = £6,000
(h) Depreciation £9,000 = 15% of cost
; cost = £9,0006100/15 = £60,000
Aggregate of depreciation at 31/3/8 = £15,000 + £9,000 = £24,000
Net value = £60,000 7 £24,000 = £36,000
( j)
Debtors = 15% of sales = £29,250
; Bank = Liquid assets 7 Debtors
= £39,300 7 £29,250
= £10,050
(k) Sum of assets = £36,000 + £32,750 = £68,750
Closing capital = sum of assets = £68,750
Add back Drawings and deduct Net pro®t
(£11,000)
(£6,000) = £73,750 opening capital
205
Lesson 19
Solution to Question 19.2
(a)
James Tower
Trading and Pro®t & Loss Account
for the year ended 31 May Year 8
£
Opening stock
Purchases
9,000
160,500
less Closing stock
169,500
12,000
Cost of sales
Gross pro®t c/d
157,500
67,500
225,000
Expenses
Net pro®t
22,500
45,000
67,500
(b)
Sales
225,000
Gross pro®t b/d
Opening stock
Purchases
£
12,000
172,350
less Closing stock
184,350
11,100
Expenses
Net pro®t
67,500
Sales
173,250
69,300
242,550
20,790
48,510
69,300
Gross pro®t b/d
Sales (£225,00061.1)60.98 = £242,550
Cost of sales (£225,00061.1) = £247,500 (before reduction)
670%
£173,250
Stock turnover ratio = 15
Cost of sales
Average stock
= 15
£
242,550
242,550
Workings for (b)
206
67,500
James Tower
Trading and Pro®t & Loss Account
for the year ended 31 May Year 9
Cost of sales
Gross pro®t c/d
;
£
225,000
69,300
69,300
Accounts interpretation
£173,250
; (£12,000 + Closing stock) = 15
2
;
;
£12,000 + Closing stock
= £11,550
2
Closing stock = £11,100
(£12,000 +2 £11,100 = £11,550)
Gross pro®t £242,550 7 £173,250 = £69,300
Net pro®t to sales = 20%6£242,550 = £48,510
; Expenses = £69,300 7 £48,510 = £20,790
Solution to Question 19.3
Wenderby Supplies
Year 5
Year 6
(a) Rate of stock turnover:
Cost of goods sold
Average stock
1,050
1,050
(50 + 100) =
75
2
=
14 times
1,520
(100 + 90)
2
=
8.7%
60
6100
1,700
=
1.4 : 1
410
368
=
1.1 : 1
1.0 : 1
320
368
=
0.9 : 1
1,520
95
=
= 16 times
=
3.5%
(b) Net pro®t to sales (%):
Net pro®t
6100
Sales
110
6100
1,260
(c) Current ratio:
Current assets
Current liabilities
320
224
(d) Liquidity ratio:
Current assets ± stock
Current liabilities
220
224
=
207
Lesson 19
(e) Return on capital employed (ROCE):
Net pro®t
6100
Capital employed
* 110
6100
236
Or
** 110
6100
286
Or
*** 110
6100
259
=
46.6%
60
6100
282
=
21.3%
=
39.0%
60
6100
287
=
20.9%
=
42.5%
60
6100
284.5
=
21.1%
Note
The alternatives in (e) represent
* Opening capital
** Closing capital
*** Average capital
The question stated that the answers should be correct to one decimal place. It is essential to
state ``times'' or ``%'' or ``: 1'' as appropriate for each ratio.
208
Lesson 20: Computerised book-keeping
and accounts
Lesson topic
Basic applications of book-keeping and accounting transactions in computer software
packages
Extended Syllabus references
The second line of the opening paragraph in the Extended Syllabus: ``the recording of
business transactions, including the in¯uence of Information Technology''.
1.4.5 Understanding in principle of how prime entry rules are applied in a
computerised accounting system
Aim of the lesson
At the end of the lesson the students will be able to have an appreciation of the basic
functions of a computer software package in relation to book-keeping and accounts
The lesson
1
Begin the lesson by advising the class that computers are part of the accountant's daily
life and are used in all types of business. The class would, therefore, bene®t from the use
of a computer software package that is related to book-keeping and accounts. The
package will not replace the course of study for the LCCIEB examination, but it could
help the students in the understanding of the subject.
Advise the class that the best course of study for the examination is to attend lessons and
to use the Candidate's Guide book!
2
Explain that a business can obtain a computer software package that will perform a
variety of book-keeping transactions. Examples of the type of transactions that can be
carried out by a computer software package are given at the bottom of page 399 of the
Candidate's Guide book.
3
Explain how an accounts code can be set up for the nominal ledger for a business. Use
the explanation given on page 400 of the Candidate's Guide book. Develop this
209
Lesson 20
explanation by using Example 1 on the same page of the Candidate's Guide book to
illustrate the types of account that are likely to be used with this type of business. Advise
the class that a structured and logical code system would be adopted similar to that
shown in the solution to the example.
4
Advise the class that when the code is set up, it is important to provide spaces for
additional items that the business could sell or purchase. Also the business may incur
different types of expenses or have different kinds of ®xed assets than it has at the
moment. Explain the solution to the class also using the Notes to the solution on page
401 of the Candidate's Guide book.
5
Advise the class that the sales ledger can also be maintained by the use of a computerised
software package. Explain the regular activities involved in the preparation of the sales
ledger. These are shown on page 403 of the Candidate's Guide book.
6
Use Example 2 on the same page of the Candidate's Guide book and explain the
solution to the class also using the Notes to the solution on page 404 to assist your
explanation.
7
Explain to the class that with the use of the computerised software package, the
balances, both debit and credit, in the sales ledger control account will automatically
agree with the total of the balances of the individual debtor accounts in the sales ledger.
8
Advise the class that the computer package will be programmed to post entries to the
sales ledger control account and the individual customer account automatically and at
the same time. This means that the accounts will agree, and is one of the reasons why
companies use the computerised systems.
Explain to the class that errors can occur, but these would not be the fault of the
computerised package. The error would be due to an omission or an error made at the
input stage of the process.
Advise the class of the types of error that could arise. Examples of these appear at the
bottom of page 404 of the Candidate's Guide book.
9
Advise the class that the purchase ledger can also be maintained by a software computer
package. Explain that a routine would be adopted that is similar to the preparation of
the computerised sales ledger.
10 Explain to the class how the cash receipts relating to the sales ledger and cash payments
relating to the purchase ledger would be dealt with by a computerised accounting
package.
Use the explanations provided on pages 405 and 406 of the Candidate's Guide book.
Advise the class of how the receipts from debtors would be related to particular sales
invoices. This means that a reference could be made within the computerised system to
relate the receipt to speci®c sales invoices. This, in turn, allows for each invoice to be
removed from the individual customer account when it has been paid. This will mean
210
Computerised book-keeping and accounts
that only those invoices that are outstanding will remain in the individual customer
account.
Explain to the class that this procedure would also apply to the payments in the
purchase ledger.
11 Explain how the other receipts and payments may be dealt with by the computerised
software package. Use Example 3 on page 406 of the Candidate's Guide book to
illustrate this procedure. Show the solution to the class. This appears on page 407 of the
Candidate's Guide book.
12 Explain to the class the type of reports that will be produced from the computer
software package at the end of each month. These are shown on page 407 of the
Candidate's Guide book.
Examples of these are shown on pages 407 and 408 of the Candidate's Guide book,
showing how a computerised ledger account will appear.
13 Advise the class that the examination will not include questions relating to the advanced
aspects of Information Technology and its relationship with book-keeping and
accounts. The levels of understanding required for this subject in the examination will
be no more than is covered in Chapter 17 of the Candidate's Guide book.
211