Fundamentals of Financial Accounting
Fourth Edition
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© 20
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Preface
The language of the International Financial Reporting Standards (IFRS) has become the
predominant globally recognised accounting language in most major capital markets. The
application of IFRS when preparing financial statements is a legal requirement for all public
companies and certain private companies in South Africa. These IFRSs bring transparency,
accountability and efficiency to financial markets in South Africa and around the world. With
increased globalisation, a standard recognised accounting language makes South African
companies comparable with the rest of the world.
Fundamentals of Financial Accounting deals with the concepts in the Conceptual Framework for
Financial Reporting (Conceptual Framework) as well as key principles from selected IFRSs, to the
degree that is possible in an introductory work on financial accounting. This work is written for an
introductory course in financial accounting and is aimed at students enrolled for a degree in
accounting or a degree in business studies, of which accounting is a substantial element. The
purpose of the work is to prepare students for further studies in financial accounting
Relevant routine transactions and events of a profit-orientated entity are contextualised and
repeatedly and consistently the recognition thereof is traced back to the Conceptual Framework
and represented by means of a journal entry. This work is unique due to the way in which concepts
and principles are integrated with the accumulation of transactions and events in accordance with
the double-entry system.
Certainly, the most important value that a textbook such as this one contributes to an introductory
course in financial accounting is that it equips students with the ability to journalise a selection of
relevant routine transactions and events with understanding, to accumulate these in accounts and
to present and disclose, by means of additional notes, these transactions and events.
Accounting records are currently mainly maintained by using computers and applicable software
packages. This phenomenon makes journalising with understanding an essential component of the
pedagogical approach followed in this work.
Changes made for the fourth edition
During March 2018, the International Accounting Standards Board (IASB) issued the revised
Conceptual Framework, replacing the previous version issued in 2010 (Conceptual Framework
2010). The revised Conceptual Framework has a fundamentally different recognition principle for
the elements of the financial statements, while many of the selected IFRSs, which are covered in
this work, are based on the previous recognition principle of definition and recognition criteria. The
authors debated this matter at length and concluded that in the interest of introductory and
consistent learning, the Conceptual Framework 2010 should be retained in Chapter 2 to form a
common foundational thread which could be used in the subsequent chapters as the previous
recognition principle still exists in most of the IFRSs. The revised Conceptual Framework is
introduced at the end of the work in a new chapter, Chapter 24. This approach is further supported
by the fact that the Conceptual Framework is not a Standard and that nothing in the Conceptual
Framework overrides any Standard or any requirement in a Standard. Therefore, the Standards are
used in solving accounting problems and the Conceptual Framework assists preparers to develop
accounting policies when no Standard applies to a particular transaction or event, or when the
Standard allows a choice of accounting policy. This approach does not detract from a conceptual
foundation for teaching and learning as the fundamental concepts in accounting remain.
The mission of the IFRS Foundation and the Board is to develop Standards that will result in
transparency, accountability and efficiency to financial markers globally. It is the intention of the
v
Board to serve the public interest of the public by fostering trust, growth and long-term financial
stability in the global economy. Chapter 24 outlines the mission statement and provides an
opportunity to link financial reporting to the concept of ethics.
In Chapter 8 (Value added tax), changes have been made to reflect the value added tax rate of
15%. This led to a consequential change to all examples in the work that reflect value added tax.
Recognition
The authors of the fourth edition recognise the contributions of the previous authors of the first,
second and third editions, namely KN Mans, Y de Wet, HC Ponting and K Dempsey.
A few remarks regarding the layout of this work
Chapter 2 deals with the Conceptual Framework in a unique way. These key concepts are
entrenched throughout the work and regularly assets and liabilities are justified and linked back to
these concepts.
Chapter 3 provides a framework for the presentation of financial statements of a profit orientated
sole proprietor. In Chapters 12 and 13 this framework is expanded to also provide disclosure in the
form of notes. At the end of Chapter 14, a framework for the presentation of financial statements,
together with applicable disclosure in the form of notes, is provided for a profit company.
For educational purposes a few aspects are initially dealt with as follows:
•
The perpetual inventory system is used in the first 5 chapters. The periodic inventory system
is introduced in Chapter 6 and dealt with in detail from Chapter 13.
•
Up to the end of Chapter 5 the effect that the journal entry has on the accounting equation is
reflected at the bottom of each journal. As from Chapter 6 this practice is replaced by
indicating between brackets next to each account mentioned in a journal entry, one of the
following abbreviations:
–
P/L (Profit or Loss) for income- and expense accounts;
–
SCE (Statement of Changes in Equity) for the capital- and distribution accounts; and
–
SFP (Statement of Financial Position) for asset accounts and liability accounts.
•
Value added tax is applicable only from Chapter 8.
•
The “simplified approach” as defined in IFRS 9 Financial Instruments is used in this work for
the impairment of trade receivables. This is considered appropriate as it fundamentally
establishes the core principles of accounting for expected credit losses which can be built on
in the later years of study.
•
The lease recognition exemption for the lessee is applied in the initial chapters until the lease
principles are covered in Chapter 15. Therefore, rental paid is expensed in the initial chapters
on short-term or low-value leases.
•
For the revised Conceptual Framework, only items that meet the definition of an element can
be recognised in the financial statements. However, not all items that meet the definition of
one of those elements are recognised. These are only recognised if they add useful
information that is relevant and faithfully represented. In this work, the elements are assumed
to be both relevant and a faithful representation.
The authors
November 2018
vi
Contents
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
Chapter 9
Chapter 10
Chapter 11
Chapter 12
Chapter 13
Chapter 14
Chapter 15
Chapter 16
Chapter 17
Chapter 18
Chapter 19
Chapter 20
Chapter 21
Chapter 22
Chapter 23
Chapter 24
Financial accounting – an introduction
Conceptual Framework for Financial Reporting 2010
Financial statements framework for a sole proprietor
Double entry rules and the application thereof
Recognition of transactions and events in the accounting records and the
presentation of account balances in the financial statements
Review and adjustments
The closing off process
Value added tax
Trade payables and trade receivables
Cash and cash equivalents
Computerised accounting systems
Property, plant and equipment
Inventories
Companies
Loans and leases
Non-current assets: Intangible assets – Trademarks and computer
software purchased
Non-current assets: Investment in subsidiary and other financial
investments
Non-current assets: Investment property
Provisions, contingent liabilities and contingent assets
Events after the reporting period
Statement of cash flows
Manufacturing entities
Revenue from contracts with customers
Revised Conceptual Framework for Financial Reporting
vii
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Chapter 1 Financial accounting – an introduction
Contents
The nature of financial accounting
The development of financial accounting
Origin of accounting
The influence of technological development
The influence of the development of forms of entities
Sole Proprietorship
Partnership
Company
The influence of the professional movement
Related fields of study
Management accounting
Financial Management
Auditing
Internal control
Taxation
International Financial Reporting Standards
Preface to International Financial Reporting Standards
The objectives of the IASB
Scope and authority of International Financial Reporting Standards
International Reporting Standards and this work
Why study accounting
1
Paragraph
1
6
6
10
14
17
20
24
27
34
35
37
38
40
43
45
45
47
48
53
56
Chapter 1 Financial accounting – an introduction
The nature of financial accounting
1
Human knowledge may be classified into two broad disciplines – natural sciences, (for
example Physics, Chemistry and Physiology) and social sciences (for example Psychology,
Economics and Accounting).
2
There are various definitions of financial accounting, but in our view the following description
embraces the essence of it:
The practice and knowledge of systematically identifying, measuring, recording and reporting
of quantitative and qualitative information in respect of economic activities of entities, that is
useful for users in making economic decisions.
3
It is important that the information provided by the accounting process is relevant, reliable,
comparable and understandable for users worldwide. Therefore, there are certain guidelines
with which one must comply. These guidelines are the set of assumptions, concepts,
principles, methods, procedures and standards jointly known as International Financial
Reporting Standards (IFRS) that were developed internationally by the accounting profession.
The treatment of accounting in this module is based on IFRS. Reference to IFRS will be
made throughout this work.
4
Financial accounting provides information to the owner and other users who are not involved
in the daily operations of the entity. The information is distributed through the financial
statements that are prepared at least annually. A set of financial statements usually includes
a statement of financial position, a statement of changes in equity, a statement of profit or
loss, a statement of cash flows and additional notes and annexures.
5
In the chapters that follow various concepts, principles and practices of financial accounting
are dealt with. This body of knowledge is directed towards one objective, namely communicating both financial and non-financial information about the entity to the stakeholders so
that they are able to understand the entity’s affairs and assess the uncertainties of the
general- and business environment in which the entity operates.
The development of financial accounting
Origin of accounting
6
Modern financial accounting had its origin in the form of the double entry system in Italy
towards the end of the 15th century.
7
Benedetto Cotrugli was probably the first writer on accounting. He completed a work on the
commercial function in 1458 and in one chapter presented a brief discussion of bookkeeping.
However, the work was published only some time later. The first published work was the full
description of the double-entry system by Luca Pacioli in his Summa de arithmetica
geometria proportioni et proportionalitate that was published in Venice in 1494. His Summa,
which was a mathematical work, contained a section on the Venetian method of double-entry
bookkeeping. Pacioli was an eminent sage and in the course of his career he served as
professor of mathematics at various universities in Italian cities. From 1514 onwards he was
professor at the Sapienza in Rome.
2
8
In the rest of Europe the first works on double-entry bookkeeping appeared towards the
middle of the 16th century: In Antwerp in 1543, in London in 1547 and in Germany in 1549.
9
In the main, the early literature described the technique of bookkeeping – of how transactions
could be recorded in accordance with the double-entry system. The development of the
theory of accounting, the why as opposed to the how, began only in the 19th century.
The influence of technological development
10
Technological development and its influence on economic development, and more
particularly on business management, was undoubtedly one of the most important factors in
the development of accounting.
11
From the middle of the 18th century a series of technological developments and inventions,
inter alia that of the steam engine by Watt, ushered in the Industrial Revolution in England,
Europe and the United States of America. These inventions and developments led to mass
production techniques and the erection of factories that replaced the home industries.
Businesses became capital intensive; the cost of buildings and equipment; which had
formerly not been an important factor, made up an ever-greater proportion of total production
costs. Far larger volumes of raw materials were handled in order to gain the benefits of mass
production, which meant that more raw materials and finished products were kept in stock.
Credit transactions in various forms grew in extent and transport, insurance and financing
services increased in significance. These phenomena led to the development of cost
accounting.
12
This development process is still in progress. Apart from the usefulness of extracting
information regarding the cost of an undertaking for the purposes of price and profit
determination, management also needs this information for the purposes of planning and
control. Management accounting thus developed out of cost accounting.
13
Technological developments regarding transport and specifically the Internet in the 20th
century led to globalisation. With world markets becoming more accessible, companies were
conducting business beyond their countries borders. There was a growing need to establish a
set of international accounting guidelines and in 2001 the International Accounting Standards
Board (IASB) was established. This board is responsible for the publication of the IFRSs.
The influence of the development of forms of entities
14
The development of different forms of entities from sole proprietorship, through partnerships,
to companies contributed greatly to the development of accounting.
15
Three forms of business ownership currently exist in South Africa. These are
16
•
a sole proprietorship;
•
a partnership; and
•
a company.
Entrepreneurs wishing to form a business entity consider a number of factors in deciding
which of the entity forms to choose. These factors include the number of owners, access to
funding, tax considerations and whether to operate as an unincorporated entity or as an
incorporated entity.
3
Sole Proprietorship
17
This type of business entity is owned by one person. For small entities this is a popular form
of ownership since there are no formal procedures required to set up the entity. Expansion in
the sole proprietorship is limited by the funding available to the owner.
18
The sole proprietorship or sole trader, as it is often referred to, is not a separate legal entity
apart from its owner. It cannot be involved in any legal relationship or activity except in the
name of the owner.
19
For normal tax purposes, the sole proprietor is not a separate taxable entity. Therefore the
owner is taxed on the activities of the business entity in his or her personal capacity.
Partnership
20
A partnership is used for relatively small business entities that wish to take advantage of
combined financial capital, managerial talent and experience. This form of entity is also frequently found amongst the professions, such as doctors, dentists, lawyers and accountants.
However, some of the large audit, tax and advisory practices have chosen to incorporate.
There are specific provisions in the existing Companies Act to cater for this.
21
A partnership is a legal relationship which arises as a result of an agreement between two or
more persons, but not exceeding twenty. The membership of organised professions which
are designated by the Minister of Trade and Industries may, however, exceed twenty.
22
No legislation exists in South Africa to control partnerships. The principles of common law are
therefore applicable. A partnership is also not a legal entity and it has no legal standing apart
from the members who constitute it. The individual partners are the joint owners of the assets
and are jointly and severally liable for the liabilities of the partnership. In other words, each
partner could incur unlimited liability for all the debts and obligations of the partnership.
23
A partnership is not taxed in its own right; it is not a taxable entity. The profits are taxed in the
hands of the individual partners.
Company
24
A company is a legal entity distinct from the persons who own it. The shareholders as a group
own the company through ownership of the shares issued by it. They do not personally own
its assets. They have no direct claim on the profit of the company. The profit becomes due to
them only if it is distributed by way of dividends. The shareholders appoint a board of
directors to conduct the activities of the company. A company, being a separate legal entity,
is liable to pay tax on its profits.
25
The two most important types of companies (according to the Companies Act 71 of 2008) are
known as the public company and the private company.
26
Accounting is a necessity in every entity, regardless of type or size. It is so important that a
full-time international body, the IASB, which represents accounting experts from several
countries, exists to provide guidance on how to account for items and transactions, and on
how this information should be communicated (presented). How transactions are recorded/
accounted for and how this information is communicated, is basically the same for all types of
entities. Therefore, in this work, the generic reference to a commercial enterprise as an entity
will mostly be used.
4
The influence of the professional movement
27
One of the most important stages in the development of accounting was undoubtedly the
emergence and development of the two professions of accountancy and auditing. Accounting
grew rapidly into a specialised discipline, and people began to qualify themselves in order to
enter the field in a professional capacity. The earliest reference to professional accountants is
as old as the literature on the double-entry system.
28
The formation of professional societies began towards the middle of the 19th century. The
year 1853 saw the establishment of the Society of Accountants in Edinburgh and of an
Institute of Accountants and Actuaries in Glasgow, and during the next two decades a number of similar societies were formed in England. In 1880, various professional accountants’
societies in Great Britain were amalgamated into the Institute of Chartered Accountants in
England and Wales, which developed into one of the most influential professional accountants’ societies.
29
In the United States of America, the first society of accountants was founded in New York in
1897. The Institute of Certified Public Accountants in the United States of America is today
one of the largest and most influential professional societies.
30
An important phase in the development of various professional societies was the decision to
make recommendations on accounting practice to members. In 1935, the American Accounting Association decided to formulate basic principles applicable to financial statements. In
1939, the American Institute of Certified Public Accountants initiated the publication of
bulletins on topical accounting subjects, and in 1942 the Institute of Chartered Accountants in
England and Wales commenced publication of a series of recommendations.
31
Today, the issuing of recommendations on accounting practice is one of the most important
functions of professional societies of accountants and auditors throughout the world.
32
The first organised society of accountants in South Africa came into being in 1894 with the
formation of the Institute of Accountants and Auditors in the then South African Republic.
Today the profession in South Africa is organised into various national accounting institutes of
societies, the most prominent being The South African Institute of Chartered Accountants
(SAICA) formed in 1980, and the South African Institute of Professional Accountants (SAIPA)
(formerly known as CFA and CPA).
33
In 1951, the Public Accountants’ and Auditors’ Act, which controls the practising section of the
accountancy profession in South Africa, was promulgated. This legislation created the Public
Accountants’ and Auditors’ Board, whose functions mostly entailed the registration of
accountants and auditors permitted to practice in public, discipline in the profession, and the
training of accountants. In 2006, the Independent Regulatory Board of Auditors was
established for the new auditing profession.
Related fields of study
34
During the past century various fields of study developed out of financial accounting, namely
management accounting and financial management. Other fields of study closely related to
financial accounting are auditing and taxation. Due to the historical course of events the
concept accounting was also used in the past to refer to the fields of study as a group. The
mastering of these fields of study on an integrated basis ensures the effective participation to
the economic environment.
5
Management accounting
35
Management accounting is a process of collecting, analysing, summarising and evaluating
various alternative courses of action. Its goal is to advise the management on the most
appropriate course of action based on the cost efficiency and capability. Cost accounting
provides the detailed cost information that management needs to control current operations
and plan for the future.
36
As mentioned above, management is also interested in the information contained in the
financial statements even though it has access to additional management and financial
information that helps it carry out its planning, decision-making and control responsibilities.
Financial Management
37
Financial management entails the planning, monitoring and controlling of the monetary
resources of an organisation in order to maximise shareholders wealth.
Auditing
38
In terms of the Companies Act 71 of 2008, certain companies are required to appoint an
auditor. It is the responsibility of the board of directors to have financial statements prepared
which fairly present the company’s financial position, performance and cash flows. The role of
the auditor is to express an opinion on the fair presentation of the information and whether or
not it has been prepared in accordance with IFRS.
39
An audit is carried out by a firm of independent auditors and, as such, adds credibility to the
financial statements.
Internal control
40
A sound system of internal control is important to ensure that the business organisation is
effectively and efficiently run, that the assets are safeguarded, and that the financial statements faithfully present the information which they purport to present.
41
A system of internal control ensures that:
42
•
the information the directors need to make decisions is available;
•
the delegated authorities are properly exercised;
•
the data needed for the control of costs is accurate and complete; and
•
the data needed for the preparation of financial statements is accurate and complete.
The internal control system is integral to ongoing business operations and is as important to
the continuation of the business as are market opportunities and cash flows. Internal control
is a subdivision of the subject Auditing.
Taxation
43
Accountants who are specialists in taxation assist their clients in planning their affairs in order
to minimise taxes payable. The taxes may, depending on the nature of the transaction,
include any of the following taxes: income tax, donations tax, estate duty, VAT and transfer
duty.
6
44
Tax specialists may also assist clients with the rendering of tax returns, the review of
assessments, objections to assessments with which the client disagrees and generally
assisting with any tax-related problems which might arise.
International Financial Reporting Standards
Preface to International Financial Reporting Standards
45
The IASB was established in 2001 and operates under the oversight of the IFRS Foundation
(previously International Accounting Standards Committee (IASC) Foundation). The governance of the IFRS Foundation rests with twenty Trustees. The Trustees’ responsibilities
include appointing the members of the IASB and associated councils and committees, as well
as securing financing for the organisation. The IASB comprises 14 full-time members.
Approval of IFRSs and related documents, such as the Conceptual drafts is the responsibility
of the IASB.
46
The IASB may amend or withdraw International Accounting Standards issued under previous
Constitutions of IASC as well as issue new Standards and Interpretations. When the term
IFRS is used, it includes standards approved by the IASB and International Accounting
Standards (IASs) issued under previous Constitutions. Also refer to paragraph 53.
The objectives of the IASB
47
The objectives of the IASB are:
•
to develop, in the public interest, a single set of high quality, understandable, enforceable and globally accepted financial reporting standards based on clearly articulated
principles. These standards should require high quality, transparent and comparable
information in financial statements and other financial reporting to help investors, other
participants in the various capital markets of the world and other users of financial
information make economic decisions;
•
to promote the use and rigorous application of those standards;
•
to take account of, as appropriate, the needs of a range of sizes and types of entities in
diverse economic settings; and
•
to promote and facilitate the adoption of IFRSs, being the standards and interpretations
issued by the IASB, through the convergence of national accounting standards and
IFRSs.
Scope and authority of International Financial Reporting Standards
48
IFRSs set out recognition, measurement, presentation and disclosure requirements
dealing with transactions and events that are important in general purpose financial statements. IFRSs are based on the Conceptual Framework for Financial Reporting (Conceptual
Framework), which addresses the concepts underlying the information presented in general
purpose financial statements. The objective of the Conceptual Framework is to facilitate the
consistent and logical formulation of IFRSs. The Conceptual Framework also provides a basis
for the use of judgement in resolving accounting issues. The Conceptual Framework 2010 is
dealt with in Chapter 2.
7
49
IFRSs are designed to apply to the general purpose financial statements and other financial
reporting of profit-oriented entities. Profit-oriented entities include those engaged in commercial, industrial, financial and similar activities, whether organised in corporate or in other
forms.
50
IFRSs apply to all general purpose financial statements. Such financial statements are
directed towards the common information needs of a wide range of users, for example, shareholders, creditors, employees and the public at large. The objective of financial statements is
to provide information about the financial position, performance and cash flows of an entity
that is useful to those users in making economic decisions.
51
A complete set of financial statements includes a statement of financial position, a statement
of profit and loss, a statement of changes in equity, a statement of cash flows and accounting
policies and explanatory notes. A statement of comprehensive income is not dealt with in this
work. Refer to Chapter 2 paragraph 12.
52
Standards approved by the IASB include paragraphs in bold type and plain type, which have
equal authority. Paragraphs in bold type indicate the main principles. An individual standard should be read in the context of the objective stated in that standard and the Preface to
International Financial Reporting Standards.
International Reporting Standards and this work
53
The following publications issued by the IASB are of particular interest with regards to the
studying of financial accounting:
•
Conceptual Framework for Financial Reporting;
•
International Financial Reporting Standards (IFRSs) – currently 17 standards; and
•
International Accounting Standards (IASs) – currently 28 standards.
54
The Conceptual Framework for Financial Reporting contains the basic concepts of accounting
which forms the foundation for the recognition and measurement of a variety of transactions
and events found in a profit-orientated entity. Each of the standards (IFRSs and IASs)
contains the principles, methods, procedures and rules applicable to transactions and events
in respect of a specific topic (for example inventories), which are important for general
purpose financial statements.
55
This work deals with the fundamentals of financial accounting. Consequently, the focus is on
the Conceptual Framework and a few standards. A (sometimes highly limited) selection of
principles, methods, procedures and rules which are contained in the following standards are,
to the degree that it is possible in an introductory work on financial accounting, dealt
with:
•
Preface to International Financial Reporting Standards;
•
Conceptual Framework for Financial Reporting;
•
IAS 1 Presentation of Financial Statements;
•
IAS 2 Inventories;
•
IAS 7 Statement of Cash Flows;
•
IAS 10 Events after the Reporting Period;
•
IAS 16 Property, Plant and Equipment;
8
•
IAS 23 Borrowing Costs;
•
IAS 32 Financial Instruments: Presentation;
•
IAS 33 Earnings per Share;
•
IAS 36 Impairment of Assets;
•
IAS 37 Provisions, Contingent Liabilities and Contingent Assets;
•
IAS 38 Intangible Assets;
•
IAS 40 Investment Property;
•
IFRS 7 Financial Instruments: Disclosure;
•
IFRS 9 Financial Instruments;
•
IFRS 15 Revenue from Contracts with Customers; and
•
IFRS 16 Leases
Why study accounting
56
A wide variety of career opportunities exist for those with training in accountancy. The
accounting profession enjoys a great deal of prestige in society and provides a great deal of
job satisfaction and security. The accountant, in the performance of his normal responsibilities, acquires a thorough insight into all the aspects of an entity’s activities. An accounting
qualification, and more specifically a professional qualification, is thus an excellent entry
opportunity into the business world.
9
Chapter 2 Conceptual Framework for Financial
Reporting 2010
Contents
Outline
General purpose financial statements
Objective of general purpose financial statements
Accrual accounting – the basis on which financial statements are prepared
Underlying assumption – going concern
Components of financial statements
Statement of financial position
Statement of profit or loss
Statement of cash flows
Statement of changes in equity
Notes and additional annexures
Users of financial statements
Reporting entity and related concepts
Reporting entity
Reporting period and the reporting date
Qualitative characteristics of useful financial information
Fundamental qualitative characteristics
Relevance
Faithful representation
Enhancing qualitative characteristics
The cost constraint on useful financial statements
Transactions and events
Transactions
Events
Elements of financial statements
Outline
Financial position
Introduction
The element assets
The definition of the element assets
A resource
Controlled by the entity
As a result of past events
Obtaining the risks and rewards associated with the right of ownership
Obtaining a right to claim
From which future economic benefits are expected to flow to the entity
The element liabilities
The definition of the element liabilities
A present obligation
Arising from past events
The settlement of the obligation (in the future) is expected to result in the
outflow of cash
The definition of the element equity (owner’s interest)
Financial performance
Introduction – the nature of retained earnings
Profit for the year
The definition of the element income
The definition of the element expenses
11
Paragraph
1
6
6
8
10
12
14
15
16
18
19
20
28
28
31
32
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34
35
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45
45
48
50
50
54
54
55
57
58
59
61
63
66
68
70
71
72
73
77
79
88
88
95
98
104
Recognition and measurement of the elements
Recognition
Measurement
Introduction
Measurement bases
The historical cost model
The fair value model
Subsequent measurement
Recognition criteria of an asset
The inflow of future economic benefits must be probable
The cost or value must be measured reliably
Recognition criteria of a liability
The outflow of future economic benefits must be probable
The cost or value must be measured reliably
Recognition and measurement of equity (only capital and drawings)
The nature, recognition and measurement of capital
The nature, recognition and measurement of drawings
Applications – Recognition and initial measurement of assets, liabilities and equity
(capital) within the framework of the accounting equation
Introduction
Recognition and initial measurement of the increase in the asset-item cash and
the increase in the associated equity-item capital
Recognition and initial measurement of the increase in the asset-item cash and
the increase in the associated liabilities-item loan received
Recognition and initial measurement of the increase in the asset-item trade
inventories and the increase in the associated liabilities-item trade payable
Recognition and initial measurement of the increase in the asset-item delivery
vehicle and the decrease in (derecognition of) the asset-item cash
Recognition criteria of income
Recognition criteria of an expense
Applications – Recognition and initial measurement of income and expenses within
the framework of the accounting equation
Introduction
Recognition and initial measurement of the increase in the expense-item
maintenance and the increase in the associated liabilities-item payable
Recognition and initial measurement of the increase in the expense-item wages
and the decrease in (derecognition of) the associated asset-item cash
Recognition and initial measurement of the increase in the income-item sales and
the increase in the associated asset-item cash
Recognition and initial measurement of the increase in the income-item sales and
the increase in the associated asset-item trade receivable
Recognition and initial measurement of the increase in the income-item rent
income and the increase in the associated asset-item cash
Derecognition of assets and liabilities
Derecognition of trade receivables
Derecognition of trade payables and loan
12
Paragraph
112
112
118
118
120
120
121
122
125
126
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135
136
139
142
142
147
155
164
177
185
188
191
191
193
206
215
232
249
259
262
263
Examples
Example
2.1
2.2
The dual effect of transactions on the accounting equation
The dual effect of transactions on the accounting equation
13
Chapter 2 Conceptual Framework for Financial
Reporting 2010
Outline
1
In this chapter, a conceptual framework for the recognition of transactions and events in the
accounting records/financial statements is dealt with on an introductory basis. During March
2018, the International Accounting Standards Board (IASB) issued the revised Conceptual
Framework for Financial Reporting (Conceptual Framework), replacing the previous version
of the Conceptual Framework issued in 2010 (Conceptual Framework 2010). The revised
Conceptual Framework has a fundamentally different recognition principle for the elements of
the financial statements, while many of the selected IFRSs that are covered in this work are
based on the old recognition principle of definition and recognition criteria. The authors
debated this matter at length and concluded that in the interest of introductory and consistent
learning, the Conceptual Framework 2010 should be retained in Chapter 2 to form a common
foundational thread which could be used in the subsequent chapters as the previous
recognition principle still exists in most of the IFRSs. The revised Conceptual Framework is
introduced in Chapter 24. This approach is further supported by the fact that the Conceptual
Framework is not a Standard and nothing in the Conceptual Framework overrides any
Standard or any requirement in a Standard. Therefore, the Standards are used in solving
accounting problems and the Conceptual Framework assists preparers to develop accounting
policies when no Standard applies to a particular transaction or event, or when the Standard
allows a choice of accounting policy. This approach does not detract from a conceptual
foundation for teaching and learning as the fundamental concepts in accounting remain. This
chapter therefore covers the Conceptual Framework 2010.
2
During September 2010, the International Accountings Standards Board (IASB) approved the
Conceptual Framework 2010. Set out in the Conceptual Framework 2010 are the concepts
and principles that underlie the preparation and presentation of financial statements. The
Conceptual Framework 2010 is incomplete, since there are parts subject to review or
completion. In July 2013, the IASB published Discussion Paper DP/2013/1 A Review of the
Conceptual Framework for Financial Reporting. This was followed by an Exposure Draft
ED/2015/3 Conceptual Framework for Financial Reporting in May 2015. In this chapter,
limited reference is made to the Discussion Paper DP/2013/1 and Exposure Draft ED/2015/3
and the focus is on the Conceptual Framework 2010.
3
In the introduction to the Conceptual Framework 2010 it is stated that this document
specifically aims at providing assistance to inter alia
4
•
the IASB as directive in respect of the development of new or the revision of existing
international financial reporting standards (IFRSs);
•
preparers of financial statements in respect of the application of IFRSs as well as in
respect of topics for which no IFRS currently exist; and
•
users of financial statements in interpreting the information in financial statements.
However, the Conceptual Framework 2010 does not mention that a conceptual or theoretical
framework is essential for studying the subject financial accounting.
14
5
The Conceptual Framework 2010 in this chapter (that is for financial reporting) deals with
•
general purpose financial statements;
•
the reporting entity and related concepts;
•
the qualitative characteristics of useful financial information;
•
transactions and events; and
•
the definition, recognition and measurement of the elements of financial statements.
General purpose financial statements
Objective of general purpose financial statements
6
The Conceptual Framework 2010 imported the comprehensive concept of financial reporting,
which comprises general purpose financial statements and other financial reporting. Other
financial reporting entails quantitative as well as qualitative information that are provided
outside the financial statements and assists in the interpretation of the financial statements or
improves a users’ ability to make the most efficient economic decisions. (Preface to IFRS.7)
The focus of this work is on financial reporting in the form of general purpose financial
statements.
7
Financial statements are a structured exposition of the financial position and the financial
performance of the reporting entity. The objective of general purpose financial statements
is to provide financial information about the financial position, the financial performance and
the cash flow of the reporting entity, which is useful to a wide range of users in making
economic decisions. Financial statements also reflect the result of the stewardship of an
entity’s management over the resources entrusted to them. To achieve this objective,
financial statements provide information about the reporting entity’s assets, liabilities, equity,
income, expenses and cash flow.
Accrual accounting – the basis on which financial statements are
prepared
8
In order to achieve the set objectives, the statement of profit or loss, the statement of
changes in equity and the statement of financial position are prepared from accounting
records in which the effect of transactions and events are, where applicable, accumulated in
accordance with accrual accounting.
9
In accordance with accrual accounting, the effect of transactions that are incurred on credit,
are recorded in the accounting records when the transaction or event is incurred and not only
at that point in time when settlement takes place. Or as stated in the Conceptual
Framework 2010.OB17, the effect of transactions and events is recognised in the period in
which it occurs, even if the resulting cash inflow or cash outflow occurs in a different period.
Or stated differently, in accordance with the accrual basis of accounting, items are recognised
as assets, liabilities, equity, income and expenses (that is the elements of financial
statements) when the items satisfy the definition and recognition criteria of that element. (IAS
1.28) The definitions and recognition criteria of elements are discussed later in this chapter.
The practical implication of accrual accounting is that the purchase of an asset on credit, the
receipt of a loan, the sale of trade inventories on credit, the incurrence of an expense on
credit and the subsequent settlement of the debt, are seperate transactions.
15
Underlying assumption – going concern
10
In this work, it is accepted that the entity is a going concern. The reporting entity normally
prepares financial statements on the assumption that the entity is a going concern and will
therefore continue to be in operation for the foreseeable future. Therefore, it is assumed that
that the entity has neither the intention nor the need to liquidate or curtail materially the scale
of its operations.
11
Foreseeable future relates to the 12-month period after the reporting date.
Components of financial statements
12
13
Financial statements comprise the following components:
•
the statement of financial position;
•
the statement of profit or loss;
•
the statement of cash flows;
•
the statement of changes in equity; and
•
notes and additional annexures.
There is a close relationship between the various components of financial statements. The
effect of a transaction or event resulting from the entity’s operating activities will usually
influence both the statement of profit or loss and the statement of financial position, whilst the
statement of cash flows is basically inferred from the other components of financial
statements. No single statement or even all the statements collectively provides all the
information that users of financial statements require. Financial statements are dealt with in
more detail in Chapter 3 and onwards. Subsequently, attention is paid to a brief overview of
each of the components of financial statements.
Statement of financial position
14
The statement of financial position reflects the extent and composition of the economic
resources (assets) of the reporting entity as well as the extent and composition of the claims
(liabilities) against such resources on a specific date, namely the reporting date. Since the
statement contains comparative amounts as at the previous reporting date, the statement
also reflects the effect of transactions and events on the resources and claims against the
resources in the previous reporting period as well as the changes between the reporting
periods. The owners’ interest, called equity, is the difference between the resources (assets)
of the reporting entity and the claims (liabilities) against such resources. The statement of
financial position was previously referred to as the balance sheet. Refer to the statement of
financial position as contained in Chapter 3.
Statement of profit or loss
15
The statement of profit or loss provides information about the financial performance of the
reporting entity during a specific period, namely the reporting period. Financial performance is
the relationship between the income and expenses of an entity for a reporting period. The
statement of profit or loss reflects the extent and composition of the income as well as the
extent and composition of the expenses for a specific reporting period. In this work it is
sufficient to use the term/title statement of profit or loss, since other comprehensive income
will not be dealt with. The statement of profit or loss was previously referred to as the income
statement. Refer to the statement of profit or loss as contained in Chapter 3.
16
Statement of cash flows
16
17
The statement of cash flows provides information in respect of:
•
the changes in the reporting entity’s financial position during a specific period in a
format that makes it possible to evaluate the entity’s investing, financing and operating
activities;
•
the manner in which cash and cash equivalents were obtained and utilised by the
entity; and
•
the ability of the entity to generate cash and cash equivalents.
Refer to the statement of cash flows as contained in Chapter 21.
Statement of changes in equity
18
The statement of changes in equity provides detail of the composition of the finance provided
by the owner(s) to the entity and the changes therein during a specific reporting period. The
statement of changes in equity reflects in respect of a specific reporting period, the extent of
and changes in capital contributions by the owner(s) as well as earnings that were retained in
the entity after distributions to the owner(s) (drawings) were made. Refer to the statement of
changes in equity as contained in Chapter 3.
Notes and additional annexures
19
The notes and the additional annexures to the financial statements provide information that is
necessary to understand the statements better. This includes information about the
accounting policy followed by the entity, risks and uncertainties that affect the reporting entity
as well as resources and claims/liabilities that are not recognised/included in the financial
statements.
Users of financial statements
20
The Conceptual Framework 2010 distinguishes between primary users and other users of
financial statements.
21
The majority of existing and potential investors, lenders and other payables cannot request
the reporting entity to provide information directly to them and consequently have to rely on
the general purpose financial statements of the reporting entity as their main source of
information in respect of the entity. Potential investors, lenders and other payables are
consequently seen as the primary or main users of general purpose financial statements.
(Conceptual Framework 2010.OB5) Other users are the government and government
institutions as well as members of the public such as customers, employees and the
community (Conceptual Framework 2010.OB10).
22
The objective of general purpose financial statements is to provide financial information in
respect of the reporting entity that is useful for existing and potential investors, lenders and
other payables when deciding on providing resources to the entity. The resources that
investors/owners provide to the entity take on the form of risk capital. Lenders provide loans
to the entity for which the entity provides some sort of security and other payables provide
resources to the entity in the form of credit. The financial statements should therefore provide
information that help primary users make rational decisions regarding investments and the
granting of credit.
23
The decisions of investors, lenders and other payables are usually made based on a forecast
of the reporting entity’s ability to generate net cash inflow in the future. The information
17
contained in the financial statements is useful for the primary users to make a forecast in
respect of the entity’s ability to generate cash and cash equivalents, the amounts, timing and
uncertainties of future cash flow and whether the entity will probably be successful in
obtaining loans in the future. Information regarding solvency and liquidity is used to forecast
the entity’s ability to timeously settle obligations/liabilities.
24
Investors, lenders and other payables often use historical information to determine future
prospects. So will the forecast of the net cash inflow that an entity will probably generate in
the future, at least partially be based on the historical performance of the entity. Historical
performance of an entity is also an indication of how effective the management’s stewardship
is over the economic resources entrusted to them.
25
General purpose financial statements do not provide all the information that existing and
potential investors, lenders and other payables require. These users will also consider other
sources of information such as general economic conditions and expectations, political
events and political climate, the relevant industry as well as the entity’s prospects. General
purpose financial statements are also not designed to indicate the value of the reporting
entity, but provide information that will help existing and potential investors, lenders and other
payables estimate the value of the reporting entity (Conceptual Framework 2010.OB6 and
OB7).
26
The management of a reporting entity is also interested in financial information regarding the
entity. Management however does not need to rely on general purpose financial statements,
since they can obtain the financial information internally (Conceptual Framework 2010.OB9).
27
Although other users (the government and government institutions, customers, employees
and the community) may also find general purpose financial statements useful, these
financial statements are not primarily directed to this other group of users (Conceptual
Framework 2010.OB10).
Reporting entity and related concepts
Reporting entity
28
When the transactions and events of an entity are recorded, classified and communicated in
financial statements, the boundaries of the entity in respect of which is reported on must
clearly be demarcated. The accounting entity concept is a fundamental concept in
Accounting. In accordance with this concept a specific enterprise/business is deemed to be
an entity that, for accounting purposes, operates totally separately from the owner(s) and also
separately from all other accounting entities. Accounting entities are therefore clearly
identifiable, separate enterprises.
29
The accounting process therefore focuses on setting procedures to accumulate all financial
information that relate to a specific entity in that reporting entity’s accounting records.
Financial information that does not pertain to the entity is not accumulated in the records of
the entity. For example, the purchase of water pipes by the owner of a plumbing business, for
use by the business, will be accumulated in the separate accounting records of the business.
On the other hand, the purchase of groceries by the owner for personal use bears no
reference to the owner’s plumbing business and will consequently not be accumulated in the
business’ financial records. A reporting entity can inter alia be a sole proprietor, a school, a
society or a company. The accounting entity concept is in respect of a company as a form of
18
an entity, in accordance with the Companies Act, which determines that a company is a
separate legal person that is independent from the shareholders (owners).
30
The reporting entity can formally be described as an entity in respect of which there are users
that rely on the financial statements of the entity as their main source of financial information
in respect of the entity. Consequently in this work, an enterprise is purposefully referred to as
an entity in order to emphasise the accounting separateness/distinctness of the enterprise.
Reporting period and the reporting date
31
In accordance with the time-interval concept of Accounting, the useful life of an entity is
divided into separate consecutive periods. The norm is consecutive periods of twelve months.
Each separate period is known as the reporting period. Each reporting period is reported on
in the form of the statement of profit or loss, the statement of changes in equity and the
statement of cash flows. The last day of a reporting period is known as the reporting date. On
each reporting date, a statement of financial position is prepared.
Qualitative characteristics of useful financial information
32
Subsequently, attention is given on an introductory basis to the characteristics that financial
information should comprise of to be useful. For financial information to be useful it should be
relevant and a faithful representation of what it purports to represent (Conceptual Framework
2010.QC4).
33
The Framework 2010 distinguishes between fundamental qualitative characteristics and
enhancing qualitative characteristics of financial information (Conceptual Framework
2010.QC4).
Fundamental qualitative characteristics
Relevance
34
Relevant financial information is capable of making a difference in decisions made by users.
Relevant information has one or both of the characteristics of confirmatory value or predictive
value (Conceptual Framework 2010.QC7). When evaluating the relevance of information,
materiality plays a role. Usually only material items are relevant, but the reporting entity has
to apply proper judgement to determine which items are not material. Information is seen to
be material if the omission or misstatement thereof could have an influence on the decisions
that users make based on the information (Conceptual Framework 2010.QC11).
Faithful representation
35
Financial statements represent economic phenomena that are expressed in words and
amounts. To be useful, financial information must not only represent relevant phenomena, but
it must also be a faithful representation of the phenomena it purports to represent. A perfectly
faithful representation contains three characteristics, namely it will be complete, neutral and
free from error. A perfect representation is probably not achievable, but it should be the aim
(Conceptual Framework 2010.QC12).
36
A complete representation includes all information necessary for a user to understand the
phenomena that is represented, including all necessary descriptions and explanations
(Conceptual Framework 2010.QC13).
19
37
A neutral representation is without bias in the selection and presentation of financial
information. A neutral representation is not slanted, weighted, emphasised, de-emphasised or
otherwise manipulated to increase the probability that financial information will be received
favourably or unfavourably by users (Conceptual Framework 2010.QC14).
38
Faithful representation does not mean accurate in all aspects. Free from error means there
are no errors or omissions in the description of the phenomenon. Free from error also means
that the selection and the application of the process followed to generate the information that
is represented is free from errors. The information contained in financial statements is, to a
large extent, based on estimates, the application of judgement, the usage of models and
methods and is therefore not exact representations (Conceptual Framework 2010.QC15).
Enhancing qualitative characteristics
39
Comparability, verifiability, timeliness and understandability are qualitative characteristics that
enhance the usefulness of information that is relevant and faithfully represented (Conceptual
Framework 2010.QC19).
40
Comparability of information for the reporting entity during and between reporting periods
and between entities enhances the usefulness of information for the users thereof.
Consistency is the most important characteristic that supports comparability. Consistency is
the use of the same methods for the same items, either in a single period within a reporting
entity or from period to period within a reporting entity or in a single period across entities.
Consistency is ensured if the number of accounting methods available to represent an
economic phenomenon is limited to the minimum (Conceptual Framework 2010.QC20 and
QC22).
41
Verifiability provides assurance to users that the information, as represented in the financial
reports, is a faithful representation of the phenomena that it purports to represent. Verifiability
means that an informed user can evaluate a depiction and decide whether it is a faithful
representation. Some depictions, such as the market value of listed shares, can be verified
explicitly whilst other depictions require the application of models and judgement.
(Conceptual Framework 2010.QC26).
42
Timeliness means to have information available on time so that the information has the
ability to influence the users’ decisions. Generally, the older the information, the less useful it
is for decision-making (Conceptual Framework 2010.QC27). Tension could exist between
supplying information on time and the faithful representation of information. In order to
provide information on time, it may be necessary to report on matters before all aspects of the
representation are known. Consequently, completeness and accuracy could be forfeited.
43
Understandability of information is brought about by appropriately classifying the information
and categorising it in a clear concise representation. In this regard it is accepted that users
have reasonable knowledge of business and economic activities as well as accounting and
that they are prepared to purposefully study the information. Information regarding complex
issues must not be left out merely because users might possibly not understand the
information (Conceptual Framework 2010.QC30 and QC31).
The cost constraint on useful financial statements
44
The cost in respect of the collection, processing and verification of information as well as the
preparation and distribution of the financial statements are essentially carried by the reporting
entity. A continuous constraint on supplying all financial information is the cost associated
20
with the preparation thereof. If the cost associated with the preparation of information
exceeds the benefit that would be obtained from supplying it, such information is usually not
provided, even if the information satisfies all qualitative characteristics. (Conceptual
Framework 2010.QC35 and QC36).
Transactions and events
Transactions
45
An entity’s participation in the economy occurs through transactions with other entities and
individuals. The majority of transactions entail the exchange of goods and services for cash.
For example, an entity purchases trade inventories from another entity, sells the trade
inventories to customers, pays salaries to employees for services delivered, etcetera.
46
Transactions with other entities and individuals always take on the form of a contract between
the related parties. The legal form of transactions in respect of the acquisition of goods and
services and the sale of trade inventories is a purchase contract, which can be a written or
oral agreement. The acquisition of property by an entity is also regulated by a purchase
contract, but in the case of property, the purchase contract has to be in writing. The
relationship between an entity and the entity’s employees is regulated by a written
employment contract. The relationship between the entity as a borrower of funds from a
financial institution, as lender of funds, is regulated by a written loan agreement. The legal
relationship between the lessee and the lessor of property is regulated by a written lease
agreement.
47
A second category of transactions has its origin from legislation. For instance, entities collect
Value Added Tax (VAT), Income tax and other levies on behalf of the government.
Events
48
Apart from transactions, there are events which an entity accumulates in the accounting
records in the same way as transactions. These events do not entail an exchange of goods or
services for cash. For example when an entity’s assets are destroyed in an incident (refer
Chapters 12 and 13) or when an entity is sued by one of its customers (refer Chapter 19).
Events usually originate from accounting processes such as subsequent measurement and
the adjustment process which is performed on each reporting date and inter alia result in the
recording of depreciation, doubtful debts, accrued and prepaid expenses and finance costs.
49
The financial effect of transactions and events are accumulated in the financial records of an
entity with reference to the elements of the end product of accounting, namely the financial
statements. The elements of financial statements are assets, liabilities, equity, income and
expenses.
Elements of financial statements
Outline
50
The end product of the accounting process is the delivery of four general purpose financial
statements, namely the statement of profit or loss, the statement of changes in equity, the
statement of financial position and the statement of cash flows.
21
51
General purpose financial statements provide information about the performance, financial
position and cash flow of an accounting entity that is useful to the owner and other users,
such as the providers of finance.
52
The financial statements of an entity describe the financial effect of transactions and events
by classifying these transactions and events in accordance with the economic characteristics
thereof into categories (named elements). The elements that relate directly to the
measurement of the financial position of the entity are assets, liabilities and equity and are
presented in the statement of financial position. The elements that relate directly to the
measurement of financial performance are income and expenses and are presented in the
statement of profit or loss.
53
Subsequently, the following will be dealt with in this section:
•
the definitions and recognition criteria of elements that relate to the financial position of
an entity;
•
the recognition of the elements that relate to the financial position of an entity;
•
the definitions and recognition criteria of elements that relate to the financial
performance of an entity;
•
the recognition of the elements that relate to the financial performance of an entity; and
•
the derecognition of elements.
Financial position
Introduction
54
The elements that relate directly to the measurement of the financial position are assets,
liabilities and equity and are presented in the statement of financial position. These elements
stand in a specific relationship to each other, which is called the accounting equation:
Assets
=
Liabilities
+
Equity
The element assets
55
The element assets comprise various asset-items. Examples of asset-items are land,
buildings, machinery, vehicles, equipment, trademarks (an acquired right to sell a specific
trademark product), trade inventories, trade receivables (arise from the sale of trade
inventories on credit), fixed term investments (investment of surplus cash) as well as cash
and cash equivalents (call deposits). Refer to the asset-items as presented in the statement
of financial position in the “Financial statements framework for a sole proprietor” as contained
in Chapter 3.
56
Although a number of assets have a physical form (e.g. property, plant and equipment,
inventories), it should be noted that physical form is not essential to the existence of an asset
(refer to chapter 16).
The definition of the element assets
57
The definition of an asset is as follows:
An asset is a resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity (Conceptual Framework
2010.4.4(a)).
22
A resource
58 A resource is that item/means that is employed in economic activities such as consumption,
production and sale. Examples of such resources in a trading environment are buildings,
machinery, equipment, trade inventories and trade receivables. A resource provides access
to benefits.
Controlled by the entity
59
Control is the ability of an entity to direct the use of an asset as well as to receive
substantially all of the remaining economic benefits associated with the asset. (IFRS 15.33)
The ability of an entity to direct the use of an asset and to receive the economic benefits
associated with the asset originates from rights that the entity has, namely right of ownership
or a right to claim or a right of use (refer Chapter 15 Part B). The mentioned rights (control)
are obtained as a result of past events.
60
An entity should consider indicators of the transfer of control, which include, but are not
limited to:
•
the entity has a present obligation for payment for the asset;
•
the entity has legal title to the asset;
•
the entity has physical possession of the asset; and
•
the entity has the significant risks and rewards of ownership of the asset. (IFRS 15.38)
As a result of past events
61 The past events are transactions that have already been incurred by the entity (in the past).
Examples of transactions in this regard are the purchase of an asset for cash or on credit and
the sale of trade inventories for cash or on credit.
62
Transactions/contracts that were incurred in the past and in accordance with which:
•
the risks and rewards associated with the right of ownership of an acquired asset were
transferred to the entity; or
•
the entity acquires the right to claim from a trade receivable consequent upon a credit
sale of trade inventories,
result in the entity controlling the asset.
Obtaining the risks and rewards associated with the right of ownership
63 The legal form of a transaction where asset-items (e.g. property, motor vehicles, machinery,
etc.) are purchased for cash or on credit is a purchase contract. This contract can be an oral
agreement, but in certain cases it has to be in writing. The risks and rewards associated with
the right of ownership of an asset that was purchased for cash or on credit, transfers to the
purchasing entity as soon as the supplier of the asset delivers the asset (in accordance with
the contract) to the purchasing entity. If an asset is purchased, the historical/past event that
results in control to the purchasing entity, is the transfer of the risks and rewards associated
with the right of ownership through the delivery of the asset by the supplier to the purchasing
entity (in accordance with the contract). Right of ownership (obtaining the risks and rewards
of ownership) of an acquired asset therefore do not transfer with the placement of an order,
the mere signing of a purchase contract or a payment to the supplier, but it transfers through
the delivery of the asset.
64
Right of ownership of land and buildings (property) transfers to the purchaser when the deeds
office registers the property in the name of the purchasing entity. The purchasing entity
receives a title deed which indicates that the purchaser is the owner of the property. Right of
23
ownership of acquired trademarks transfers to the purchaser as soon as the transfer of right
of ownership is, in accordance with the Act on Trademarks Nr 94 of 1993, registered in the
name of the purchaser. Right of ownership of the asset-item cash transfers with receipt of the
cash.
65
Right of ownership of assets such as property, machinery, equipment and trade inventories
includes rights of the owner such as:
•
the right to use the asset;
•
the right to sell the asset;
•
the right to let the asset; and
•
the right to pledge the asset to obtain a loan.
Obtaining a right to claim
66 Another important asset-item, namely trade receivables, arises when trade inventories are
sold on credit to customers. The legal form of a sales transaction is a purchase contract
which can be an oral agreement or in writing. An enforceable right to claim in respect of the
amount due by a trade receivable arises as soon as the sold trade inventories are delivered
to the customer (trade receivable) in accordance with the contract. A receivable (the right to
claim) is therefore a resource controlled by the selling entity based on the right to claim that
arose with the delivery of the goods to the receivable.
67
A right to claim of assets such as trade receivables includes rights to the selling entity such
as:
•
the right to collect the amount receivable;
•
the right to legally enforce the collection;
•
the right to pledge the amount due to obtain a loan; and
•
the right to sell the right to claim.
From which future economic benefits are expected to flow to the entity
68 The future economic benefit embodied in an asset, is the ability it has to contribute, directly or
indirectly, to the inflow of cash or cash equivalents to the entity or reduce cash outflows. The
inflow of economic benefits originates for instance from the use/utilisation of a building or the
sale of trade inventories. The requirement is that the future economic benefits associated with
an asset are expected to flow to the entity. Therefore, the requirement is not that they
will/must flow to the entity.
69
A purchase transaction of asset-items, such as buildings, machinery and delivery vehicles,
that establish the capacity and which is employed by an entity to conduct its operating
activities, is preceded by an investigation into the desirability of such a transaction. In the
process, attention is paid to whether the expected future economic benefits associated with
the asset will be sufficient. In this work it is accepted that a purchased item that satisfies the
definition of an asset, is expected to cause the inflow of future economic benefits, unless the
specific circumstances do not justify such a point of view.
The element liabilities
70
The element liabilities comprise various liability-items. Examples of liability-items are
mortgage bonds, bank loans, suppliers’ loans and payables. Refer to the liability-items as
presented in the statement of financial position in the “Financial statements framework for a
24
sole proprietor” as contained in Chapter 3 as well as the liability-items as listed in Chapter 4
paragraph 6.
The definition of the element liabilities
71
A liability is a present obligation of the entity arising from past events, the settlement of which
is expected to result in an outflow from the entity of resources embodying economic benefits
(Conceptual Framework 2010.4.4(b)). In this work, obligations will usually originate from a
contract or legislation and the obligation will be settled in cash.
A present obligation
72 A present obligation is a duty or responsibility to act in a certain way. The duty or
responsibility must already exist and not only in the future. A legal obligation means that the
obligation is enforceable in accordance with a contract (e.g. a purchase contract or a loan
agreement) or that it is enforceable in accordance with legislation. (The latter is dealt with in
Chapters 8 and 14.)
Arising from past events
73 The past events arise from transactions (contracts) incurred by the entity. Examples of
transactions in this regard are the purchase of an asset on credit, the incurrence of an
expense on credit and the incurrence of a loan.
74
The legal form of a purchase transaction is a purchase contract, which could be an oral
agreement or in writing. The purchase contract as such does not create an enforceable
obligation. A legally enforceable obligation arises only when the risks and rewards associated
with the right of ownership of the acquired asset (the purchased item) have been transferred
to the purchasing entity. The risks and rewards of the right of ownership transfer to the
purchasing entity on the date on which the supplier delivers the asset to the purchasing entity
in accordance with the contract. The historical/past event that causes a liability resulting from
the credit purchase of an asset is the transfer of the risks and rewards associated with the
right of ownership through delivery of the asset by the supplier to the purchasing entity in
accordance with the contract. The transfer of the risks and rewards associated with the right
of ownership through delivery (in accordance with the contract) of an asset that was
purchased on credit, is the past event that:
•
gives the purchasing entity control of the asset; as well as
•
causes a legal obligation for the purchasing entity.
75
A legal obligation can also arise due to a service being rendered to the entity on credit, e.g.
when an entity services its delivery vehicle, but for which payment occurs only 30 days after
the service delivery. The past event that causes a legal obligation consequent upon the
purchase of a service on credit is the satisfactory delivery /completion of the service by the
supplier in accordance with the contract previously incurred.
76
A legal obligation can also arise due to a loan that is incurred, e.g. when an entity signs a
loan agreement in accordance with which an amount (e.g. R500 000) is borrowed from a
bank (a separate accounting entity). Subsequent to the signing of the loan agreement, the
bank will transfer the loan amount to the entity. The past event in respect of the loan
transaction, which causes a legally enforceable obligation (a loan), is the receipt of the
borrowed amount by the borrower in accordance with the contract previously signed. The
mere signing of the loan agreement without any funds flowing does not cause a legally
enforceable obligation.
25
The settlement of the obligation (in the future) is expected to result in the outflow of cash
77 A legal obligation arises because a contract was incurred, in accordance with which:
78
•
an acquired item’s right of ownership was obtained; or
•
an acquired service was delivered satisfactorily; or
•
a loan amount was received.
The settlement of such a legal obligation is expected to result in the outflow of cash in the
future. The requirement is that cash is expected to flow from the entity when the obligation is
settled.
The definition of the element equity (owner’s interest)
79
The definition of equity is as follows:
Equity is the residual interest in the assets of the entity after deducting all its liabilities
(Conceptual Framework 2010.4.4(c)).
80
81
By defining equity as the remaining/residual interest in the context of the accounting equation
a closed system is created which forms the basis for:
•
the recordkeeping of the effect of transactions and events on the elements; and
•
the preparation of financial statements.
The definition of equity causes the following axiomatic (obvious) relationship between assets,
liabilities and equity:
Equity
82
84
85
Assets
–
Liabilities
In accordance with the accounting entity concept (paragraphs 28 to 30), the abovementioned
equation is however written as follows:
Assets
83
=
=
Liabilities
+
Equity
To put the elements that deal with the financial position of an entity (assets, liabilities and
equity) into context, refer to the statement of financial position as contained in Chapter 3. The
relevant statement of financial position provides detail of AC Entity’s financial position on
31 December 20.7. Naturally, the accounting equation is in balance as at the dates indicated:
Assets
=
Liabilities
+
Equity
31/12/20.6
12 937 055
=
4 790 000
+
8 147 055
31/12/20.7
14 408 535
=
4 897 015
+
9 511 520
The statement of financial position therefore indicates that the total assets of AC Entity on
31 December 20.7, namely R14 408 535, is financed as follows:
•
R4 897 015 by external parties (non-current liabilities and current liabilities); and
•
R9 511 520 by the owner.
The statement of financial position furthermore indicates that equity on 31 December 20.7 to
the amount of R9 511 520 comprises two items, namely capital of R6 500 000 and retained
earnings of R3 011 520.
26
86
The accounting equation can therefore be expanded as follows:
Assets
87
= Liabilities +
Capital
Equity
+
Retained earnings
Capital represents the cash or other assets (e.g. property and vehicles) that the owner makes
available to the entity. Retained earnings are the accumulated profits of the entity since the
inception of the entity, which have not been withdrawn by the owner. Distributions to the
owner are, in the context of a sole proprietor, known as drawings. The owner usually
withdraws a cash amount every month for personal use.
Financial performance (Profit/loss for the year)
Introduction – the nature of retained earnings
88
In paragraph 86 above, the accounting equation is indicated as follows:
Assets
89
= Liabilities +
Capital
Equity
+
Retained earnings
The abovementioned accounting equation can, with reference to the amounts as contained in
the statement of financial position of AC Entity in Chapter 3, be provided with the following
amounts:
=
R
4 790 000 +
Equity
Capital
+
Retained
earnings
R
R
6 000 000 +
2 147 055
14 408 535
=
4 897 015 +
6 500 000 +
3 011 520
1 471 480
increase
=
107 015 +
increase
500 000 +
increase
864 465
increase
Assets
31 Dec 20.6
R
12 937 055
31 Dec 20.7
Change
=
Liabilities
+
90
During 20.7 the assets increased with R1 471 480 due to the liabilities and equity that
collectively increased with R1 471 480. Capital increased with R500 000 because the owner
deposited a further R500 000 into AC Entity’s bank account.
91
The retained earnings concept is clearly illustrated in the statement of changes in equity.
Refer to the statement of changes in equity of AC Entity for the year/reporting period ended
31 December 20.7 in Chapter 3. During 20.7 the owner’s interest in AC Entity’s assets
increased from R8 147 055 to R9 511 520 because the owner’s capital contribution increased
with R500 000 and because retained earnings increased with R864 465 (R3 011 520 –
R2 147 055). Retained earnings increased with R864 465 because the entity made a profit of
R1 824 465 for 20.7, of which the owner withdrew R960 000 for personal use. The R864 465
can also be referred to as the retained earnings for the current year/reporting period. If the
statement of profit or loss as contained in Chapter 3 is referred to, it can be observed that the
profit for the year of R1 824 465 is calculated as the sum of the income-items (R12 819 735)
less the sum of the expense-items (R10 995 270).
27
92
With reference to the amounts as contained in the statement of changes in equity of
AC Entity in Chapter 3, retained earnings comprises the following components:
Profit for the current reporting period
Retained
earnings at the
end of the
reporting period
R
3 011 520
93
=
=
Retained
earnings at the
beginning of the
reporting period
R
2 147 055
+
+
Income for the
–
current reporting
period
R
12 819 735
Expenses for the
current reporting
period
– Distributions for
the current
reporting period
R
10 995 270 –
–
R
960 000
It is now possible to expand the accounting equation as follows:
Equity
Retained earnings
Profit for the year
Assets = Liabilities + Capital + Retained earnings + Income for – Expenses – Drawings
the year
for the year
opening balance
for the year
94
The abovementioned equation lays the foundation for recognising transactions and events in
the accounting records of an entity. In Accounting, there are only a few transactions/events
that reduce the retained earnings balance as at the beginning of the year. Such transactions/
events are dealt with in later years of study.
Profit for the year
95
Financial performance is the relationship between the income and expenses of an entity for a
reporting period. Performance of an entity for a reporting period is indicated as “Profit for the
period” or “Loss for the period”. A profit for a reporting period arises when the income is
greater than the expenses for the specific period. A loss for a reporting period arises when
the income is less than the expenses for the specific period. Refer to the statement of profit or
loss in Chapter 3 in which detail of the performance of AC Entity for the year/reporting period
ended 31 December 20.7 is indicated. The statement of profit or loss reflects that the profit for
20.7 is R1 824 465. The profit is calculated as the sum of the income-items less the sum of
the expense-items (R1 824 465 = R12 819 735 – R10 995 270). The statement of profit or
loss furthermore reflects detail of the different income and expense-items.
96
The elements that relate directly to the measurement of the financial performance (profit or
loss) of an entity are income and expenses and are presented in the statement of profit or
loss (Conceptual Framework 2010.4.24).
97
Income and expenses are defined within the framework of the accounting equation and are
named elements (Conceptual Framework 2010.4.24). However, income and expenses are
components of retained earnings, which belong to the element equity.
The definition of the element income
98
Income relates to a specific reporting period and is mainly the result of the operating activities
of an entity.
28
99
The definition of income is as follows:
Income is increases in economic benefits during the accounting period in the form of inflows
or enhancements of assets or decrease of liabilities that result in increases in equity, other
than those relating to contributions from equity participants (owner(s)) (Conceptual
Framework 2010.4.25(a)). Equity participants are the owner in respect of a sole proprietor
and the owners/shareholders in respect of a company. Income is therefore increases in cash
or other assets such as trade receivables that cause an increase in equity (retained
earnings). No other element of the accounting equation is affected by income.
100 Income comprises various income-items, e.g. sales, rent income and interest income. Sales
are the main income-item of a trading entity and represent the gross inflow of economic
benefits resulting from the sale of trade inventories by an entity. The sale of the trade
inventories can occur in accordance with a cash or credit transaction. The legal form of the
sales transaction is a purchase contract, which can be an oral agreement or in writing. If an
entity sells trade inventories, which cost R4 000, for R9 000 cash, the income-item sales is at
the gross amount, namely R9 000.
101 Additional to the main income-item sales, an entity can also obtain income resulting from:
•
the use of an entity’s assets by another party. The following is examples of such
income-items: rent income (because the entity lets a portion of its building – refer
Chapter 5), interest income or dividend income (because an entity invests funds – refer
Chapter 17) or profit on the subsequent measurement of an asset such as an
investment in shares (because the market value of the shares increased – refer
Chapter 17); and
•
the sale of a non-current asset item, for example profit on the sale of a delivery vehicle
(refer Chapter 12).
102 In the case of a service delivery entity, the main income-item is the relevant service that is
delivered. There are various services that can be delivered, for example medical services,
repair services, postal services, cosmetic services, etcetera.
103 Refer to Chapter 3 and note how the income-items of AC Entity for 20.7 are presented in the
statement of profit or loss for the year/reporting period ended 31 December 20.7. Note that
the performance of AC Entity for 20.7 is indicated as a profit of R1 824 465.
The definition of the element expenses
104 Expenses relate to a specific reporting period and are mainly the result of the operating
activities of an entity. Expenses are incurred to generate income.
105 The assets of an entity (such as machinery, equipment, delivery vehicles and trade
inventories) create the capacity for the execution of the operating activities. Operating
activities are activities of an entity which entail the utilisation of the entity’s assets, with the
aim of making a profit. The assets are usually purchased by the entity with cash made
available to the entity by the owner and long term lenders. To execute the operating activities,
the entity also needs employees, water and electricity, insurance, petrol, etcetera. Apart from
the acquisition of assets, the entity therefore also needs to incur monthly expenditure (e.g.
salaries, water and electricity, etc.) to execute operating activities.
29
106 The purchase of an asset such as equipment (office or computer equipment) by an entity
entails those cash flows out of the entity to obtain the right of ownership of the asset. The
economic benefits associated with the use of the equipment will flow to the entity over several
years.
107 An expense such as salaries is paid monthly by the entity and is time and again for work
done by the employees for a specific month. The salaries also hold economic benefits for the
entity. As opposed to most assets, where the economic benefits associated with the asset
flow to the entity over several years, the economic benefits associated with an expense such
as salaries are usually limited to a one month period.
108 The definition of expenses is therefore as follows:
Expenses are decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants (owner(s)) (Conceptual
Framework 2010.4.25(b)). Expenses are therefore decreases in cash or other assets (e.g.
trade inventories in respect of sales) or increases in liabilities (e.g. trade payables) that result
in a decrease in equity (retained earnings), excluding drawings.
109 Distributions to the equity participants (owner(s)) are, in the context of a sole proprietor,
known as drawings by the owner. The owner usually withdraws a cash amount every month
for personal use. Although drawings decrease the assets of an entity as well as the retained
earnings, it is not an expense, but a distribution to the owner. Drawings to the
owners/shareholders of a company are known as dividends distributed.
110 Expenses consist of various expense-items, e.g. cost of sales, salaries, wages, water and
electricity, telephone and communication. Refer to the statement of profit or loss of AC Entity
as contained in Chapter 3 and note how the expense-items of AC Entity for 20.7 are
presented in the statement of profit or loss for the year/reporting period ended 31 December
20.7. Note that the performance of AC Entity for 20.7 is indicated as a profit of R1 824 465.
Also refer to the list of expenses as set out in Chapter 4 paragraph 6.
111 Note the following in respect of equity (retained earnings):
•
If income increases, profit for the period will increase, which causes retained earnings
to increase, which again leads to an increase in equity.
•
If expenses increase, profit for the period will decrease, which causes retained earnings
to decrease, which again leads to a decrease in equity.
•
If drawings increase, retained earnings decreases, which results in a decrease in
equity.
Recognition and measurement of the elements
Recognition
112 Recognition is the process that causes the incorporation and accumulation of (an increase in)
an item that satisfies the definition and recognition criteria of an element in the accounting
records. Recognition also entails measurement; that is the allocation of a monetary amount to
the increase that is recognised. Measurement is further dealt with in paragraphs 118 to 124
below.
30
113 The description of the concept recognition, as set out in Conceptual Framework 2010.4.37,
places the focus on the recognition of items in the statement of profit or loss and the
statement of financial position. Financial statements are however prepared from financial
information that is accumulated in the financial records of the reporting entity. IFRSs focus on
reporting and not on the accumulation of financial information in the accounting records.
Transactions and events should consequently be accumulated in the accounting records in
such a manner that appropriate financial statements can be prepared from these records.
The incorporation of the effect of transactions and events in the accounting records occurs on
the basis of an analytical framework which is also known as the double entry system. The
double entry system is brilliantly designed and is derived from the accounting equation. The
double entry system is dealt with in Chapter 4.
114 An entity participates in the economy through transactions. The financial effect of transactions
and events (refer to paragraphs 45 to 49) is recognised in the financial records of an entity
with reference to the elements of financial statements. Each of the elements consists of
various items. For instance, the asset-element comprises inter alia office furniture, trade
inventories and bank.
115 A transaction or an event always has a financial effect on at least two items, which can
belong to the same element or two different elements. The financial effect of the transactions
and events causes the amounts of the elements to change (increase or decrease) due to the
fact that the amounts of the components of the elements (namely the individual items)
change.
116 Recognition should take place at a fixed date (that is determinable). The recognition of a
transaction or event must always occur in such a manner that the accounting equation
remains in balance.
117 As a result of the relationship that exists between the elements (Assets = Liabilities + Equity),
each transaction or event of an entity will result in one of the following four effects on the
elements of the accounting equation, which causes the accounting equation to always remain
in balance:
•
The transaction increases an asset and increases a liability or equity;
•
The transaction decreases an asset and decreases a liability or equity;
•
The transaction increases an asset and decreases another asset; and
•
The transaction increases a liability and decreases another liability or equity.
Measurement
Introduction
118 Measurement is the process whereby an entity determines the monetary amount at which
assets, liabilities, equity, income and expenses must be recognised (Conceptual Framework
2010.4.54). In this regard, distinction is made between initial measurement and subsequent
measurement. Initial measurement is the determination of the amount at which assets,
liabilities, equity, income and expenses are initially recognised in the accounting records.
Subsequent measurement is the remeasurement of assets and liabilities on the reporting
date and on each subsequent reporting date.
31
119 There are various models whereby measurement can occur. The nature of the cost that is
measured is a function of the measurement basis adopted by the entity. In this work, the
historical cost model is mainly used. The other model that is used in this work to a limited
degree is the fair value model.
Measurement bases
The historical cost model
120 In accordance with the historical cost model, assets, liabilities, equity, income and expenses
are, with initial recognition of the item, measured at the historical cost price. In respect of
initial measurement this work mostly deals with items of which the initial measurement is
either the invoice amount or, in the case of a loan, the amount received.
The fair value model
121 Although the fair value model is currently not mentioned in the Conceptual Framework 2010,
this model is described and applied in IFRSs. Fair value is the price that would be received to
sell an asset in an orderly transaction between market participants at the measurement date.
Subsequent measurement
122 Subsequent measurement is the remeasurement of assets and liabilities on the reporting
date and on each subsequent reporting date.
123 Subsequent measurement of assets and liabilities mostly occurs at the following costs, which
are derived from the historical cost price:
•
The subsequent measurement of land occurs at the historical cost price thereof. (Refer
Chapter 12)
•
The subsequent measurement of depreciable non-current assets (property, plant and
equipment) occurs at the depreciated cost thereof. (Refer Chapter 12)
•
The subsequent measurement of trade inventories occurs at the lower of cost price and
net realisable value. (Refer Chapter 13)
•
The subsequent measurement of a term deposit occurs at the amortised cost thereof.
(Refer Chapter 5)
•
The subsequent measurement of trade receivables occurs at the amount that would
probably be received, namely the outstanding invoice price less the allowance for
doubtful debts. (Refer Chapter 9)
•
The subsequent measurement of trade payables occurs at the amount that would be
paid, namely the outstanding invoice price. (Refer Chapter 9)
•
The subsequent measurement of a loan received occurs at the amortised cost thereof.
(Refer Chapters 5 and 15)
•
The subsequent measurement of an investment in the ordinary shares on an unlisted
company occurs in this work at the historical cost price thereof. (Refer Chapter 17)
124 The subsequent measurement of investment property (Refer Chapter 18) and an investment
in the ordinary shares of a listed company (Refer Chapter 17) occurs in this work at the fair
value thereof.
32
Recognition criteria of an asset
125 An item that meets the definition of an asset is recognised only if it satisfies both the following
two recognition criteria:
•
it is probable that any future economic benefit associated with the item will flow to the
entity; and
•
the item has a cost or a value that can be measured with reliability (Conceptual
Framework 2010.4.44).
The inflow of future economic benefits must be probable
126 The concept probable that is used in the recognition criteria refers to the degree of
uncertainty that future economic benefits, which are associated with the relevant asset-item,
will indeed flow to the entity. The concept fits in with the uncertainty of the environment in
which the entity operates (Conceptual Framework 2010.4.40). The meaning that must be
attached to probable, is more likely than not, therefore the probability is greater than 50%.
127 An acquired asset-item that satisfies the definition of an asset, will probably cause the inflow
of future economic benefits, unless the detail of the given circumstances does not justify such
a point of view. The purchase of an asset by the entity, such as a delivery vehicle, is
preceded by an investigation into the desirability of the purchase. In the process, attention is
paid to whether the expected future economic benefits associated with the asset will be
sufficient to justify the purchase. (Such investment decisions are dealt with in the course
Financial Management.)
The cost or value must be measured reliably
128 Assets are, with initial recognition, measured at the historical cost price thereof. The historical
cost price of an asset is the cash price of the asset, which is usually the invoice price.
129 In this work it is accepted that the cost of an asset can, with initial recognition, be measured
reliably at the historical cost price thereof.
Recognition criteria of a liability
130 An item that meets the definition of a liability is recognised only if it satisfies both the following
recognition criteria:
•
It is probable that any future economic benefits associated with the item will flow from
the entity; and
•
The amount at which the settlement will take place can be measured reliably
(Conceptual Framework 2010.4.46).
The outflow of future economic benefits must be probable
131 The concept probable that is used in the recognition criteria refers to the degree of
uncertainty that future economic benefits will indeed flow from the entity. The meaning that
must be attached to probable, is more likely than not, therefore the probability is greater
than 50%.
132 The future settlement of an item that satisfies the definition of a liability must also be
probable. The existence of a legal obligation (in accordance with a contract or legislation)
leaves the entity no other choice but to settle the obligation on the date as stipulated in the
purchase contract or the loan agreement or by legislation. Settlement of the obligation entails
33
the outflow of cash in the future. However, this is not always the case and will be dealt with in
Chapter 19.
The cost or value must be measured reliably
133 Liabilities are, with initial recognition, measured at the historical cost price thereof. The
historical cost price of a liability is the invoice price in the case of the credit purchase of an
asset or a service and, in respect of a loan incurred, it is the amount received.
134 In this work it is accepted that the cost of a liability can, with initial recognition, be measured
reliably at the historical cost price thereof. There are however also liabilities of which the
amount and the settlement date are unknown because the origin/source of the liability is not
an incurred contract. An example of such a liability is a claim for damages instituted against
the entity by a customer. The amount of the liability as well as the settlement date would have
to be determined through negotiations or a settlement agreement or through a court order.
Such liabilities with unspecified payment conditions are defined as a “Provision” and are
dealt with in Chapter 19.
Recognition and measurement of equity (only capital and drawings)
135 The recognition and measurement of transactions with the owner are dealt with below.
Transactions with the owner entail capital contributions by the owner as well as drawings by
the owner.
The nature, recognition and measurement of capital
136 Capital represents the cash or other resources that the owner makes available to the entity.
From the owner’s perspective the resources that are transferred to the entity are an
investment for the owner on which a return (drawings/dividends) is expected.
137 In Accounting, the entity operates totally separate from the owner(s) and also separate from
all other accounting entities (reporting entities). The resources that the owner of a sole
proprietor makes available to the entity are controlled by the entity. The resources can
comprise cash and other assets such as land, buildings, furniture and equipment.
138 The transaction in accordance with which resources (cash and other assets) are transferred
by the owner to the entity, bring about the following items: the asset-items for example cash
or other assets and the equity-item capital. If the resources that the owner transferred to the
entity satisfy the definition and recognition criteria of an asset, the increase in the asset-item
is recognised on the day on which the asset-item is received. An increase in the equity-item
capital is recognised at the same time. The recognition occurs at the amount at which the
cash or the other asset increases and indeed on the day on which the cash or the other asset
is received.
The nature, recognition and measurement of drawings
139 In the context of a sole proprietor, distributions to the owner are known as drawings. The
owner usually withdraws a cash amount for personal use every month. Drawings by the
owner decrease the assets of the entity as well as the equity, more specifically the retained
earnings, of the entity.
140 Drawings by the owner usually entails that the owner takes cash from the entity. Drawings
can however also occur through the owner taking trade inventories of the entity for personal
use or where the entity makes a payment on behalf of the owner or is legally obliged to make
such a payment in the future. For instance, if the entity has the owner’s private vehicle
serviced and pays for the service or has an obligation to pay within 30 days, the following
34
items are brought about by the transaction: the equity-item, more specifically the retained
earnings-item, drawings and the asset-item cash or the liabilities-item payable (if the payment
does not occur immediately, but is postponed through the utilisation of credit).
141 Drawings are recognised by decreasing equity (retained earnings) and at the same time
recognising the decrease in the asset-item cash or trade inventories or recognising the
increase in the liabilities-item payable. The recognition occurs at the amount with which the
cash or the trade inventories decreases or the payable increases on the day on which the
cash or trade inventories decrease or the payable increases.
Applications – Recognition and initial measurement of assets, liabilities
and equity (capital) within the framework of the accounting equation
Introduction
142 The element assets comprise various asset-items, e.g. machinery, vehicles, equipment, trade
inventories and trade receivables. The element liabilities also comprise various liability-items,
e.g. loan received and trade payables. The element equity comprises the following two items,
namely capital and retained earnings. The equity-item retained earnings in turn comprise
income-items, e.g. sales and rent income, and expense-items, e.g. cost of sales, salaries and
water and electricity, and the item drawings.
143 As a result of the relationship that exists between the elements (Assets = Liabilities + Equity),
each single transaction or event that brings about the recognition of an asset and/or the
recognition of a liability and/or the recognition of equity (more specifically capital), will result in
one of the following dual effects on the elements of the accounting equation:
•
An asset-item (e.g. cash) increases and the equity-item capital increases (because the
owner made an asset, e.g. cash or land and buildings, available to the entity);
•
An asset-item (e.g. cash) increases and a liabilities-item (e.g. bank loan) increases
(because the entity received a borrowed amount);
•
An asset-item (e.g. delivery vehicle or trade inventories) increases and a liabilities-item
(e.g. payable/trade payable) increases (because the entity purchased the said assets
on credit); or
•
An asset-item (e.g. delivery vehicle or trade inventories) increases and an asset-item
(e.g. cash) decreases (because the entity purchased the said assets for cash).
144 Transactions that have an effect on retained earnings are dealt with in the following section.
145 With reference to the cases mentioned in the preceding paragraph, the recognition of assets,
liabilities and equity (more specifically capital) are subsequently dealt with. Various aspects of
the recognition of assets, liabilities and equity are dealt with. The dual effect of the
transactions is at this stage recognised within the framework of the accounting equation.
146 In respect of each of the transactions, the items that are brought about by the relevant
transaction are indicated. Thereafter, as in paragraph 150 and 151 below, it is then every
time demonstrated that each of the identified items indeed satisfies the definition and
recognition criteria of the relevant element.
35
Recognition and initial measurement of the increase in the asset-item cash and the
increase in the associated equity-item capital
147 If the owner deposits an amount in the entity’s bank account being the owner’s capital
contribution, the two items brought about by the transaction are the asset-item cash/bank (an
increase) and the equity-item capital (an increase).
148 Cash and cash equivalents include cash in the general sense of the word, but usually refer to
cash in the bank. Cash in the bank means that an entity transfers/deposits the cash that an
entity has on hand into a bank account at a registered bank. If an entity wants to appropriate
some of the cash in the bank, a written instruction (e.g. a cheque) or an electronic instruction
(an EFT) is given to the bank to appropriate the cash in the bank on behalf of the entity.
149 Take the following applicable transaction as an example:
On 2 January 20.7 the owner deposited an amount of R4 500 000 into AC Entity’s bank
account being his capital contribution.
150 Cash received in accordance with a transaction because the owner made a capital
contribution is recognised if the cash received satisfies the definition and recognition criteria
of an asset. The Conceptual Framework 2010 does not contain guidelines for the recognition
of capital. In this work, the equity-item capital is recognised when the associated asset-item is
recognised. It can be indicated as follows that cash satisfies the definition of an asset:
Definition of an asset
Application – cash
An asset is a resource
Cash is a resource that can be utilised by AC Entity, for
example to buy other assets or to pay salaries.
controlled by the entity as a
result of past events
The entity has the legal right to the cash. As a result, the
entity will have the ability to direct the right of use of the
cash and will obtain substantially all the remaining
benefits from the cash.
The past event is the owner depositing the money into the
entity’s account as capital.
and from which future
economic benefits are expected
to flow to the entity.
Cash can for example be utilised to purchase assets or to
pay employees, which will lead to the future inflow of
economic benefits such as cash.
36
151 It can be indicated as follows that cash satisfies the recognition criteria of an asset:
Recognition criteria of an asset Application – cash
An item that meets the definition
of an asset is recognised only if
it satisfies both the following
recognition criteria:
As set out above, the asset-item cash satisfies the
definition of an asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
As the cash has already been received (on 2 January
20.7), the inflow is guaranteed and therefore probable.
the item has a cost or a value
that can be measured with
reliability.
Cash can be measured reliably as the amount received,
namely R4 500 000.
152 The increase in the asset-item cash and the associated increase in the equity-item capital is
recognised on the day on which the cash is received, in other words the day on which the
owner made the deposit, namely 2 January 20.7. This date represents the date on which the
cash satisfied the definition and recognition criteria of an asset. The amount of the increase is
the amount of the capital contribution by the owner.
153 The element assets increase (because the asset-item cash increases) and the element equity
increases (because the equity-item capital increases). The accounting equation consequently
remains in balance.
154 The recognition of the increase in the asset-item cash and the increase in the equity-item
capital occur as follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
Classification
+4 500 000
=
0
+
+4 500 000
Capital
(Cash)
Remark in respect of the accounting equation
1
The classification column in the accounting equation relates to the equity-column. If a
transaction changes equity, detail is provided in the classification column about the
component of equity that changed. There are four possibilities, namely Capital,
Retained earnings – income, Retained earnings – expense and Retained earnings –
drawings.
Recognition and initial measurement of the increase in the asset-item cash and the
increase in the associated liabilities-item loan received
155 If a loan is incurred with a financial institution, the two items brought about by the transaction
are the asset-item cash/bank (an increase) and the liabilities-item loan (an increase).
156 Cash received in accordance with a loan agreement, is recognised if the cash satisfies the
definition and recognition criteria of an asset and if the loan satisfies the definition and
recognition criteria of a liability.
37
157 Take the following appropriate transaction as an example:
On 4 January 20.7, AC Entity received a bank loan of R800 000. The contract was signed on
19 December 20.6.
158 It is already indicated in paragraphs 150 and 151 that cash satisfies the definition and
recognition criteria of an asset.
159 It can be indicated as follows that a bank loan received satisfies the definition of a liability:
Definition of a liability
Application – bank loan
A liability is a present obligation As a result of the transfer of the loan amount by the
of the entity
financial institution to AC Entity in accordance with the
written loan agreement, the financial institution has a
legally enforceable right to claim from AC Entity and
AC Entity has a legally enforceable obligation towards the
financial institution.
arising from past events
The transfer of the loan amount on 4 January 20.7 in
accordance with the loan agreement, is the past event
that gave rise to the present, legal obligation of AC Entity.
the settlement (in the future) is The settlement of the obligation (bank loan) is expected
expected to result in an outflow to result in the outflow of cash in the future, for AC Entity.
of
resources
embodying
economic benefits.
160 It can be indicated as follows that a bank loan received satisfies the recognition criteria of a
liability:
Recognition criteria of a
liability
Application – bank loan
An item that meets the definition
of a liability is recognised only if
it satisfies both the following
recognition criteria:
As set out above, a bank loan received satisfies the
definition of a liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The existence of the legal obligation on 4 January 20.7
(the day on which AC Entity received the loan amount in
accordance with the loan agreement) leaves AC Entity no
other choice but to settle the obligation on the future date
as stipulated in the loan agreement.
the item has a cost or a value
that can be measured reliably.
The cost of the bank loan can be measured reliably at
the historical cost price thereof, namely the loan amount
of R800 000 that was received in accordance with the
loan agreement.
161 A legal obligation towards the financial institution, which satisfies the definition and
recognition criteria of a liability, arises on the day on which the money was received from the
financial institution (4 January 20.7). The increase in the asset-item cash and the increase in
the associated liabilities-item bank loan are recognised on the day on which the cash is
received. The increases are measured at the amount of the loan received.
38
162 The element assets increase (because the asset-item cash increases) and the element
liabilities increase (because the liabilities-item bank loan increases). The accounting equation
consequently remains in balance.
163 The recognition of the increase in the asset-item cash and the increase in the liabilities-item
bank loan occur as follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
+800 000
=
+800 000
+
0
(Cash)
Classification
(Bank loan)
Recognition and initial measurement of the increase in the asset-item trade
inventories and the increase in the associated liabilities-item trade payable
164 If trade inventories are purchased on credit, the two items brought about by the transaction
are the asset-item trade inventories (an increase) and the liabilities-item trade payable (an
increase).
165 Take the following appropriate transaction as an example:
AC Entity, that uses the perpetual inventory system, purchased trade inventories on credit
from Payable L for R226 000. The trade inventories were received on 1 March 20.7 and the
debt is payable on or before 31 March 20.7.
Remarks
1
In accordance with accrual accounting (refer paragraph 9) the purchase of the trade
inventories on credit and the subsequent settlement of the debt are two separate
transactions.
2
In accordance with the perpetual inventory system, acquired trade inventories satisfy
the definition and recognition criteria of an asset. (Initially, only the perpetual inventory
system is dealt with in this work. Inventory systems are dealt with in Chapters 5 and
13.)
166 Trade inventories purchased on credit and the accompanying trade payable are recognised if
the trade inventories satisfy the definition and recognition criteria of an asset and if the trade
payable satisfies the definition and recognition criteria of a liability.
167 It can be indicated as follows that trade inventories satisfy the definition of an asset:
Definition of an asset
Application – trade inventories
An asset is a resource
Trade inventories are a resource for a trading entity such
as AC Entity since it is purchased to be sold at a profit to
customers in order to generate cash flow.
controlled by the entity as a
result of past events
Inventory is controlled by the entity, as physical
possession of the inventories has transferred to the
entity. The risks and rewards associated with ownership
of the inventories have passed to the entity. As a result,
the entity will have the ability to direct the use of the
inventory and will obtain substantially all the remaining
benefits from the inventories.
39
Definition of an asset
Application – trade inventories
The past events in this transaction are the ordering of
inventories by AC Entity and delivery by Payable L.
and from which future economic
benefits are expected to flow to
the entity.
Future economic benefits are expected to flow to
AC Entity when the trade inventories are sold.
168 It can be indicated as follows that trade inventories satisfy the recognition criteria of an asset.
Recognition criteria of an asset Application – trade inventories
An item that meets the definition
of an asset is recognised only if
it satisfies both the following
recognition criteria:
As set out above, trade inventories satisfy the definition of
an asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
An acquired asset-item, such as trade inventories, which
satisfies the definition of an asset, will probably cause the
inflow of future economic benefits when the trade
inventories are sold.
The date on which the inflow of future economic benefits
became probable is the date on which control was
obtained over the trade inventories, and that is the date
on which the trade inventories were delivered by the
supplier (Payable L) in accordance with the purchase
contract, namely 1 March 20.7.
the item has a cost or a value
that can be measured reliably.
The cost of the trade inventories can be measured
reliably at the historical cost price thereof, namely the
invoice price of R226 000.
169 Besides the asset-item trade inventories, the transaction (the credit purchase of an asset)
also brings about a liabilities-item, a trade payable. It can be indicated as follows that a trade
payable satisfies the definition of a liability:
Definition of a liability
Application – trade payable
A liability is a present obligation As a result of the delivery of the trade inventories by
of the entity
Payable L to AC Entity in accordance with the purchase
contract, Payable L has a legally enforceable right to
claim from AC Entity and AC Entity has a legally
enforceable obligation towards Payable L.
arising from past events
The delivery of the trade inventories on 1 March 20.7 in
accordance with the purchase contract is the past event
that gave rise to the present, legal obligation of AC Entity.
and of which the settlement (in
the future) is expected to result
in an outflow of resources
embodying economic benefits.
The settlement of the obligation towards Payable L is
expected to result in the outflow of cash in the future.
40
170 It can be indicated as follows that a trade payable, resulting from the purchase of trade
inventories on credit, satisfies the recognition criteria of a liability:
Recognition criteria of a
liability
Application – trade payable
An item that meets the definition As set out above, Payable L (a trade payable) satisfies
of a liability is recognised only if the definition of a liability.
it satisfies both the following
recognition criteria:
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The existence of the legal obligation on 1 March 20.7 (the
day on which Payable L delivered the trade inventories in
accordance with the contract) leaves AC Entity no other
choice but to settle the obligation on the future date as
agreed upon in the purchase contract.
the item has a cost or a value The cost of Payable L can be measured reliably at the
that can be measured reliably.
historical cost price thereof, namely the invoice price of
R226 000.
171 The acquired asset-item trade inventories satisfy the definition and recognition criteria of an
asset. The associated liabilities-item trade payable satisfies the definition and recognition
criteria of a liability. Note that the historical/past event, namely the delivery of the purchased
items (the trade inventories) in accordance with the contract that was entered into, causes the
following for the purchasing entity:
•
the trade inventories are controlled; and
•
a legally enforceable obligation arises.
172 Trade inventories (that satisfy the definition and recognition criteria of an asset) that were
purchased on credit from a trade payable (that satisfies the definition and recognition criteria
of a liability) are consequently recognised simultaneously with the trade payable on the date
on which the trade inventories were delivered in accordance with the purchase contract
(1 March 20.7). The increase in the asset-item trade inventories and the increase in the
liabilities-item Payable L are recognised on the day on which the trade inventories are
received. The increases are measured at the same amount, namely the cost of the trade
inventories purchased.
173 The element assets increase (because the asset-item trade inventories increases) and the
element liabilities increase (because the liabilities-item Payable L increases). The accounting
equation consequently remains in balance.
174 The recognition of the increase in the asset-item trade inventories and the increase in the
liabilities-item Payable L occur as follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
+226 000
=
+226 000
+
0
(Trade inventories)
Classification
(Payable L)
175 When the payment of the trade payable takes place 30 days later, the two items brought
about by the transaction are the asset-item cash (a decrease) and the liabilities-item
Payable L (a decrease). The asset-item cash as well as the liabilities-item trade payable
decreases because cash is appropriated to pay the trade payable. In these circumstances,
41
the asset-item cash must be partially derecognised/removed and the liabilities-item trade
payable must be derecognised/removed in full. (Refer to paragraph 263) The date on which
the derecognition occurs, is the date on which the payment occurs.
176 The partial derecognition of the asset-item cash and the total derecognition of the liabilitiesitem Payable L occur as follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
- 226 000
=
- 226 000
+
0
(Cash)
Classification
(Payable L)
Recognition and initial measurement of the increase in the asset-item delivery
vehicle and the decrease in (derecognition of) the asset-item cash
177 If a delivery vehicle is purchased for cash, the two items brought about by the transaction are
the asset-item delivery vehicle (an increase) and the asset-item cash (a decrease).
178 Take the following appropriate transaction as an example:
On 1 April 20.7, AC Entity purchased and received a delivery vehicle from Supplier M. The
invoice price of R645 000 was paid in cash on this day.
179 A delivery vehicle purchased in accordance with a transaction for cash is recognised if the
delivery vehicle satisfies the definition and recognition criteria of an asset. Simultaneously
with the recognition of the delivery vehicle, a portion of the asset-item cash is derecognised.
180 It can be indicated as follows that the delivery vehicle satisfies the definition of an asset:
Definition of an asset
Application – delivery vehicle
An asset is a resource
A delivery vehicle is a resource for a trading entity since it
can be used to deliver trade inventories that were sold to
customers.
controlled by the entity as a
result of past events
The delivery vehicle is controlled by the entity as physical
possession of the delivery vehicle has transferred to the
entity. The risks and rewards associated with ownership
of the delivery vehicle have passed to the entity. As a
result the entity will have the ability to direct the use of
the delivery vehicle and will obtain substantially all the
remaining benefits from the delivery vehicle.
The past event is the purchase of the delivery vehicle by
AC Entity.
and from which future economic
benefits are expected to flow to
the entity.
Future economic benefits are expected to flow to
AC Entity when the delivery vehicle is used to deliver
sold trade inventories to customers.
42
181 It can be indicated as follows that the delivery vehicle satisfies the recognition criteria of an
asset:
Recognition criteria of an asset Application – delivery vehicle
An item that meets the definition
of an asset is recognised only if
it satisfies both the following
recognition criteria:
As set out above, a delivery vehicle satisfies the definition
of an asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
An acquired asset-item, such as a delivery vehicle, which
satisfies the definition of an asset, will probably cause the
inflow of future economic benefits when the delivery
vehicle is utilised.
The date on which the inflow of future economic benefits
became probable is the date on which control was
obtained over the delivery vehicle, and that is the date on
which the delivery vehicle was delivered by Supplier M in
accordance with the purchase contract, namely
1 April 20.7.
The cost of the delivery vehicle can be measured reliably
at the historical cost price thereof, namely the invoice
price of R645 000.
the item has a cost or a value
that can be measured reliably.
182 It is indicated above that on 1 April 20.7 (the date on which the right of ownership transferred
to AC Entity) the delivery vehicle satisfied the definition and recognition criteria of an asset.
The increase in the asset-item delivery vehicle must consequently be recognised on
1 April 20.7 and at the same time, the decrease in the asset-item cash must be recognised.
The increase in the asset-item delivery vehicle and the decrease in the asset-item cash are
measured at the same amount, namely the cost of the delivery vehicle, which is also the
amount at which cash decreases.
183 The element assets increase (because the asset-item delivery vehicle increases) and the
element assets decrease (because the asset-item cash decreases). The accounting equation
consequently remains in balance.
184 The recognition of the increase in the asset-item delivery vehicle and the decrease in the
asset-item cash occur as follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
+645 000
=
0
+
0
(Delivery vehicle)
- 645 000
(Cash)
43
Classification
Recognition criteria of income
185 Income bears reference to a specific reporting period and is mainly the result of an entity’s
operating activities. Income comprises various income-items, e.g. sales, rent income and
interest income.
186 Income is increases in economic benefits during the reporting period in the form of inflows or
enhancements of assets or decrease of liabilities that result in increases in equity, other than
those relating to contributions from equity participants (owner(s)) (Conceptual Framework
2010.4.25(a)). An item that satisfies the definition of income is recognised when an increase
in future economic benefits associated with an increase that occurred in an asset, can be
measured reliably (Conceptual Framework 2010.4.47). An income-item is therefore
recognised simultaneously with/at the same time as the increase in the associated asset
(cash or trade receivables) and the associated asset is recognised if the asset-item satisfies
the definition and recognition criteria of an asset. The income-item is measured at the same
amount at which the increase in the asset-item is measured.
187 Within the framework of the accounting equation an income-item is recognised as an
increase in equity (retained earnings). (Refer to paragraphs 93 and 111)
Recognition criteria of an expense
188 Expenses relate to a specific reporting period and are mainly the result of an entity’s
operating activities. Expenses comprise various expense-items, e.g. cost of sales, salaries,
wages, water and electricity and telephone and communication.
189 Expenses are decreases in economic benefits during the reporting period in the form of an
outflow or depletions of assets or incurrences of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants (owner(s)) (Conceptual
Framework 2010.4.25(b)). An item that satisfies the definition of an expense is recognised
when a decrease in future economic benefits, associated with a decrease that occurred in an
asset or an increase that occurred in a liability, can be measured reliably (Conceptual
Framework 2010.4.49). An expense-item is therefore recognised simultaneously with the
decrease in the associated asset (cash or other assets) or simultaneously with the increase in
the associated liability (payable). The decrease in the associated asset-item is recognised
when the asset-item decreases. The increase in the associated liabilities-item is recognised
when the liabilities-item satisfies the definition and the recognition criteria of a liability. The
expense-item is measured at the same amount at which the increase in the liabilities-item or
the decrease in the asset-item is measured.
190 Within the framework of the accounting equation an expense-item is recognised as a
decrease in equity (retained earnings). (Refer to paragraphs 93 and 111)
44
Applications – Recognition and initial measurement of income and
expenses within the framework of the accounting equation
Introduction
191 As a result of the relationship that exists between the elements (Assets = Liabilities + Equity),
each transaction or event that brings about the recognition of income or the recognition of an
expense, will result in one of the following dual effects on the elements of the accounting
equation:
•
A liabilities-item (e.g. payable) increases and an expense-item (e.g. maintenance)
increases (because the entity had maintenance work performed on credit).
•
An asset-item (e.g. cash) decreases and an expense-item (e.g. wages) increases
(because the entity paid the wages).
•
An asset-item (e.g. trade receivable/cash) increases and an income-item (e.g. sales)
increases (because trade inventories are sold on credit or for cash).
•
An asset-item (e.g. trade inventories) decreases and an expense-item (e.g. cost of
sales) increases (because trade inventories that were sold were delivered to the
customer). (There are various other expenses that arise from the decrease in assets
other than cash. These expenses are dealt with in Chapter 5.)
•
An asset-item (e.g. cash) increases and an income-item (e.g. rent income) increases
(because rent income was received in cash).
192 With reference to the cases mentioned in the preceding paragraph, the recognition of income
and expenses are subsequently dealt with. Various aspects of the recognition of income and
expenses are dealt with. The dual effect of the transactions is at this stage recognised within
the framework of the accounting equation.
Recognition and initial measurement of the increase in the expense-item
maintenance and the increase in the associated liabilities-item payable
193 Various expenses of an entity are usually incurred on credit. Examples of expenses that are
usually incurred on credit are the purchase of office supplies and the purchase of services,
e.g. water and electricity, telecommunication and maintenance.
194 If an expense is incurred on credit, the two items brought about by the transaction are the
relevant expense-item (an increase) and the liabilities-item payable (an increase).
195 Take the following appropriate transaction as an example:
AC Entity had its delivery vehicle repaired with Payable M. The repairs were completed on
3 March 20.7 at a cost of R11 000 and it was agreed with the service provider that payment
will take place within 30 days.
196 The items brought about by this transaction are the expense-item maintenance/repairs (an
increase) and the liabilities-item Payable M (an increase). (In accordance with accrual
accounting, the incurrence of an expense on credit and the subsequent payment of the
obligation are two separate transactions.)
45
197 An item that is incurred on credit and that satisfies the definition of an expense, is recognised
when a decrease in future economic benefits, associated with an increase that occurred in a
liability, can be measured reliably. The expense-item maintenance is therefore recognised
simultaneously with the increase in the associated liabilities-item Payable M. The increase in
the associated liabilities-item is recognised when the liabilities-item satisfies the definition and
the recognition criteria of a liability.
198 It can be indicated as follows that Payable M (a payable that arises from the incurrence of an
expense on credit) satisfies the definition of a liability:
Definition of a liability
Application – payable
A liability is a present obligation
of the entity
As a result of the completion of the repairs by Payable M
in accordance with the contract and to the satisfaction of
AC Entity, Payable M has a legally enforceable right to
claim from AC Entity and AC Entity has a legally
enforceable obligation towards Payable M.
arising from past events
The satisfactory completion of the repairs on 3 March
20.7 in accordance with the contract is the past event that
gave rise to the present, legal obligation of AC Entity.
and of which the settlement (in
the future) is expected to result
in an outflow of resources
embodying economic benefits.
The settlement of the obligation towards Payable M is
expected to result in the outflow of cash in the future.
199 It can be indicated as follows that Payable M (a payable that arises from the incurrence of an
expense on credit) satisfies the recognition criteria of a liability.
Recognition criteria of a
liability
Application – payable
An item that meets the definition
of a liability is recognised only if
it satisfies both the following
recognition criteria:
As set out above, Payable M satisfies the definition of a
liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The existence of the legal obligation on 3 March 20.7 (the
day on which the repairs were satisfactory completed in
accordance with the contract) leaves AC Entity no other
choice but to settle the obligation on the future date as
stipulated in the contract.
the item has a cost or a value
that can be measured reliably.
The cost of Payable M can be measured reliably at the
historical cost price thereof, namely the invoice price of
R11 000.
46
200 It can be indicated as follows that maintenance satisfies the definition of an expense:
Definition of an expense
Application – maintenance expense
Expenses are decreases in
economic benefits during the
reporting period in the form of
an outflow or depletions of
assets or incurrences of
liabilities
The incurrence of the maintenance expense on credit is a
decrease in economic benefits during the reporting period
in the form of an increase in a liability, namely Payable M.
that result in a decrease in
equity (retained earnings),
excluding those decreases that
relate to distributions to equity
participants (owner(s)).
The decrease in economic benefits arising from the
incurrence of the maintenance expense on credit results in
an increase in the liabilities-item Payable M and an
increase in the expense-item maintenance.
The expense-item maintenance that increases, decreases
the profit for the reporting period.
If the profit decreases, there is a decrease in equity
(retained earnings).
201 The increase in the expense-item maintenance, which satisfies the definition of an expense,
arises simultaneously with the increase that occurs in the associated liabilities-item
Payable M. As set out above, the associated liabilities-item Payable M satisfies the definition
and recognition criteria of a liability on 3 March 20.7, since this represents the date on which
a present obligation arose. The increase in the associated liabilities-item Payable M must
therefore be recognised on 3 March 20.7. The increase in the expense-item maintenance is
recognised at the same time (therefore on 3 March 20.7). The increase in the expense-item
maintenance is measured at the same amount at which the increase in Payable M is
measured.
202 The element liabilities increase (because the liabilities-item Payable M increases) and the
element equity (retained earnings) decreases (because the increase in the expense-item
maintenance decreases the profit for the reporting period and if the profit decreases, retained
earnings decreases). The accounting equation consequently remains in balance.
203 The recognition of the increase in the expense-item maintenance (which causes a decrease
in equity (retained earnings)) and the increase in the liabilities-item Payable M occur as
follows within the framework of the accounting equation:
Assets
0
=
=
Liabilities
+11 000
(Payable M)
+
+
Equity
- 11 000
Classification
Retained earnings –
expense (maintenance)
204 When the payment of the payable takes place 30 days later, the two items brought about by
the transaction are the asset-item cash (a decrease) and the liabilities-item Payable M (a
decrease). The asset-item cash as well as the liabilities-item Payable M decreases because
cash is appropriated to pay the payable. In these circumstances, the asset-item cash must be
partially derecognised/removed and the liabilities-item Payable M must be derecognised/
removed in full. (Refer to paragraph 263) The date on which the derecognition occurs, is the
date on which the payment occurs.
47
205 The partial derecognition of the asset-item cash and the total derecognition of the liabilitiesitem Payable M occur as follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
- 11 000
=
- 11 000
+
0
(Cash)
Classification
(Payable M)
Recognition and initial measurement of the increase in the expense-item wages and
the decrease in (derecognition of) the associated asset-item cash
206 Certain expenses of an entity are usually incurred in cash. Examples of such expenses are
wages (of temporary employees) and insurance premium.
207 If an expense is incurred in cash, the two items that are brought about by the transaction are
the relevant expense-item (an increase) and the asset-item cash (a decrease).
208 Take the following appropriate transaction as an example:
AC Entity employed a number of temporary employees for two weeks and at the end of the
two weeks, on 30 June 20.7, paid them in total R8 000 in cash.
209 The items that are brought about by this transaction are the expense-item wages (an
increase) and the asset-item cash (a decrease).
210 An item that is incurred in cash and that satisfies the definition of an expense, is recognised
when a decrease in future economic benefits associated with a decrease that occurred in an
asset, can be measured reliably. The expense-item wages is therefore recognised
simultaneously with the decrease in the associated asset-item cash. The asset-item cash is
partially derecognised (on the day) when the cash outflow occurs. The expense-item wages
is recognised at the same amount at which the asset-item cash decreases.
211 It can be indicated as follows that the expense-item wages satisfies the definition of an
expense:
Definition of an expense
Expenses are decreases in
economic benefits during the
reporting period in the form of
an outflow or depletions of
assets or incurrences of
liabilities
that result in a decrease in
equity (retained earnings),
excluding those decreases that
relate to distributions to equity
participants (owner(s)).
Application – wages
The payment of wages is a decrease in economic
benefits during the reporting period in the form of an
outflow of cash.
The decrease in economic benefits arising from the
payment of wages results in a decrease in the asset-item
cash and an increase in the expense-item wages.
The expense-item wages that increases, decreases the
profit for the reporting period.
If the profit decreases, there is a decrease in equity
(retained earnings).
212 The increase in the expense-item wages, which satisfies the definition of an expense, arises
simultaneously with the decrease that occurred in the associated asset-item cash, and is
recognised on the day on which the cash flows to the temporary employees (30 June 20.7).
The increase in the expense-item wages is measured at the same amount at which the
decrease in the asset-item cash is measured. The increase in the expense-item wages
consequently has to be recognised on 30 June 20.7 and at the same time, the decrease in
the asset-item cash has to be recognised.
48
213 The element assets decrease (because the asset-item cash decreases) and the element
equity (retained earnings) decreases (because the increase in the expense-item wages
decreases the profit for the reporting period and if profit decreases, retained earnings
decreases). The accounting equation consequently remains in balance.
214 The recognition of the increase in the expense-item wages (which causes a decrease in
equity (retained earnings)) and the decrease in the asset-item cash occur as follows within
the framework of the accounting equation:
Assets
- 8 000
(Cash)
=
=
Liabilities
0
+
+
Equity
- 8 000
Classification
Retained earnings –
expense (wages)
Recognition and initial measurement of the increase in the income-item sales and
the increase in the associated asset-item cash
215 In the case of a cash sales transaction, the delivery of trade inventories occurs
simultaneously with the receipt of the cash. The delivery of the trade inventories and the
receipt of the cash can take place in the sales room or the delivery of the trade inventories
and the receipt of the cash occurs, in the case of a COD-sales transaction (cash on delivery),
at the premises of the customer. Cash sales occur in accordance with a purchase contract,
which is mostly an oral agreement.
216 If trade inventories are sold for cash, the two items brought about by the transaction are the
income-item sales (an increase) and the asset-item cash (an increase). If the entity uses the
perpetual inventory system, two more items are brought about by the transaction, namely the
expense-item cost of sales (an increase) and the asset-item trade inventories (a decrease).
217 Take the following appropriate transaction as an example:
On 3 May 20.7, AC Entity, who uses the perpetual inventory system, sold trade inventories
with a cost price of R6 000 to a customer for R14 000 cash.
218 The items that are brought about by this transaction are the asset-item cash (an increase)
and the income-item sales (an increase) as well as the expense-item cost of sales (an
increase) and the asset-item trade inventories (a decrease).
219 An item that satisfies the definition of income is recognised when an increase in future
economic benefits associated with an increase that occurred in an asset, can be measured
reliably. The income-item sales is therefore recognised simultaneously with the increase in
the associated asset-item cash and the asset-item cash is recognised if it satisfies the
definition and recognition criteria of an asset.
220 The asset-item cash satisfies the definition and recognition criteria of an asset, as indicated in
paragraphs 150 and 151 above.
49
221 It can be indicated as follows that sales, in accordance with a cash sale, satisfy the definition
and recognition criteria of income:
Definition of income
Application – sales
Income is increases in
economic benefits during the
reporting period in the form of
inflows or enhancements of
assets or decrease of liabilities
Sales for cash are an increase in economic benefits during
the reporting period in the form of an inflow of cash.
that result in an increase in
equity (retained earnings)
The increase in economic benefits arising from the sale of
trade inventories for cash results in an increase in the
asset-item cash and an increase in the income-item sales.
The income-item sales that increases, increases the profit
for the reporting period.
If the profit increases there is an increase in equity
(retained earnings).
222 The increase in the income-item sales, which satisfies the definition of income, arises
simultaneously with the increase that occurred in the associated asset-item cash, and is
recognised on the day on which the cash is received, namely 3 May 20.7. The increase in the
income-item sales is measured at the same amount at which the increase in the asset-item
cash is measured. The increase in the income-item sales consequently has to be recognised
on 3 May 20.7 and at the same time, the increase in the asset-item cash has to be
recognised.
223 The element assets increase (because the asset-item cash increases) and the element equity
(retained earnings) increases (because the increase in the income-item sales increases the
profit for the reporting period and if profit increases, retained earnings increases). The
accounting equation consequently remains in balance.
224 The recognition of the increase in the asset-item cash and the increase in the income-item
sales (which causes an increase in equity (retained earnings)) occur as follows within the
framework of the accounting equation:
Assets
=
Liabilities
+
Equity
Classification
+14 000
=
0
+
+14 000
Retained earnings –
income (sales)
(Cash)
225 Besides the asset-item cash and the income-item sales that are brought about by the
transaction, the expense-item cost of sales and the asset-item trade inventories are also
brought about by the transaction if the entity uses the perpetual inventory system.
226 Cost of sales is the main expense-item of a trading entity and represents the outflow of
economic benefits arising from the delivery of the sold trade inventories by an entity. (Initially
only the perpetual inventory system will be used in this work). The sold trade inventories are
delivered to the customer, which causes the asset-item trade inventories to decrease. The
expense-item cost of sales arises simultaneously with the decrease that occurs in the
associated asset-item trade inventories.
50
227 An item that satisfies the definition of an expense is recognised when a decrease in future
economic benefits associated with a decrease that occurred in an asset, can be measured
reliably. The expense-item cost of sales is therefore recognised at the same time as the
decrease in the associated asset-item trade inventories. The decrease in the asset-item trade
inventories is recognised when the asset-item decreases.
228 It can be indicated as follows that cost of sales satisfies the definition of an expense:
Definition of an expense
Application – cost of sales
Cost of sales is a decrease in economic benefits during
Expenses are decreases in
the reporting period in the form of trade inventories that
economic benefits during the
reporting period in the form of an flow from the entity.
outflow or depletions of assets or
incurrences of liabilities
that result in a decrease in
equity (retained earnings),
excluding those decreases that
relate to distributions to equity
participants (owner(s)).
The decrease in economic benefits arising from the
delivery of the trade inventories that were sold to the
customer results in a decrease in the asset-item trade
inventories and an increase in the expense-item cost of
sales.
The expense-item cost of sales that increases, decreases
the profit for the reporting period.
If the profit decreases, there is a decrease in equity
(retained earnings).
229 The increase in the expense-item cost of sales, which satisfies the definition of an expense, is
recognised simultaneously with the decrease in the associated asset-item trade inventories.
The decrease in the asset-item trade inventories takes place on 3 May 20.7 since the sold
trade inventories were delivered to the customer on this date. The increase in the expenseitem cost of sales is measured at the same amount at which the decrease in the asset-item
trade inventories is measured. The increase in the expense-item cost of sales must
consequently be recognised on 3 May 20.7 and at the same time, the decrease in the assetitem trade inventories must be recognised.
230 The element assets decrease (because the asset-item trade inventories decreases) and the
element equity (retained earnings) decreases (because the increase in the expense-item cost
of sales decreases the profit for the reporting period and if profit decreases, retained earnings
decreases). The accounting equation consequently remains in balance.
231 The recognition of the increase in the expense-item cost of sales (which causes a decrease
in equity (retained earnings)) and the decrease in the asset-item trade inventories occur as
follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
Classification
- 6 000
=
0
+
- 6 000
Retained earnings –
expense (cost of sales)
(Trade inventories)
51
Recognition and initial measurement of the increase in the income-item sales and
the increase in the associated asset-item trade receivable
232 The use of credit sales by trading entities in order to stimulate sales is a distinctive
phenomenon of the modern economy. Sales of trade inventories occur in accordance with a
written or oral purchase contract to selected customers.
233 If trade inventories are sold on credit, the two items brought about by the transaction are the
income-item sales (an increase) and the asset-item trade receivable (an increase). If the
entity uses the perpetual inventory system, another two items are brought about by the
transaction, namely the expense-item cost of sales (an increase) and the asset-item trade
inventories (a decrease).
234 Take the following appropriate transaction as an example:
AC Entity uses the perpetual inventory system. On 7 May 20.7, AC Entity sold trade
inventories with a cost price of R10 000 to a selected customer, Receivable A, for R22 000 on
credit and delivered the goods on the same day. The amount due is payable on or before 6
June 20.7. In accordance with accrual accounting, the sale of the trade inventories on credit
and the subsequent payment by the trade receivable are two separate transactions.
235 The items that are brought about by this transaction are the asset-item Receivable A (an
increase) and the income-item sales (an increase) as well as the expense-item cost of sales
(an increase) and the asset-item trade inventories (a decrease).
236 An item that satisfies the definition of income is recognised when an increase in future
economic benefits associated with an increase that occurred in an asset, can be measured
reliably. The income-item sales is therefore recognised simultaneously with the increase in
the associated asset-item Receivable A and the asset-item Receivable A is recognised if it
satisfies the definition and recognition criteria of an asset.
237 In paragraph 221 above, it is indicated that sales in accordance with a cash sale, satisfy the
definition of income. Sales in accordance with a credit sale also satisfy the definition of
income for the same reasons as for a cash sale. The only difference is that the increase in
economic benefits occurs in the form of an increase in a trade receivable.
238 It can be indicated as follows that the trade receivable, resulting from the credit sale of trade
inventories, satisfies the definition of an asset:
Definition of an asset
An asset is a resource
controlled by the entity
as a result of past events
And from which future
economic benefits are
expected to flow to the
entity.
Application – trade receivable
The enforceable right to claim in respect of the amount due by a
selected customer, Receivable A, is a resource to AC Entity
since economic benefits will flow to the entity in the form of cash
as soon as Receivable A settles his debt.
Receivable A is controlled by the entity as the entity has right to
claim payment as a result of the credit sale to receivable A. The
entity has control over the receivable as it has right of claim of
payment from the receivable A.
The past event is the sale of trade inventories on credit to
Receivable A.
When Receivable A settles his account, the entity will receive
cash.
52
239 It can be indicated as follows that the trade receivable satisfies the recognition criteria of an
asset:
Recognition criteria of an asset Application – a trade receivable
An item that meets the definition
of an asset is recognised only if
it satisfies both the following
recognition criteria:
As set out above, Receivable A satisfies the definition of
an asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
A selected customer such as Receivable A, that satisfies
the definition of an asset, will probably pay the amount
due in accordance with the contract and therefore the
inflow of future economic benefits is probable.
(The sale of trade inventories on credit to a customer will
be preceded by an investigation into the credit worthiness
of the customer. In the process, a credit limit is
determined for each trade receivable.)
The date on which the inflow of future economic benefits
became probable is the date on which control was
obtained over the right to claim in respect of
Receivable A’s debt. Control over the right to claim was
obtained on the date on which the trade inventories were
delivered by AC Entity in accordance with the purchase
contract, namely 7 May 20.7.
The item has a cost or a value
that can be measured reliably.
The cost of Receivable A can be measured reliably at
the historical cost price thereof, namely the invoice price
of R22 000.
240 The income-item sales (that satisfies the definition of income) and the associated asset-item
Receivable A (that satisfies the definition and recognition criteria of an asset) are recognised
simultaneously on 7 May 20.7, namely the day on which the trade inventories were delivered
to Receivable A. The increase in the income-item sales is measured at the same amount at
which the increase in the asset-item Receivable A is measured.
241 The element assets increase (because the asset-item Receivable A increases) and the
element equity (retained earnings) increases (because the increase in the income-item sales
increases the profit for the reporting period and if profit increases, retained earnings
increases). The accounting equation consequently remains in balance.
242 The recognition of the increase in the asset-item trade receivable and the increase in the
income-item sales (which causes an increase in equity (retained earnings)) occur as follows
within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
Classification
+22 000
=
0
+
+22 000
Retained earnings –
income (sales)
(Trade receivable)
243 Since AC Entity uses the perpetual inventory system, another two items that are brought
about by the transaction are the expense-item cost of sales (an increase) and the asset-item
trade inventories (a decrease).
53
244 The increase in the expense-item cost of sales (that satisfies the definition of an expense –
refer paragraph 228 above) is recognised simultaneously with the decrease in the associated
asset-item trade inventories. The decrease in the asset-item trade inventories occurs on
7 May 20.7 because the sold trade inventories were delivered on this day to Receivable A.
The increase in the expense-item cost of sales is measured at the same amount at which the
decrease in the asset-item trade inventories is measured.
245 The element assets decrease (because the asset-item trade inventories decreases) and the
element equity (retained earnings) decreases (because the increase in the expense-item cost
of sales decreases the profit for the reporting period and if profit decreases, retained earnings
decreases). The accounting equation consequently remains in balance.
246 The recognition of the increase in the expense-item cost of sales (which causes a decrease
in equity (retained earnings)) and the decrease in the asset-item trade inventories occur as
follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
Classification
- 10 000
=
0
+
- 10 000
Retained earnings –
expense (cost of sales)
(Trade inventories)
247 When Receivable A pays 30 days later, the two items brought about by the transaction are
the asset-item cash (an increase) and the asset-item Receivable A (a decrease). The assetitem cash increases and the asset-item Receivable a decreases because cash was received
from the trade receivable. The asset-item cash, which satisfies the definition and recognition
criteria of an asset (refer to paragraphs 150 and 151), is recognised on the day on which the
cash inflow occurs. In these circumstances the asset-item Receivable A must be
derecognised/removed in full. (Refer to paragraph 262) The date on which the derecognition
should take place is the date on which the trade receivable paid, in other words the date on
which the cash inflow occurred.
248 The recognition of the asset-item cash and the total derecognition of the asset-item trade
receivable occur as follows within the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
+22 000
(Cash)
- 22 000
(Receivable A)
=
0
+
0
Classification
Recognition and initial measurement of the increase in the income-item rent income
and the increase in the associated asset-item cash
249 If an entity rents out an unused portion of its building, a written lease agreement is entered
into between the entity (lessor) and the lessee. The lease amount is payable in cash.
250 If rent income is received in cash, the two items brought about by the transaction are the
asset-item cash (an increase) and the income-item rent income (an increase).
251 Take the following appropriate transaction as an example:
AC Entity entered into a written agreement with a lessee in accordance with which an unused
portion of AC Entity’s building is rented out to the lessee at R9 000 per month. On 1 June
20.7, the lease amount for June 20.7 was received.
54
252 The items brought about by this transaction are the asset-item cash (an increase) and the
income-item rent income (an increase).
253 An item that satisfies the definition of income is recognised when an increase in future
economic benefits associated with an increase that occurred in an asset, can be measured
reliably. The increase in the income-item rent income is therefore recognised simultaneously
with an increase in the associated asset-item cash and the asset-item cash is recognised if it
satisfies the definition and recognition criteria of an asset.
254 As indicated in paragraphs 150 and 151, cash satisfies the definition and recognition criteria
of an asset.
255 It can be indicated as follows that rent income satisfies the definition of income:
Definition of income
Application – rent income
Income is increases in economic
benefits during the reporting
period in the form of inflows or
enhancements of assets or
decrease of liabilities
Rent income arising from the letting of an unused portion
of buildings in an increase in economic benefits during
the reporting period in the form of an inflow of cash.
that result in an increase in
equity (retained earnings)
The increase in economic benefits arising from the letting
of buildings for cash results in an increase in the assetitem cash and an increase in the income-item rent
income.
The income-item rent income that increases, increases
the profit for the reporting period.
If the profit increases there is an increase in equity
(retained earnings).
256 The increase in the income-item rent income (that satisfies the definition of income) and the
increase in the associated asset-item cash (that satisfies the definition and recognition criteria
of an asset) are recognised simultaneously on 1 June 20.7, namely the day on which the
cash was received. The increase in the income-item rent income is measured at the same
amount at which the increase in the asset-item cash is measured.
257 The element assets increase (because the asset-item cash increases) and the element equity
(retained earnings) increases (because the increase in the income-item rent income
increases the profit for the reporting period and if profit increases, retained earnings
increases). The accounting equation consequently remains in balance.
258 The recognition of the increase in the asset-item cash and the increase in the income-item
rent income (which causes an increase in equity (retained earnings)) occur as follows within
the framework of the accounting equation:
Assets
=
Liabilities
+
Equity
Classification
+9 000
=
0
+
+9 000
Retained earnings –
income (rent income)
(Cash)
55
Derecognition of assets and liabilities
259 If an asset-item (or liabilities-item) that was previously recognised as an asset (or liability) no
longer meets the definition and recognition criteria of an asset (or liability), then the asset (or
liability) has to be derecognised/removed from the records.
260 Derecognition therefore entails:
•
the removal of certain asset-items (e.g. land, furniture, trade inventories, etc.), which
were previously recognised, from the records of the entity when the relevant asset-item
is sold or scrapped. (Refer Chapter 12)
•
the removal or decrease of an asset-item such as trade receivables, which were
previously recognised, from the records of the entity because the receivable settled its
debt either in full or partially.
•
the removal or decrease of an asset-item such as cash, which was previously
recognised, from the records of the entity because the cash is utilised to purchase an
asset in cash or because an expense is incurred in cash or because an obligation is
settled.
•
the removal or decrease of a liability, such as a trade payable or a loan, which was
previously recognised, from the records of the entity since the obligation towards the
payable or the lender is paid in full or partially.
261 Subsequently the derecognition of trade receivables, trade payables and loans are briefly
dealt with.
Derecognition of trade receivables
262 A trade receivable is derecognised or partially derecognised if the receivable settles its debt
in full or partially. An appropriate transaction is as follows: A receivable pays the full amount
due by him to the entity. The derecognition (removal) of the asset-item trade receivable
occurs simultaneously with the increase that occurs in the asset-item cash and indeed on the
date on which the amount is received. The transaction is recognised as follows: an increase
in the asset-item cash and a decrease in the asset-item trade receivable. Refer to paragraphs
247 and 248.
Derecognition of trade payables and loan
263 A trade payable may only be derecognised or partially derecognised if the debt is paid in full
or partially paid. An appropriate transaction is as follows: An entity pays a trade payable the
full amount due. The derecognition (removal) of the liabilities-item trade payable occurs
simultaneously with the decrease that occurs in the asset-item cash and indeed on the day
on which the payment occurs. The transaction is recognised as follows: a decrease in the
asset-item cash and a decrease in the liabilities-item trade payable. Refer to paragraphs 175
and 176.
264 A loan incurred is usually repaid in instalments. A loan may only be derecognised or partially
derecognised if the debt is paid in full or partially paid. An appropriate transaction is as
follows: An entity pays the monthly instalment on a loan. The partial derecognition of the
liabilities-item loan occurs simultaneously with the decrease that occurs in the asset-item
cash and indeed on the day on which the payment occurs.
56
Example 2.1 The dual effect of transactions on the accounting equation
On 2 January 20.7, AC Entity commenced with activities and incurred the following transactions
during January 20.7:
1
On 2 January 20.7, the owner made the property that AC Entity utilises available for the
exclusive use of the entity. The property was registered in the owner’s name a few days
before 2 January 20.7. The purchase price of the property was R1 200 000 (R200 000 for the
land and R1 000 000 for the buildings).
2
On 2 January 20.7, the owner opened a cheque account for the entity and deposited
R1 800 000 into the account.
3
On 5 January 20.7, a delivery vehicle to the amount of R225 000 was ordered. The supplier,
Payable K, delivered the delivery vehicle to AC Entity’s premises on 10 January 20.7. On the
same day, the local authority registered the vehicle in AC Entity’s name. The invoice price is
R225 000 and it was agreed with Payable K to pay the outstanding amount on 30 January
20.7.
4
Trade inventories to the amount of R20 000 was ordered on 7 January 20.7. On 25 January
20.7, Payable L delivered the trade inventories to AC Entity’s premises. The invoice price is
R20 000 and it was agreed with Payable L that the outstanding amount will be paid on
24 February 20.7. (AC Entity uses the perpetual inventory system to account for trade
inventories.)
5
On 30 January 20.7, the amount due to Payable K was paid.
Required:
a)
Identify the items brought about by each of the transactions for January 20.7 and indicate
whether an increase or a decrease occurred in the identified items. The items brought about
must be preceded by the element to which the item belongs.
(Example: Asset-item Receivable X (increase).)
b)
Identify the date on which recognition in respect of each transaction must occur and motivate
briefly why the specific date was identified.
c)
Indicate the dual effect of the abovementioned transactions for January 20.7 on the
accounting equation.
Example 2.1 Solution
a) Items brought about by the transactions
Transaction
number
Items brought about by transaction
1
Asset-item land (increase) and asset-item buildings (increase) and equity-item
capital (increase)
2
Asset-item cash (increase) and equity-item capital (increase)
3
Asset-item delivery vehicle (increase) and liabilities-item Payable K (increase)
4
Asset-item trade inventories (increase) and liabilities-item Payable L (increase)
5
Asset-item cash (decrease) and liabilities-item Payable K (decrease)
57
b) Date of recognition
Transaction
number
Recognition Motivation
date
1
2 Jan 20.7
This date represents the date on which AC Entity obtained control of
the property since the owner made the property available to the
exclusive use of AC Entity on 2 January 20.7. It consequently
becomes probable on this date that economic benefits will flow to
the entity from the future utilisation of the property.
2
2 Jan 20.7
This date represents the date on which AC Entity obtained right of
ownership (control) over the cash (through receipt of the cash). It
consequently becomes probable on this date that the future
utilisation of the cash will result in the inflow of economic benefits to
AC Entity.
3
10 Jan 20.7
This date represents the date on which the delivery vehicle was
delivered and therefore the date on which AC Entity obtained the
right of ownership (control) over the delivery vehicle. It consequently
becomes probable on this date that the future utilisation of the
delivery vehicle will result in the inflow of economic benefits to
AC Entity.
4
25 Jan 20.7
This date represents the date on which the trade inventories were
delivered and therefore the date on which AC Entity obtained the
right of ownership (control) over the trade inventories. It
consequently becomes probable on this date that the future sale of
the trade inventories will result in the inflow of economic benefits to
AC Entity.
5
30 Jan 20.7
The derecognition (removal) of the liabilities-item Payable K occurs
simultaneously with the decrease in the asset-item cash and
specifically on the date on which the payment occurred, namely on
30 January 20.7.
58
c) Dual effect of the transactions on the accounting equation
AC Entity
Transaction
Assets
1
2 Jan On 2 Jan 20.7 the owner makes
property available to AC Entity. The
cost of the land is R200 000 and the
cost of the buildings is R1 000 000.
(An increase in assets (land as well as
buildings) and an increase in equity
+200 000
(capital)).
+1 000 000
Subtotal
1 200 000
2
3
4
5
2 Jan
10 Jan
25 Jan
30 Jan
The owner deposits R1 800 000 into
AC Entity’s bank account.
(An increase in assets (cash) and an
increase in equity (capital)).
Subtotal
+1 800 000
3 000 000
Delivery vehicle purchased on credit
and received.
(An increase in assets (delivery
vehicle) and an increase in liabilities
(Payable K)
(See remark 3 below regarding the
accrual principle).
Subtotal
+225 000
3 225 000
Trade inventories purchased on credit
and received.
(An increase in assets (trade
inventories) and an increase in
liabilities (Payable L)).
(See remarks 3 and 4 below regarding
the accrual principle and the treatment
of trade inventories).
Subtotal
3 245 000
Pay Payable K the amount due.
(A decrease in assets (cash) and a
decrease in liabilities (Payable K)).
Total 31 January 20.7
-225 000
3 020 000
=
Liabilities +
Equity
0
=
+1 200 000
0 + 1 200 000
=
0
+1 800 000
0 + 3 000 000
=
+20 000
+225 000
225 000 +
+20 000
0
3 000 000
0
=
245 000 +
3 000 000
=
-225 000
20 000 +
0
3 000 000
Remarks in respect of Example 2.1’s solution
1
Note that the financial effect of each transaction influences at least two items, of which
each item is classified as an element with reference to the respective definitions of the
elements, and that after the accounting for the effect of each transaction the accounting
equation still remains in balance.
2
Land and buildings thereon are separable assets and are, for accounting purposes,
treated separately.
59
3
In accordance with accrual accounting, the purchase of the delivery vehicle and trade
inventories on credit (respectively on 10 and 25 January 20.7) and the payment of the
associated payables (respectively 30 January 20.7 and 24 February 20.7) are two
separate transactions.
4
The purchase of trade inventories is in this work initially recognised as an increase in
assets (25 January 20.7). Inventory systems (perpetual or periodic) are briefly dealt
with in Chapter 5 and more comprehensively in Chapter 13.
Example 2.2 The dual effect of transactions on the accounting equation
AC Entity commenced with activities on 2 January 20.7. AC Entity uses the perpetual inventory
system to account for trade inventories. The dual effect on the accounting equation in respect of
transactions for January 20.7 have already been recognised and the accounting equation was as
follows on 31 January 20.7 (refer to Example 2.1):
Transaction
Assets
3 020 000
Total 31 January 20.7
=
=
Liabilities +
20 000 +
Equity
3 000 000
During February 20.7, AC Entity incurred the following transactions:
1
On 1 February 20.7, a deposit to the amount of R20 000 was paid to the local authority, Jozi,
for the connection of water and electricity. The deposit is repayable to AC Entity with the
termination of the service.
2
On 2 February 20.7, the owner deposited an additional R200 000 in AC Entity’s bank account
as an increase in capital.
3
On 3 February 20.7, trade inventories to the amount of R145 000 were ordered and it was
agreed with Payable L that the amount due will be paid within 30 days after delivery of the
trade inventories. On 5 February 20.7, Payable L delivered the trade inventories to
AC Entity’s premises.
4
Trade inventories to the amount of R60 000 were ordered on 4 February 20.7 and it was
agreed with the supplier that payment would occur with delivery (COD). On 6 February 20.7,
the supplier delivered the trade inventories to AC Entity’s premises.
5
On 23 February 20.7, trade inventories were sold on credit to a selected customer,
Receivable A, for R96 000. The trade inventories were delivered to Receivable A on the same
day and it was agreed that the amount due must be paid within 30 days after delivery. The
cost price of the trade inventories sold is R48 000.
6
On 24 February 20.7 a payment of R20 000 was made to Payable L, being the amount due in
respect of trade inventories purchased on credit on 25 January 20.7.
7
On 24 February 20.7, trade inventories were sold for R64 000 cash and delivered on the
same day. The cost price of the trade inventories sold is R32 000.
8
Gross salaries to the amount of R15 000 was paid on 28 February 20.7.
9
On 28 February 20.7, a cheque to the amount of R12 000 was issued to the owner for
personal use.
10
On 28 February 20.7 the account for water and electricity for February 20.7 was received
electronically from Jozi. An amount of R8 000 is payable before 24 March 20.7.
60
Required:
a)
Identify the items brought about by each of the transactions for February 20.7 and indicate
whether an increase or a decrease occurred in the identified items. The items brought about
must be preceded by the element to which the item belongs. Also indicate the date on which
the transactions must be recognised.
b)
With reference to transaction 5 above, explain the nature of the accrual principle.
c)
With reference to transactions 1 and 10 above, indicate if:
d)
i)
the item deposit for water and electricity satisfies the definition and recognition criteria
of an asset;
ii)
the item Payable Jozi satisfies the definition and recognition criteria of a liability; and
iii)
the item water and electricity satisfy the definition of an expense.
Indicate the dual effect of the abovementioned transactions for February 20.7 on the
accounting equation.
Example 2.2 Solution
a) Items brought about by the transactions
Transaction
number
Items brought about by transaction
Recognition
date
1
Asset-item deposit: water and electricity (increase) and asset-item
cash (decrease)
1 Feb 20.7
2
Asset-item cash (increase) and equity-item capital (increase)
2 Feb 20.7
3
Asset-item trade inventories
Payable L (increase)
liabilities-item
5 Feb 20.7
4
Asset-item trade inventories (increase) and asset-item cash
(decrease)
6 Feb 20.7
5
Asset-item Receivable A (increase) and income-item sales
(increase) and
23 Feb 20.7
(increase)
and
Expense-item cost of sales (increase) and asset-item trade
inventories (decrease)
6
Asset-item
(decrease)
cash
(decrease)
and
liabilities-item
Payable L
7
Asset-item cash (increase) and income-item sales (increase) and
24 Feb 20.7
24 Feb 20.7
Expense-item cost of sales (increase) and asset-item trade
inventories (decrease)
8
Expense-item salaries (increase) and asset-item cash (decrease)
28 Feb 20.7
9
Equity (retained earnings)-item drawings (increase) and asset-item
cash (decrease)
28 Feb 20.7
10
Expense-item water and electricity (increase) and liabilities-item
Payable Jozi (increase)
28 Feb 20.7
61
b) The nature of the accrual principle in respect of transaction 5
In accordance with accrual accounting, the effect of transactions that are incurred on credit, are
recorded in the accounting records when the transaction or event is incurred and not only at that
point of time when settlement takes place. The practical implication of accrual accounting is that the
purchase of an asset on credit, the receipt of a loan, the sale of trade inventories on credit, the
incurrence of an expense on credit and the subsequent settlement of the debt, are seperate
transactions.
With reference to transaction 5, trade inventories were sold on credit to Receivable A on
23 February 20.7 for R96 000. The trade inventories were delivered on the same day. On
23 February 20.7 the asset-item Receivable A and the income-item sales are recognised. When
Receivable A settles its debt on 20 March 20.7 (assumption), the increase in the asset-item cash is
recognised on this date simultaneously with the decrease in the asset-item Receivable A.
Remark
1
Cash accounting (which is not an acceptable alternative for accrual accounting) would
have recognised only on 20 March 20.7 an increase in the asset-item cash and at the
same time an increase in the income-item sales (which causes an increase in the
equity-item retained earnings).
c) i) Deposit for water and electricity
Definition of an asset
Application – deposit: water and electricity
An asset is a resource
The refundable deposit is a resource since it will be repaid with
the termination of services to AC Entity and can consequently
be utilised in the entity.
controlled by the entity as a result
of past events
The entity has the legal right to the refundable deposit. As a
result, the entity will have the ability to direct the right of use of
the refundable deposit and will obtain substantially all the
remaining benefits from the refundable deposit.
The past event is the deposit of the money by the entity into
the local authority’s account.
and from which future economic
benefits are expected to flow to
the entity.
Future economic benefits are expected to flow to AC Entity
when the deposit is received with the termination of services.
Recognition criteria of an asset
Application – deposit: water and electricity
An item that meets the definition
of an asset is recognised only if it
satisfies both the following
recognition criteria:
As set out above, the deposit: water and electricity satisfies the
definition of an asset.
it is probable that future economic
benefits associated with the item
will flow to the entity; and
An acquired asset-item such as a refundable deposit, which
satisfies the definition of an asset, will probably cause the
inflow of future economic benefits when the entity gives notice
for the termination of the services.
The date on which the inflow of future economic benefits
became probable is the date on which control was obtained
over the right to claim, and that is the date on which the
refundable deposit was paid, namely 1 February 20.7.
the item has a cost or a value that The cost of the deposit: water and electricity can be measured
can be measured reliably.
reliably at the historical cost price thereof, namely the amount
initially paid (R20 000).
62
c) ii) Payable Jozi
Definition of a liability
Application – Payable Jozi
A liability is a present obligation As a result of the delivery of water and electricity services by
of the entity
Jozi to AC Entity during February 20.7 in accordance with the
written service delivery contract, Jozi has a legally enforceable
right to claim from AC Entity and AC Entity has a legally
enforceable obligation towards Jozi.
arising from past events
The satisfactory delivery of the water and electricity services by
Jozi to AC Entity during February 20.7 in accordance with the
contract, is the past event that gave rise to the present, legal
obligation of AC Entity.
and of which the settlement (in The settlement of the obligation towards Payable Jozi is
the future) is expected to result in expected to result in the outflow of cash in the future.
an
outflow
of
resources
embodying economic benefits.
Recognition criteria of a
liability
Application – Payable Jozi
An item that meets the definition As set out above, Payable Jozi satisfies the definition of a
of a liability is recognised only if it liability.
satisfies both the following
recognition criteria:
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
It is accepted in this work that, in respect of items that satisfy
the definition of a liability, the future settlement of the liability is
probable.
The existence of the legal obligation (as a result of the
utilisation of water and electricity by AC Entity during February
20.7 in accordance with the contract) leaves AC Entity no other
choice but to settle the obligation on or before 24 March 20.7
as indicated on the statement.
the item has a cost or a value The cost of Payable Jozi can be measured reliably at the
that can be measured reliably.
historical cost price thereof, namely the invoice (statement)
price of R8 000.
63
c) iii) Water and electricity
Definition of an expense
Application – Water and electricity
Expenses are decreases in
economic benefits during the
reporting period in the form of an
outflow or depletions of assets or
incurrences of liabilities
The incurrence of the water and electricity expense on credit is
a decrease in economic benefits during the reporting period in
the form of an increase in a liability.
that result in a decrease in equity
(retained earnings), excluding
those decreases that relate to
distributions to equity
participants (owner(s)).
The decrease in economic benefits arising from the incurrence
of the water and electricity expense on credit results in an
increase in the liabilities-item Payable Jozi and an increase in
the expense-item water and electricity.
The expense-item water and electricity that increases,
decreases the profit for the reporting period.
If the profit decreases, there is a decrease in equity (retained
earnings).
Recognition criteria of the expense-item water and electricity
The increase in the expense-item water and electricity (that satisfies the definition of an expense) is
recognised simultaneously with the increase in the associated liabilities-item Payable Jozi. The
increase in the expense-item water and electricity (which causes a decrease in equity (retained
earnings)) must therefore be recognised on 28 February 20.7.
d) Dual effect of the transactions on the accounting equation
AC Entity
Transaction
1
2
Assets
=
Liabilities +
Equity
31 Jan
Total 31 January 20.7
3 020 000
=
20 000 +
3 000 000
1 Feb
Pay a refundable deposit for water
and electricity.
(An increase in assets (deposit: water
and electricity) and a decrease in
assets (cash)).
Subtotal
+20 000
-20 000
3 020 000
=
20 000 +
3 000 000
The owner deposits cash in the
entity’s bank account.
(An increase in assets (cash) and an
increase in equity (capital)).
Subtotal
+200 000
3 220 000
=
0
20 000 +
+200 000
3 200 000
2 Feb
64
Transaction
3
5 Feb
Assets
Trade inventories purchased on credit
and received.
(An increase in assets (trade
inventories) and an increase in
liabilities (Payable L)).
(See remark 2 below regarding the
accrual principle).
Subtotal
4
6 Feb
Trade inventories purchased for cash
and received.
(An increase in assets (trade
inventories) and a decrease in assets
(cash)).
Subtotal
5
23 Feb Trade inventories sold on credit and
delivered.
(An increase in assets (Receivable A)
and an increase in equity (retained
earnings – income: sales)).
(A decrease in assets (trade
inventories) and a decrease in equity
(retained earnings – expense: cost of
sales)).
(See remark 2 below regarding the
accrual principle).
Subtotal
6
7
24 Feb Pay Payable L R20 000.
(A decrease in assets (cash) and a
decrease in liabilities (Payable L)).
Subtotal
24 Feb Trade inventories sold for cash and
delivered.
(An increase in assets (cash) and an
increase in equity (retained earnings –
income: sales)).
(A decrease in assets (trade
inventories) and a decrease in equity
(retained earnings – expense: cost of
sales)).
Subtotal
65
+145 000
3 365 000
+60 000
-60 000
3 365 000
=
Liabilities +
Equity
=
+145 000
165 000 +
0
3 200 000
0
=
+96 000
-48 000
3 413 000
-20 000
3 393 000
0
3 200 000
+96 000
=
0
165 000 +
-48 000
3 248 000
=
-20 000
145 000 +
0
3 248 000
0
+64 000
-32 000
3 425 000
165 000 +
0
=
0
145 000 +
+64 000
-32 000
3 280 000
Transaction
8
9
28 Feb Pay gross salaries in cash.
(A decrease in assets (cash) and a
decrease in equity (retained earnings
– expense: salaries)).
Subtotal
28 Feb The owner withdrew cash for personal
use.
(A decrease in assets (cash) and a
decrease in equity (retained earnings
– a distribution to the owner:
drawings).
Subtotal
10 28 Feb Receive water and electricity account.
(An increase in liabilities (payable)
and a decrease in equity (retained
earnings – expense: water and
electricity)).
(See remark 2 below regarding the
accrual principle).
28 Feb Total 28 February 20.7
Assets
=
Liabilities +
-15 000
3 410 000
=
0
145 000 +
-12 000
3 398 000
0
=
0
3 398 000
145 000 +
+8 000
=
153 000 +
Equity
-15 000
3 265 000
-12 000
3 253 000
-8 000
3 245 000
Remarks in respect of Example 2.2’s solution
1
Note that the financial effect of each transaction influences at least two items, of which
each item is classified as an element with reference to the respective definitions of the
elements, and that after accounting for the effect of each transaction the accounting
equation still balances.
2
In accordance with accrual accounting, the:
-
purchase of an item (asset or a service) on credit (refer transactions 3 and 10) and
the payment of the associated payable are two separate transactions.
-
sale of an item on credit (refer transaction 5) and the payment by the associated
trade receivable are two separate transactions.
3
A transaction that entails the purchase of an asset is recognised by the purchasing
entity on the day on which control/right of ownership over the asset transfers to the
purchasing entity.
4
The purchase of trade inventories is in this work initially recognised as an increase in
assets (refer transactions 3 and 4). Inventory systems (perpetual or periodic) are briefly
dealt with in Chapter 5 and more comprehensively in Chapter 13.
5
An income-item (sales) is recognised simultaneously with an increase that occurred in
the associated asset-item (cash or trade receivable) (refer transactions 5 and 7).
6
An expense-item (cost of sales (refer transactions 5 and 7) and salaries (refer
transaction 8)) are recognised simultaneously with a decrease that occurred in the
associated asset-item (trade inventories or cash). An expense-item incurred on credit
((water and electricity (refer transaction 10) is recognised simultaneously with the
increase that occurred in the associated liabilities-item (payable).
66
Chapter 3 Financial statements framework for a sole
proprietor
Contents
Paragraph
1
7
7
8
9
12
15
17
18
20
27
27
31
33
34
Introduction
The statement of financial position
Introduction
Assets
Non-current assets
Current assets
Liabilities
Non-current liabilities
Current liabilities
Equity (proprietary interest)
The statement of profit or loss
Introduction
Income
Expenses
The statement of changes in equity
67
Chapter 3 Financial statements framework for a sole
proprietor
Introduction
1
The final product of the accounting process is the delivery of general purpose financial
statements that comprise the following components:
•
the statement of financial position;
•
the statement of profit or loss;
•
the statement of changes in equity;
•
the statement of cash flows; and
•
additional notes and annexures.
2
General purpose financial statements provide information on the financial position,
performance and cash flow of an entity that is useful to the owner thereof and other users,
as well as the providers of finance.
3
In this chapter a financial statements framework is presented for a sole proprietor. The
financial statements framework comprises a statement of financial position, statement of
profit or loss and statement of changes in equity. The purpose of this framework is to act as
reference as progress is made with the preparation of financial statements. During the course
of the work this set of concept financial statements will be further formalised and provided
with additional disclosure in the form of notes. Chapter 14 contains a financial statements
framework for a company. The statement of cash flows is dealt with in Chapter 21.
4
General purpose financial statements are prepared from the accounting records. The
financial effect of transactions and events is accumulated in the financial records of an entity
with reference to the elements (assets, liabilities and equity) of the final product of
Accounting, namely the financial statements. Each of the elements consists of various items,
for example:
5
6
•
asset-items: land, buildings, trade inventories, cash, etc.;
•
liability-items: loans, trade payables and other payables; and
•
equity-items: capital and retained earnings.
Retained earnings consist of the elements income and expenses as well as drawings
(distributions to the owner). Each of the elements income and expenses consists of various
items, for example:
•
income-items: sales, rent income and interest income; and
•
expense-items: cost of sales, salaries, water and electricity, etc.
In the accounting records there is a record (known as an account) for each element-item (e.g.
buildings). The effect of transactions and events on elements is accumulated in the
accounting records (accounts) for the relevant items when the items that are brought about
by the transaction or event meet the definition and recognition criteria of the relevant item.
The net effect of the impact of transactions and events on an item is reflected by the balance
of the accounting record (account). General purpose financial statements are prepared from
the balances of these accounting records. The accumulation of the financial effect of
transactions and events in the accounting records of an entity is dealt with in Chapters 4 and
5.
68
Financial statements framework for a sole proprietor
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
20.6
R
ASSETS
Non-current assets
Land
Buildings
Machinery
Delivery vehicles
Furniture and equipment
Trade marks purchased
Total non-current assets
1 450 200
1 530 680
937 500
570 000
547 050
1 500 000
6 535 430
1 450 200
1 620 720
1 125 000
760 000
625 200
1 800 000
7 381 120
Current assets
Inventories
Trade receivables
Other current assets
Term deposit
Cash and cash equivalents
Total current assets
Total assets
1 927 025
3 850 500
402 300
420 000
1 273 280
7 873 105
14 408 535
1 825 525
2 950 075
380 255
0
400 080
5 555 935
12 937 055
EQUITY AND LIABILITIES
Equity
Capital
Retained earnings
Total equity
6 500 000
3 011 520
9 511 520
6 000 000
2 147 055
8 147 055
Non-current liabilities
Bank loan
Total non-current liabilities
2 200 355
2 200 355
2 306 930
2 306 930
2 350 085
240 000
106 575
2 696 660
4 897 015
14 408 535
2 005 300
380 000
97 770
2 483 070
4 790 000
12 937 055
Current liabilities
Trade and other payables
Short term loans
Current portion of long term loans
Total current liabilities
Total liabilities
Total equity and liabilities
Remarks in respect of specific line items in the statement of financial position
1
Land is presented at cost price.
2
Buildings, machinery, delivery vehicles as well as furniture and equipment are
presented at depreciated cost or carrying amount, in other words cost price less
accumulated depreciation.
69
3
Trademarks purchased are presented at carrying amount, in other words cost price less
accumulated amortisation.
4
Inventories are presented at cost price less write-offs to net realisable value.
5
Trade receivables are presented at the total of the individual trade receivables’ balances
less the allowance for doubtful debts.
6
Term deposits are presented at amortised cost, in other words the initial investment plus
accrued interest.
7
Loans are presented at amortised cost, in other words the initial loan amount plus
accrued interest.
8
If the balance on the bank account is favourable, it will be presented in the line item
cash and cash equivalents under the heading current assets. However, if the balance is
in overdraft, it will be presented in the line item bank overdraft under the heading current
liabilities.
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
20.7
R
12 799 735
(5 827 005)
6 972 730
Sales
Cost of sales
Gross profit
Other income
Rent income
Salaries and wages
Water and electricity
Assessment rates
Telephone and communication
Office supplies
Insurance
Fuel and maintenance
Depreciation
Amortisation
Bad debts
Other administrative expenses
Interest expense
Profit for the year
20 000
(2 525 950)
(246 500)
(156 000)
(204 800)
(417 000)
(148 000)
(242 525)
(800 690)
(45 000)
(142 500)
(22 800)
(216 500)
1 824 465
Remarks
1
The sum of the income-items is R12 819 735.
2
The sum of the expense-items is R10 995 270.
70
20.6
R
AC ENTITY
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.7
Retained
earnings
R
Capital
R
Balance at 1 January 20.6
Changes in equity for 20.6
Additional capital contribution by owner
Profit for the year
Distribution to owner (drawings)
Balance at 31 December 20.6
0
Total
R
0
0
2 147 055
6 000 000
2 147 055
2 147 055
8 147 055
1 824 465
(960 000)
3 011 520
500 000
1 824 465
(960 000)
9 511 520
6 000 000
6 000 000
Changes in equity for 20.7
Additional capital contribution by owner
Profit for the year
Distribution to owner (drawings)
Balance at 31 December 20.7
500 000
6 500 000
General remarks in respect of the framework
1
AC Entity is the reporting entity. The reporting period is the year ended 31 December
20.7 and the reporting date is 31 December 20.7.
2
Each line item, description and amount next to the line item, e.g. “Land R1 450 200”, in
respect of each of the above financial statements has reference to an item and reflects
the net effect (balance) of the impact of the transactions and events on the item, as
accumulated in the accounting record (account) for the relevant item. Some of the line
items have reference to more than one item and contain in such an event the total of the
accumulated information in more than one accounting record (account).
3
In practice financial statements are usually provided with comparative amounts. In the
case of the statement of financial position comparative amounts are provided as at the
immediately preceding reporting date.
The statement of financial position
Introduction
7
The statement of financial position indicates the financial state/position of the entity at a
specific date, usually the reporting date. The statement of financial position deals with the
assets, liabilities and equity of an entity in a specific format. Detail of an entity’s assets and
the detail of the sources of finance (liabilities and equity), out of which the assets were
acquired, are presented in the statement of financial position. The records from which the
statement is prepared, changes daily as result of the financial effect of transactions and
events on asset-, liability- and equity-items. The informed user will however pay attention to
the mutual relationship between sections of the statement of financial position, e.g. between
current assets and current liabilities. The comparative amounts that are provided will
furthermore enable the informed user to identify trends. The statement of financial position
was previously referred to as the balance sheet.
71
Assets
8
Assets are purchased resources that are controlled by the reporting entity and that were
recognised in the accounting records when the definition and recognition criteria of an asset
were satisfied. Assets consist of various items and are presented in the statement of financial
position under two classification headings, namely non-current assets and current assets.
Non-current assets
9
Non-current assets are defined as all assets that are not current assets. The definition does
not explain much of the nature of non-current assets. Non-current assets mainly consist of
physical assets, but also include intangible assets such as trademarks purchased (a
purchased right to sell a particular trademark). Non-current assets provide the basis, mostly a
physical capacity, within which the operating activities of an entity take place.
10
Land and buildings are often obtained as a unit, but are separable assets and are treated
separately for accounting purposes. Land has an unlimited useful life. Buildings, however,
have a limited useful life, but can usually be utilised for a relatively long period (20 – 25 years)
by the entity. Because non-current assets (excluding land) have a limited useful life, the cost
of a non-current asset (excluding land) is annually reduced over the useful life thereof by
recognising an associated expense-item, namely depreciation. In the case of an intangible
asset such as trademarks, the expense is known as amortisation. The line item “Buildings” is
therefore the part of the cost of buildings that, at the reporting date, has not yet been
allocated to the depreciation expense. The systematic allocation of the cost of an asset with a
limited useful life to an expense is dealt with in Chapters 5, 12 and 16.
11
The transactions that give rise to the purchase of non-current assets are known as
investment activities. An entity often incurs loans to purchase non-current assets.
Current assets
12
13
14
An entity will classify an asset as a current asset if:
•
the asset is primarily held for the purposes of trading, with the expectation to sell or use
the asset within the normal operating cycle (e.g. trade inventories and trade
receivables); or
•
the asset will realise into cash within twelve months from the current reporting date (e.g.
a term deposit with a financial institution); or
•
the asset is cash or cash equivalents.
Current assets are brought forth by the operating activities (trading) of the entity. Operating
activities take a course known as the operating cycle, namely:
•
trade inventories are purchased (giving rise to trade inventories and trade payables);
•
trade inventories are sold at a profit/mark-up (giving rise to cash or trade receivables);
•
as soon as the trade receivables pay, cash is brought forth; and
•
the cash is used to pay trade and other payables and expenses or to again purchase
trade inventories for cash.
The operating cycle is repetitive and the trade inventories on hand, the trade receivables
outstanding, the cash on hand and the trade payables outstanding change daily and in this
process income and expenses are brought forth.
72
Liabilities
15
Liabilities are present legal obligations of the reporting entity that were incurred in the past
and that were recognised in the accounting records when the items satisfied the definition
and recognition criteria of a liability.
16
Liabilities consist of various liability-items and are presented in the statement of financial
position under two classification headings, namely non-current liabilities and current
liabilities.
Non-current liabilities
17
Non-current liabilities are defined as all liabilities that are not current liabilities. The definition
does not explain much of the nature of non-current liabilities. Non-current liabilities in this
work consist of long term loans. A long term loan is a loan of which the initial loan term is
longer than 12 months. The loan term is however often many years and loans are mostly
obtained to finance the acquisition of non-current assets. The part of a long term loan that is
payable within 12 months of the reporting date, is presented as part of the line item “Current
portion of long term loans” under the heading current liabilities. The transactions that give rise
to non-current liabilities result from the financing activities of an entity.
Current liabilities
18
19
An entity will classify a liability as a current liability if:
•
it is the expectation to settle the liability in cash within the normal operating cycle (e.g.
other payables); or
•
the liability is primarily held for trading (e.g. trade payables); or
•
the liability has a settlement date that falls within twelve months from the current
reporting date (e.g. a bank loan).
The transactions that give rise to current liabilities arise from the operating activities of an
entity.
Equity (proprietary interest)
20
Equity is defined with reference to the element assets and the element liabilities and is the
owner’s remaining interest in the assets after all liabilities have been deducted. This definition
of equity results in an axiomatic relationship between assets, liabilities and equity that is
represented by the following equation:
Equity
21
=
Assets
–
Liabilities
In accordance with the accounting entity concept (Chapter 2 paragraphs 28 to 30) the above
equation is written as follows:
Assets
=
Liabilities
+
Equity
22
The above equation is also known as the accounting equation. It is further the convention to
place the element assets on the left hand side of the equation.
23
The amounts below are obtained from the statement of financial position of AC Entity.
Assets
=
Liabilities
+
Equity
31/12/20.6
12 937 055
=
4 790 000
+
8 147 055
31/12/20.7
14 408 535
=
4 897 015
+
9 511 520
73
24
Note that on 31 December 20.7, the total assets of AC Entity, namely R14 408 535, are
financed as follows:
•
R4 897 015 by external parties (non-current liabilities and current liabilities); and
•
R9 511 520 by the owner.
25
Equity consists of the following two items: capital and retained earnings. The statement of
financial position of AC Entity indicates that the equity/financing provided by the owner at
31 December 20.7, namely R9 511 520, comprises capital of R6 500 000 and retained
earnings of R3 011 520.
26
The accounting equation can therefore be expanded as follows:
Assets
= Liabilities +
Capital
Equity
+
Retained earnings
The statement of profit or loss
Introduction
27
The statement of profit or loss deals with the performance of the entity for a relevant reporting
period (usually one year) and is prepared to reflect the calculation of profit (or loss) for the
year. Performance is therefore the relationship between income and expenses of an entity for
a reporting period. If income is greater than expenses, the performance is a profit for the year
and if expenses are greater than income, the performance is a loss for the year. The
statement of profit or loss of AC Entity reflects the profit for the year ended 31 December 20.7
as
R1 824 465 and is calculated as the total of income (R12 819 735) less the total of the
expenses (R10 995 270).
28
The profit or loss for the year, as reflected in the statement of profit or loss, is transferred to
the retained earnings column in the statement of changes in equity.
29
Those transactions and events that give rise to income and expenses are referred to as the
operating activities of an entity. The associated assets that are brought forth, namely trade
inventories, trade receivables and cash, are known as current assets. The associated
liabilities that are brought forth, namely trade- and other payables, are known as current
liabilities.
30
The statement of profit or loss was previously known as the statement of income or the
income statement.
Income
31
Income is increases in economic benefits in the form of increases in assets, such as cash
and trade receivables, that occurred during the reporting period, which resulted in an increase
in equity, more specifically retained earnings. Items that meet the definition of income are
recognised in the accounting records when the associated asset-item cash or trade
receivables meet the definition and recognition criteria of an asset.
32
The main income-item of a trading entity is known as sales. In the statement of profit or loss
of AC Entity sales is presented as the line item “Sales R12 799 735”. Other income-items
include, amongst others, interest income and rent income.
74
Expenses
33
Expenses are decreases in economic benefits in the form of decreases in assets (e.g. cash)
or increases in liabilities (e.g. payables) that occurred during the reporting period, which
resulted in a decrease in equity, more specifically retained earnings. Items that meet the
definition of an expense are recognised in the accounting records when the decrease in the
asset occurred or when the associated liability-item payable meets the definition and
recognition criteria of a liability. Expenses comprise various expense-items, e.g. cost of sales,
salaries, etc. Refer to the statement of profit or loss of AC Entity.
The statement of changes in equity
34
The statement of changes in equity provides detail of the composition of the finance provided
by the owner to the entity and the changes therein during the reporting period. The statement
also indicates the extent of capital contributions by the owner during the reporting period as
well as earnings that are retained in the entity after distributions to the owner.
35
In respect of a sole proprietor, capital represents the funds or resources provided by the
owner at the disposal of the entity. The transactions that bring forth capital arise from the
financing activities of the entity.
36
Retained earnings are the accumulated profits of the entity since the inception of the entity,
which have not been withdrawn by the owner and are subsequently dealt with.
37
The totals of the capital column and the retained earnings column in the statement of
changes in equity are transferred to the two line items “Capital” and “Retained earnings” in
the statement of financial position, under the heading equity.
38
The statement of changes in equity of AC Entity for the year ended 31 December 20.7
indicates the following:
R
8 147 055
9 511 520
1 364 465
Equity at the beginning of the year (20.7)
Equity at the end of the year (20.7)
Therefore: increase in equity during the year (20.7)
39
The increase in equity during the year (20.7) is made up as follows:
Capital contributions by the owner during the year (20.7)
Increase in retained earnings during the year (20.7)
40
R
500 000
864 465
1 364 465
The increase in retained earnings during the year (20.7) is made up as follows:
Income for the year (total of all income)
Less: Expenses for the year (total of all expenses)
Profit for the year (20.7)
Less: Drawings for the year (20.7)
Retained earnings for the current year (20.7)
75
R
12 819 735
(10 995 270)
1 824 465
(960 000)
864 465
41
If the compounding items of retained earnings, as identified above, namely retained earnings
at the beginning of the reporting period, income (for the current reporting period), expenses
(for the current reporting period) and drawings (for the current reporting period), are taken
into account, the accounting equation can be expanded as follows:
Equity
Retained earnings
Profit for the year
Assets = Liabilities + Capital + Retained earnings + Income – Expenses – Drawings
opening balance
or set out more simply:
Equity
Assets = Liabilities + Capital + Retained earnings + Income – Expenses –
opening balance
42
Drawings
The above equation forms the basis of the analytical framework according to which the
financial effect of transactions and events is accumulated in the accounting records. This
analytical framework is known as the double entry system and is the topic of Chapter 4.
76
Chapter 4 Double entry rules and the application thereof
Contents
Paragraph
1
6
7
11
11
12
17
20
24
28
Outline
The account as accounting record
Format of an account
The double entry rules
Background
Double entry rules
Balancing of accounts
List of account balances (the trial balance)
Journal entries
The bookkeeping process then and now
77
Examples
Example
4.1
4.2
4.3
4.4
4.5
4.6
The dual effect of transactions recorded directly in T-accounts (for asset-items,
liabilities-items and capital)
Balancing of accounts
Formulation of transactions
List of balances (trial balance) as well as a statement of financial position
Journal entries (asset-items, liabilities-items and capital)
Journalise income and expenses. Post transactions to accounts. Prepare a list of
balances. Statement of profit or loss. Statement of changes in equity. Statement of
financial position
78
Chapter 4 Double entry rules and the application thereof
Outline
1
A relationship exists between the elements of financial statements as expressed in the
accounting equation. Due to the relationship between the elements, each transaction or event
has a dual effect on the elements of the accounting equation. A transaction or event will time
and again have one of the following four effects on the elements of the accounting equation:
•
The transaction or event increases an asset and decreases another asset
•
The transaction or event increases an asset and increases a liability or equity;
•
The transaction or event decreases an asset and decreases a liability or equity; and
•
The transaction or event increases a liability and decreases another liability or equity.
2
According to the Conceptual Framework 2010, element-items (the increase) can only be
recognised if the element items (e.g. delivery vehicle, trade receivable, bank, trade payable,
sales, and cost of sales) satisfy the definition as well as the recognition criteria of the relevant
element.
3
Derecognition of element-items bears reference to the recognition of the decrease (reduction)
of assets and liabilities that were previously recognised. In this chapter, concerning
derecognition of items, only the following will be dealt with:
•
the decrease in the asset-item bank (cash was utilised);
•
the decrease in the asset-item trade receivable (the trade receivable paid); and
•
the decrease in the liabilities-item trade payable or loan (the payable/loan was paid).
The decrease in the assets and liabilities mentioned above is recognised on the day on which
the cash flows.
4
The change (increase or decrease) in the element-items was recognised in Chapter 2 within
the context of the accounting equation. (Review Examples 2.1 and 2.2.)
5
In this chapter, the following aspects will be dealt with:
•
The account as accounting record for the accumulation of changes (increases or
decreases) which occurred in element-items as a result of transactions and events.
•
The application of the double entry rules for the recording/recognition of changes
(increases or decreases) in element-items in the accounts/records as a result of
transactions and events that occurred.
79
The account as accounting record
6
In Chapter 2 it was indicated that each of the elements of the accounting equation comprises
at least one or more items. The following information represents a list of element-items that
typically occurs within a trading entity:
Asset-items (A)
Account
number
Non-current asset items
Land
Buildings (cost price)
Accumulated depreciation – buildings
Machinery (cost price)
Accumulated depreciation – machinery
Vehicles (cost price)
Accumulated depreciation – vehicles
Furniture and equipment (cost price)
Accumulated depreciation – furniture and equipment
Trademarks (cost price)
Accumulated amortisation – trademarks
Right-of-use asset (cost price)
Accumulated depreciation – right-of-use asset
A1
A2.1
A2.2
A3.1
A3.2
A4.1
A4.2
A5.1
A5.2
A6.1
A6.2
A7.1
A7.2
Current asset items
Trade inventories
Trade receivables (total of individual balances)
Allowance for doubtful debts
Office supplies on hand
Prepaid insurance
Prepaid rent
Deposit: water and electricity
Rent deposit paid
Term deposit
VAT payment control (favourable balance)
Bank (favourable bank balance)
Call deposits – money market
Income receivable
A20
A21.1
A21.2
A23.1
A23.2
A23.3
A23.4
A23.5
A24
A25
A30
A31
A32
Equity-items (E)
Account
number
E1
E2.1
E2.2
Capital
Retained earnings
Drawings
80
Liabilities-items (L)
Account
number
Non-current liability items
Mortgage bond
Bank loan
Lease liability
Supplier’s loan
L1
L2
L3
L4
Current liability items
Trade payables (total of individual balances)
Rent expense payable
Audit fees payable
Rent deposit received
SARS – PAYE
Pension fund contributions
Medical aid fund contributions
VAT payment control (unfavourable balance)
Short term loan
Bank (overdraft bank balance)
L10
L11.1
L11.2
L11.3
L11.5
L11.6
L11.7
L14
L17
A30
Income-items (I)
Sales
Rent income
Interest income on term deposit
Interest income on favourable bank balance
Profit on sale of non-current assets
Expense-items (U)
Account
number
I1
I4.1
I4.2
I4.3
I4.4
Account
number
U1
U3
U4
U5
U6
U7
U8
U9
U10
U11
U12
U15
U19
U20.1
U20.2
Cost of sales
Salaries and wages
Water and electricity
Assessment rates
Telephone and communication
Office supplies
Insurance
Fuel and maintenance
Loss on sale of non-current assets
Bad debts
Rent expense
Bank charges
Administrative expenses
Depreciation – buildings
Depreciation – machinery
81
Expense-items (U) (continue)
Account
number
U20.3
U20.4
U20.5
U20.7
U30.1
U30.2
U30.3
U30.4
U30.5
U40
Depreciation – vehicles
Depreciation – furniture and equipment
Depreciation – right-of-use asset
Amortisation – trademarks
Interest expense on bank overdraft
Interest expense on bank loan
Interest expense on supplier’s loan
Interest expense on mortgage bond
Interest expense on lease liability
Audit fees
Remarks in respect of specific element-items
1
The accumulated depreciation account in essence forms part of the (credit side of the)
asset account, but is kept separately for the sake of maintaining important accounting
information.
2
The accumulated amortisation account in essence forms part of the (credit side of the)
asset account, but is kept separately for the sake of maintaining important accounting
information.
3
The allowance for doubtful debts account in essence forms part of the (credit side of
the) asset account (trade receivables), but is kept separately for the sake of maintaining
important accounting information.
4
Audit fees are only applicable if the entity elected/requires a formal/statutory audit.
5
The bank account can switch between favourable (thus an asset) and overdraft (thus a
liability).
6
For each of the items, a record, which is known as an account, is maintained. The
abovementioned table is referred to as a list of accounts, which also contains a unique
number for each record/account. The abovementioned list of accounts and account
numbers are, where applicable, used in some of the subsequent chapters.
Format of an account
7
There is a separate record in the entity’s accounting records for each of the element-items in
which the effect of transactions and events on the relevant element-item is accumulated. This
record is known as an account. The account initially had a T-format, but with the arrival of the
computer, the format changed to a statement format/column format. In this work, accounts
will mostly be presented in the T-format.
8
As the name indicates, a T-account has the format of a T. The name of the specific asset-,
liability- or equity-item, in respect of which the detail of the dual effect of transactions or
events is accumulated, appears on the horizontal line of the T. The name of the account is in
most cases usually the name of the element-item itself, e.g. the asset-item buildings’ account
name is merely buildings. Each account also has a unique number that contains a reference
to the relevant element. In this work, the element-items and the unique account numbers, as
reflected in paragraph 6, will mostly be used initially.
82
9
The left side of any T-account (assets, liabilities, equity, income or expenses) is known as the
debit side of the T-account and the right side of any T-account is known as the credit side of
the T-account. Therefore, the abbreviations “Dr” (debit) and “Cr” (credit) respectively appear
on the left side and the right side of the horizontal line of the T-account.
Dr
Name of the account/record
Debit side
10
Cr
Credit side
The term “debit (verb) an account” means to record/account for/recognise a transaction or
event (amount and description) on the left side of a T-account. The term “credit (verb) an
account” means to record/account for/recognise a transaction or event (amount and
description) on the right side of a T-account. The T-account however has a more formal
format, as set out below.
Dr
Account name
Date
Detail of contra
account
Nr
Amount
Date
Cr
Detail of contra
account
Nr
Amount
Remarks in respect of the more formal format of the T-account
1
The T-format is formalised by inserting date columns, in order to provide each debit- or
credit entry with a date.
2
On the debit side of each account is a space provided for detail in respect of the
account that is credited (contra account) and on the credit side of each account a space
is provided for detail in respect of the account that is debited (contra account). When an
account is debited with an amount, detail of the name of the account that is credited is
provided next to the amount. When an account is credited with an amount, detail of the
name of the account that is debited is provided next to the amount. The use of the
detail columns makes it possible to clearly reflect the dual effect of transactions. In
Accounting the other account credited and the other account debited is referred to as
contra accounts.
3
The T-format is furthermore formalised by including reference columns (in the Taccount referred to as “Nr”) which is used to provide a reference number for each debit
amount or credit amount. The unique reference number makes it possible to trace each
entry in an account to the source document.
The double entry rules
Background
11
The double entry rules were developed in 1494 by Luca Pacioli, an Italian intellectual, by
applying Arabic algebra and are described in his book Summa de Arithmetic. The invention of
the double entry rules was so brilliant that even up to today, the rules serve as basis to
incorporate the effect of transactions and events in the records of entities.
83
Double entry rules
12
The accounting equation in an elaborated format is as follows:
Equity
Assets = Liabilities + Capital + Retained earnings + Income – Expenses – Drawings
opening balance
13
If expenses and drawings are transferred to the left side of the equal sign, in order to have
only positive amounts on each side of the equal sign, the equation is as follows:
Left side
Right side
Assets + Expenses + Drawings = Liabilities + Capital +
14
Retained earnings
opening balance
+ Income
The double entry rules are deduced from the accounting equation, which should always be in
balance. The rules are obviously not influenced by whether the equation is presented in an
abbreviated format or in a more elaborated format. If the accounting equation is presented in
the format of paragraph 13, the rules of the double entry system can be formulated concisely.
Furthermore, an association with the accounting equation can be made, by referring to the
left side and right side of the equation.
Rules for the double entry system
Table 4.1
Each transaction or event that the entity is a party to, affects at least two items/accounts in
the entity’s records. If only two accounts are affected, the one account is debited and the
other account is credited with an equal amount. If more than two accounts are affected by the
transaction or event, the sum of the accounts that are debited is always equal to the sum of
the accounts that are credited.
This treatment of the dual effect of transactions and events causes that:
1. for each debit amount there will be a corresponding credit amount; and
2. the accounting equation remains in balance.
Items on the left side of the accounting
equation:
Asset-items, expense-items and drawings
Items on the right side of the accounting
equation:
Liabilities-items, income-items, retained
earnings opening balance and capital
An increase in an asset-item, an expenseitem and drawings (paragraph 13) causes
the account of these items to be debited and
that the account of another item concerned is
credited.
An increase in a liabilities-item, an
income-item, retained earnings opening
balance and capital (paragraph 13) causes
the account of these items to be credited
and that the account of another item
concerned is debited.
A decrease in an asset-item, an expenseitem and drawings (paragraph 13) causes
the account of these items to be credited and
that the account of another item concerned is
debited.
(A decrease of an expense-item and drawings
seldom occurs.)
A decrease in a liabilities-item, an incomeitem, retained earnings opening balance
and capital (paragraph 13) causes the
account of these items to be debited and
that the account of another item concerned
is credited.
(A decrease of capital and income-items
seldom occurs.)
84
Remark in respect of the retained earnings opening balance
1
Transactions and events that cause the retained earnings opening balance to be
debited or credited are limited to a few unique transactions, which fall outside the scope
of this work.
The basis of the doubly entry system
Dr
Any asset account Cr
Increases
(debits)
Decreases
(credits)
Table 4.2
Dr Any expense account Cr
Increases
(debits)
Decreases
(credits)
Dr Any liability account Cr
Dr Any income account
Decreases
(debits)
Decreases
(debits)
Increases
(credits)
Cr
Increases
(credits)
Dr
Drawings account
Increases
(debits)
Dr
Decreases
(credits)
Capital account
Decreases
(debits)
Cr
Cr
Increases
(credits)
Remarks in respect of the above table
1
The drawings account is a temporary account and is closed off against the retained
earnings account at the end of each reporting period. The drawings account is therefore
in essence part of the debit side of the retained earnings account. A new drawings
account is therefore opened for each reporting period.
2
The income accounts are temporary accounts, also called nominal accounts, and are
closed off against the retained earnings account at the end of each reporting period.
Income accounts are therefore in essence part of the credit side of the retained
earnings account. A new set of income accounts are therefore opened for each
reporting period.
3
The expense accounts are temporary accounts, also called nominal accounts, and are
closed off against the retained earnings account at the end of each reporting period.
Expense accounts are therefore in essence part of the debit side of the retained
earnings account. A new set of expense accounts are therefore opened for each
reporting period.
4
If the sum of the balances on the income accounts is greater than the sum of the
balances on the expense accounts, the entity yielded a profit for the year/reporting
period. If the sum of the balances on the income accounts is however smaller than the
sum of the balances on the expense accounts, the entity yielded a loss for the
year/reporting period.
85
Practical application of the double entry rules
Table 4.3
Effect of transaction:
The transaction increases an asset and decreases another asset
Examples of such
a transaction
Effect on items concerned
Account debited
Account
credited
Purchase an asset
(e.g. delivery
vehicle) for cash
Increase in delivery vehicle
(asset) and
Decrease in bank (asset)
Vehicles
Bank
Purchase an asset
(e.g. trade
inventories) for cash
Increase in trade inventories
(asset) and
Decrease in bank (asset)
Trade inventories
Bank
Invest surplus funds
in a call deposit
Increase in call deposit
(asset) and
Decrease in bank (asset)
Call deposit
Bank
Invest surplus funds
in a term deposit
Increase in term deposit
(asset) and
Decrease in bank (asset)
Term deposit
Bank
Effect of transaction:
The transaction increases an asset and increases a liability or equity
Examples of such
a transaction
Effect on items concerned
Account debited
Account
credited
Purchase an asset
(e.g. delivery
vehicle) on credit
Increase in delivery vehicle
(asset) and
Increase in payable/
supplier’s loan (liability)
Vehicles
Payable/
Supplier’s loan
Purchase an asset
(e.g. trade
inventories) on
credit
Increase in trade inventories
(asset) and
Increase in trade payable
(liability)
Trade inventories
Trade payable
Owner deposits
amount in entity’s
bank account
Increase in bank (asset) and
Increase in capital (equity –
capital)
Bank
Capital
Cash sales of trade
inventories (sales
price)
Increase in bank (asset) and
Increase in sales (equity –
retained earnings)
Bank
Sales
Credit sales of trade
inventories (sales
price)
Increase in trade receivable
(asset) and
Increase in sales (equity –
retained earnings)
Trade receivable
Sales
Rent income
received in cash
Increase in bank (asset) and
Increase in rent income
(equity – retained earnings)
Bank
Rent income
86
Effect of transaction:
The transaction decreases an asset and decreases a liability or equity
Examples of such
a transaction
Effect on items concerned
Account debited
Account
credited
Pay an amount due
to a trade payable
Decrease in trade payable
(liability) and
Decrease in bank (asset)
Trade payable
Bank
Pay the instalment
on a loan
Decrease in loan (liability)
and
Decrease in bank (asset)
Loan
Bank
Pay the owner his
monthly drawings
Increase in drawings
(decrease in equity –
retained earnings) and
Decrease in bank
Drawings
Bank
Pay an expense
(e.g. wages) in cash
Increase in wages (decrease
in equity – retained earnings)
and
Decrease in bank
Wages
Bank
Pay an expense
(e.g. repairs to
delivery vehicle) in
cash
Increase in repairs (decrease
in equity – retained earnings)
and
Decrease in bank
Repairs
Bank
Deliver sold trade
inventories (cost
price) – perpetual
inventory system
Increase in cost of sales
(decrease in equity –
retained earnings) and
Decrease in trade inventories
Cost of sales
Trade
inventories
Effect of transaction:
The transaction increases a liability and decreases another liability or equity
Examples of such
a transaction
Effect on items concerned
Account debited
Account
credited
Incur an expense
(e.g. repairs to
delivery vehicle) on
credit
Increase in repairs (decrease
in equity – retained earnings)
and
Increase in payable (liability)
Repairs
Payable
Obtain a service
(e.g. water and
electricity) on credit
Increase in water and
electricity (decrease in equity
– retained earnings) and
Increase in payable (liability)
Water and
electricity
Payable
Pay a payable with
an overdraft bank
account
Decrease in payable (liability)
and
Increase in bank overdraft
(liability)
Payable
Bank
87
15
It is clear that the items on the left side of the equal sign in the accounting equation increase
on the left side of the account and decrease on the right side of the account. Assets,
expenses and drawings consequently increase on the debit side of the T-account and
decrease on the credit side of the T-account.
16
It is furthermore clear that the items on the right side of the equal sign in the accounting
equation increase on the right side of the account and decrease on the left side of the
account. Liabilities, capital, retained earnings (opening balance) and income consequently
increase on the credit side of the T-account and decrease on the debit side of the T-account.
Example 4.1 The dual effect of transactions recorded directly in T-accounts (for asset-items,
liabilities-items and capital)
On 2 January 20.7, AC Entity commenced with activities and during January 20.7 the entity
incurred the following transactions:
1
On 2 January 20.7, the owner made the property that AC Entity utilises available for the
exclusive use of the entity. The property was registered in the owner’s name a few days
before 2 January 20.7. The purchase price of the property was R1 200 000 (R200 000 for the
land and R1 000 000 for the buildings).
2
On 2 January 20.7, the owner opened a cheque account for the entity and deposited
R1 800 000 in the account.
3
On 2 January 20.7, furniture and equipment to the amount of R225 000 was ordered. The
supplier, Payable K, delivered the furniture and equipment on 5 January 20.7 to AC Entity’s
premises. The invoice price is R225 000 and it was agreed with Payable K to pay the
outstanding amount on 30 January 20.7.
4
Trade inventories to the amount of R20 000 was ordered on 7 January 20.7 and it was
agreed with Payable L that the outstanding amount will be paid 30 days after delivery. On
25 January 20.7, Payable L delivered the trade inventories to AC Entity’s premises. The
invoice price is R20 000 and the invoice reflects that the amount is payable on 24 February
20.7.
5
On 30 January 20.7, the amount due to Payable K was paid.
Required:
Open appropriate accounts in the records of AC Entity. (AC Entity uses the perpetual inventory
system.) Subsequently recognise the abovementioned transactions for January 20.7 directly in the
accounts.
Example 4.1 Solution
AC Entity
Dr
Date
20.7
2 Jan
A1 Land
Detail of contra
account
Capital
Nr
E1
Dr
Date
20.7
2 Jan
Amount
Cr
Date
Detail of contra
account
Nr
Amount
Detail of contra
account
Nr
Amount
200 000
A2.1 Buildings
Detail of contra
account
Capital
Nr
E1
Amount
Date
1 000 000
88
Cr
Dr
A5.1 Furniture and equipment
Date
20.7
5 Jan
Detail of contra
account
Payable K
Nr
Amount
K1
Dr
Date
Cr
Detail of contra
account
Nr
Amount
Date
Detail of contra
account
Nr
Amount
Date
Detail of contra
account
Nr
Amount
K1
cf
225 000
1 575 000
1 800 000
Nr
Amount
225 000
A20 Trade inventories
Date
20.7
25 Jan
Detail of contra
account
Payable L
Nr
K2
Dr
Amount
Cr
20 000
A30 Bank
Date
Detail of contra
account
Nr
20.7
2 Jan
Capital
E1
1 Feb
Balance
bd
Dr
Amount
Cr
20.7
1 800 000 30 Jan
31 Jan
1 800 000
1 575 000
Payable K
Balance
E1 Capital
Date
Detail of contra
account
Nr
Amount
Cr
Date
20.7
2 Jan
2 Jan
2 Jan
Dr
Detail of contra
account
Land
Buildings
Bank
A1
200 000
A2.1 1 000 000
A30 1 800 000
3 000 000
K1 Payable K
Date
20.7
30 Jan
Detail of contra
account
Bank
Nr
A30
Dr
Amount
Date
20.7
225 000 5 Jan
Cr
Detail of contra
account
Nr
Furniture and equipment
A5.1
Detail of contra
account
Nr
K2 Payable L
Date
Detail of contra
account
Nr
Amount
Date
20.7
25 Jan
Amount
225 000
Cr
Trade inventories
A20
Amount
20 000
Remarks in respect of the above
1
In this example, the reference number column (“Nr”) was used to refer to the number of
the contra account.
89
2
The practical application of the double entry rules in respect of transaction number 2 is
as follows: Determine the items concerned, namely bank and capital. With reference to
the respective definitions of the elements identify the relevant elements, namely assets
(bank) and equity (capital). Identify whether an increase or a decrease in the element
occurred and then apply the double entry rules, as set out in Table 4.1. The asset-item
bank increased and therefore the bank account is debited. The equity-item capital
increased and therefore the capital account is credited. This approach must time and
again be applied until the necessary skills in the application of the double entry rules
have been obtained.
3
The practical application of the double entry rules in respect of transaction number 4 is
as follows: Determine the items concerned, namely trade inventories and trade
payable. With reference to the respective definitions of the elements, identify the
relevant elements, namely assets (trade inventories) and liabilities (trade payable).
Identify whether an increase or a decrease in the element occurred and then apply the
double entry rules, as set out in Table 4.1. The asset-item trade inventories increased
and therefore the trade inventories account is debited. The liabilities-item trade
payables increased and therefore Payable L’s account is credited. This approach must
time and again be applied until the necessary skills in the application of the double
entry rules have been obtained.
Balancing of accounts
17
Balancing of an account is the action whereby the balance of the account is determined.
Balancing of accounts mostly occurs monthly.
18
Balancing of accounts involves a basic technique which, within the context of accounts in the
T-format, works as follows:
•
Determine in respect of the relevant account the sum of the amounts in the amount
column of the debit side as well as the sum of the amounts in the amount column of the
credit side for the relevant month. (The amounts indicated hereafter were obtained from
the balancing of the trade inventories account in Example 4.2 below.)
•
Subsequently determine the balance of the account as at the end of the relevant month
by deducting the smallest total (R96 000) from the biggest total (R410 000). With
reference to the trade inventories account below, the balance is therefore R314 000
(R410 000 – R96 000).
•
Then write down the balance (R314 000) directly underneath the last amount that
appears in the column of which the total is the smallest. This is done as follows: Date
(last day of the relevant month, e.g. 28 Feb in Example 4.2), Balance cf, Amount
(R314 000 in Example 4.2). This is the balance that is carried forward from 28 February
20.7 to 1 March 20.7. The sum of the amounts in the two amount columns are now in
balance. With reference to Example 4.2 the two amount columns balance on R410 000.
•
Add the total (R410 000) in each amount column on the same horizontal line and
provide the totals with total lines.
•
Lastly place the balance directly underneath the total amount in the amount column that
initially had the biggest total. This is done as follows: Date (first day of the following
month, e.g. 1 March in Example 4.2), Balance bd, Amount (R314 000 in Example 4.2).
90
19
For the application of the basic technique on how to balance an account, refer to account A30
of Example 4.1, as well as to the accounts of Example 4.2 directly below. Take note that the
asset accounts and expense accounts have debit balances and that the liability accounts,
income accounts and the capital account have credit balances.
Example 4.2 Balancing of accounts
The following information represents accounts in the accounting records of AA Entity for February
20.7.
Dr
Date
A20 Trade inventories
Detail of contra
account
20.7
1 Feb
Balance
4 Feb
Bank
26 Feb Payable K
Nr
bd
A30
K1
Dr
Date
Nr
bd
D1
Dr
Nr
bd
I1
Dr
Cost of sales
Nr
U1
Amount
20.7
800 000 4 Feb
140 000 25 Feb
Amount
Nr
Date
20.7
204 000 22 Feb
192 000
A30
Dr
Amount
Detail of contra
account
Trade inventories
Payable K
Nr
A20
K1
Nr
Date
20.7
24 000 1 Feb
26 Feb
Amount
Amount
60 000
24 000
Bank
Nr
A30
Amount
140 000
Cr
Detail of contra
account
Balance
Trade inventories
Nr
bd
A20
Amount
84 000
130 000
Cr
Date
20.7
24 Feb
Detail of contra
account
Receivable A
Required:
Balance the abovementioned accounts of AA Entity, as at 28 February 20.7.
91
96 000
Cr
Detail of contra
account
I1 Sales
Detail of contra
account
Amount
Cr
Date
K1 Payable K
Detail of contra
account
20.7
25 Feb Bank
Date
20.7
220 000 24 Feb
60 000
130 000
Cr
Detail of contra
account
D1 Receivable A
Detail of contra
account
20.7
1 Feb
Balance
24 Feb Sales
Date
Date
A30 Bank
Detail of contra
account
20.7
1 Feb
Balance
22 Feb Receivable A
Date
Amount
Nr
D1
Amount
192 000
Example 4.2 Solution
AA Entity
Dr
Date
A20 Trade inventories
Detail of contra
account
20.7
1 Feb
Balance
4 Feb
Bank
26 Feb Payable K
1 Mar
Balance
Nr
bd
A30
K1
bd
Dr
Date
Nr
bd
D1
1 Mar
bd
Balance
Dr
Nr
bd
I1
1 Mar
bd
Balance
Dr
Cost of sales
Balance
Nr
U1
cf
Amount
Nr
20.7
800 000 4 Feb
140 000 25 Feb
28 Feb
940 000
856 000
Date
20.7
204 000 22 Feb
192 000 28 Feb
396 000
256 000
A30
cf
Dr
Amount
Detail of contra
account
Trade inventories
Payable K
Balance
Nr
A20
K1
cf
Date
20.7
24 000 1 Feb
190 000 26 Feb
214 000
1 Mar
20.7
28 Feb Balance
Nr
cf
Amount
60 000
24 000
856 000
940 000
Bank
Balance
Nr
A30
cf
Amount
140 000
256 000
396 000
Cr
Detail of contra
account
Balance
Trade inventories
Balance
Nr
bd
A20
bd
Amount
84 000
130 000
214 000
190 000
Cr
Date
20.7
192 000 24 Feb
192 000
1 Mar
92
Amount
Cr
Detail of contra
account
I1 Sales
Detail of contra
account
96 000
314 000
Cr
Date
Amount
Amount
410 000
K1 Payable K
Detail of contra
account
20.7
25 Feb Bank
28 Feb Balance
Date
20.7
220 000 24 Feb
60 000 28 Feb
130 000
410 000
314 000
Cr
Detail of contra
account
D1 Receivable A
Detail of contra
account
20.7
1 Feb
Balance
24 Feb Sales
Date
Date
A30 Bank
Detail of contra
account
20.7
1 Feb
Balance
22 Feb Receivable A
Date
Amount
Detail of contra
account
Nr
Receivable A
D1
Balance
bd
Amount
192 000
192 000
192 000
Example 4.3 Formulation of transactions
Refer to the trade inventories account (A20), bank account (A30), Receivable A’s account (D1) and
Payable K’s account (K1) in Example 4.2 above.
Required:
a)
With reference to the bank account (A30), Receivable A’s account (D1) and Payable K’s
account (K1), explain the meaning of the balances brought down (“Balance bd”) on
1 February 20.7.
b)
With reference to the bank account (A30), Receivable A’s account (D1) and Payable K’s
account (K1), explain the meaning of the balances carried forward (“Balance cf”) on
28 February 20.7.
c)
Formulate appropriate transactions of which the effect will result in the entries as contained in
trade inventories account (A20), bank account (A30), Receivable A’s account (D1) and
Payable K’s account (K1).
Example 4.3 Solution
a) Meaning of the balances brought down on 1 February 20.7
As the accounts are balanced on a monthly basis, the balances on 1 February 20.7 represent the
balances carried forward from 31 January 20.7.
Bank (A30)
Receivable A (D1)
Payable K (K1)
The net effect of cash
received and cash paid
from the time when
operating activities
commenced up until
31 January 20.7, is a
favourable amount/balance
of R800 000 in the bank.
From the time when trade
inventories were sold to
Receivable A on credit up until
31 January 20.7, the net effect
of the credit sales to
Receivable A and payments
received from Receivable A is
an amount/a balance of
R204 000 due by Receivable A.
From the time when trade
inventories were purchased on
credit from Payable K up until
31 January 20.7, the net effect
of the credit purchases from
Payable K and payments made
to Payable K is an amount/a
balance of R84 000 due to
Payable K.
b) Meaning of the balances carried forward on 28 February 20.7
As the accounts are balanced on a monthly basis, the balances on 28 February 20.7 represent the
balances that are carried forward from 28 February 20.7 to 1 March 20.7.
Bank (A30)
Receivable A (D1)
Payable K (K1)
The net effect of cash
received and cash paid
from the time when
operating activities
commenced up until
28 February 20.7, is a
favourable amount/balance
of R856 000 in the bank.
From the time when trade
inventories were sold to
Receivable A on credit up until
28 February 20.7, the net effect
of the credit sales to
Receivable A and payments
received from Receivable A is
an amount/a balance of
R256 000 due by Receivable A.
From the time when trade
inventories were purchased on
credit from Payable K up until
28 February 20.7, the net effect
of the credit purchases from
Payable K and payments made
to Payable K is an amount/a
balance of R190 000 due to
Payable K.
93
c) Formulation of transactions
20.7
AA Entity purchased trade inventories of R60 000 cash and received the items on this
4 Feb
day.
22 Feb Receive R140 000 from Receivable A as partial settlement of the amount due.
24 Feb Trade inventories were sold on credit to Receivable A for R192 000 and delivered on the
same day. The cost of the trade inventories sold is R96 000.
25 Feb Pay a portion of the amount due to Payable K, namely R24 000.
26 Feb Trade inventories were purchased on credit from Payable K for R130 000 and were
received on the same day.
List of account balances (the trial balance)
20
As already mentioned, the financial effect of transactions and events are recognised in the
accounting records (accounts) of an entity in accordance with the double entry system. Each
transaction or event affects at least two accounts of which one is debited and the other is
credited. Since all transactions and events are dually recognised in an accounting system,
the total of all the debit entries should equal the total of all the credit entries. Furthermore, the
balance of an account represents a summary of the net effect of the transactions and events
on an account and therefore it also follows that the total of all debit balances should agree
with the total of all credit balances.
21
The list of account balances is usually extracted monthly from the accounts of the entity. This
list of account balances is also known as a trial balance. The information below represents
the list of balances (trial balance) of AB Entity on 28 February 20.7. On 2 January 20.7,
AB Entity commenced with trading activities. The list of account balances (trial balance) is, in
the context of accounts presented in the format of T-accounts, prepared with reference to the
balances as brought down on 1 March 20.7.
AB Entity
List of account balances (trial balance) as at 28 February 20.7
Land
Buildings
Furniture and equipment
Trade inventories
Receivable A
Deposit: water and electricity
Bank
Capital
Retained earnings
Drawings
Payable K
Payable Jozi
Sales
Cost of sales
Salaries and wages
Water and electricity
Acc
no
A1
A2.1
A5.1
A20
D1
A23.4
A30
E1
E2.1
E2.2
K1
K7
I1
U1
U3
U4
94
Dr
R
200 000
1 000 000
225 000
145 000
96 000
20 000
512 000
Cr
R
2 000 000
0
12 000
145 000
8 000
160 000
80 000
15 000
8 000
2 313 000
2 313 000
Remarks in respect of the list of account balances
1
Take note that assets, expenses and drawings have debit balances and that liabilities,
capital and income have credit balances.
2
Take note that the total of the debit balances is equal to (balance with) the total of the
credit balances. This is as a result of the recognition of transactions and events in
accordance with the double entry system.
22
During the time when accounting records were still manually maintained, the primary purpose
of the list of account balances (trial balance) was to determine whether the dual recognition of
transactions and events was complete and accurate. Nowadays, accounting records are
maintained by means of computers and sophisticated computer software. In this context, the
primary purpose of the list of account balances (trial balance) is to provide a summary of the
accounting records at the end of each month.
23
The list of balances is not part of the rules of debiting and crediting, but it is a by-product
thereof.
Example 4.4 List of balances (trial balance) as well as a statement of financial position
Refer to Example 4.1’s solution that reflects the accounts in the records of AC Entity for
January 20.7.
Required:
a)
Prepare a list of account balances (trial balance) for AC Entity on 31 January 20.7.
b)
Present the balances in the statement of financial position of AC Entity on 31 January 20.7.
Example 4.4 Solution
a) List of account balances
AC Entity
List of account balances (trial balance) as at 31 January 20.7
Land
Buildings
Furniture and equipment
Trade inventories
Bank
Capital
Retained earnings
Payable K
Payable L
Acc no
A1
A2.1
A5.1
A20
A30
E1
E2.1
K1
K2
Dr
200 000
1 000 000
225 000
20 000
1 575 000
3 020 000
95
Cr
3 000 000
0
0
20 000
3 020 000
b) Presentation in the statement of financial position
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY 20.7
20.7
R
ASSETS
Non-current assets
Land
Buildings
Furniture and equipment
Total non-current assets
200 000
1 000 000
225 000
1 425 000
Current assets
Inventories
Cash and cash equivalents
Total current assets
Total assets
20 000
1 575 000
1 595 000
3 020 000
EQUITY AND LIABILITIES
Equity
Capital
Retained earnings
Total equity
3 000 000
0
3 000 000
Current liabilities
Trade and other payables
Total current liabilities
Total equity and liabilities
20 000
20 000
3 020 000
Journal entries
24
Luca Pacioli required that all transactions and events first be recorded in a day journal before
the effect of the transactions and events is included in the T-accounts. Pacioli’s day journal
developed into journal entries of the following format:
Date
25
Name of account debited
Name of account credited
Reason for the journal and reference to
the source document
Dr
Amount debited
Cr
Amount credited
A journal entry indicates which accounts are affected by the dual effect of a transaction or
event as well as the amount with which the account is affected. In practice, each account
and each journal entry has a unique reference number. A journal entry is therefore merely an
instruction of which T-accounts to debit or credit on which date and with what amount. By
using journal entries an audit trail is created between the entry in the T-account, the journal
entry and the supporting documentation for the transaction or event.
96
26
In this work, directly underneath the journal entry, the effect of the transaction or event on the
accounting equation is also indicated. In practice, the accounting equation is not part of the
journal entry, but it is educative to indicate the effect of each journal entry on the accounting
equation.
27
Consequently, in this work the Conceptual Framework 2010, the journal entry and the Taccount forms the basis for obtaining a fundamental concept of accounting.
The bookkeeping process then and now
28
Since the development of the double entry system in 1494 until approximately 1960/70
accounting records were essentially maintained manually and by means of mechanical
machines. During this period, the concept ledger developed. The ledger comprised of
individual accounts that were compiled on appropriately ruled/lined pages, somewhat bigger
than the current A4 pages. The ledger comprised of between 500 and 800 pages. Even
today, the accounts are sometimes referred to as the ledger accounts whilst nowadays the
ledger exists in an electronic format.
29
During the time from the development of the double entry system up to approximately
1960/70, when accounting records were essentially maintained manually, the journal entries
were compiled on appropriately ruled/lined pages, somewhat bigger than the current A4
pages, and bound into a journal book (in the format of a general journal as discussed in
paragraph 24). These entries were then, on a regular basis, manually posted to the ledger.
30
The past 40 to 50 years, accounting systems developed from a manual system to a
computerised electronic system. At the end of the manual era, the general journal (as book of
first entry) was expanded to additional sub-journals (books of first entry). Examples of the
additional sub-journals are as follows:
•
Receipts and payments journal (also called the cashbook) in which cash receipts and
cash payments are recorded directly from documents;
•
A sales journal in which credit sales are recorded directly from documents;
•
A purchases journal in which credit purchases are recorded directly from documents;
and
•
A salaries journal.
The general journal was therefore only used to record the remaining transactions directly
from documents.
31
The additional sub-journals were introduced to put the manual system’s bookkeeping process
in order and to simplify the posting to the ledger accounts.
32
Accounting was changed irrevocably with computers that became generally available. The
past few decades, transactions are no longer recorded in sub-journals. This means that a
purchases journal, a sales journal, a cash receipts journal or a cash payments journal actually
no longer exists.
97
33
Transactions and events are nowadays recorded in the database of the entity, often hosted
on a network or on the Cloud. Sales transactions are often recorded in the accounting
database in time (simultaneously with the sales transaction) at the point of sale. These days
the effect of transactions and events are therefore recognised by completing a frame/form on
the computer screen for each transaction. The frame/form that should be completed on the
screen contains all the essential features of a journal. Human errors can still occur with the
recording of data, e.g. it is possible to enter an amount incorrectly or to use incorrect account
codes in respect of non-routine transactions. However, as soon as transactions are recorded,
the posting to and balancing of accounts are programmatic and therefore the occurrence of
errors are highly unlikely.
Example 4.5 Journal entries (asset-items, liabilities-items and capital)
The same set of facts as for Example 4.1 is applicable. On 2 January 20.7, AC Entity commenced
with activities and during January 20.7 the entity incurred the following transactions:
1
On 2 January 20.7, the owner made the property that AC Entity utilises available for the
exclusive use of the entity. The property was registered in the owner’s name a few days
before 2 January 20.7. The purchase price of the property was R1 200 000 (R200 000 for the
land and R1 000 000 for the buildings).
2
On 2 January 20.7, the owner opened a cheque account for the entity and deposited
R1 800 000 in the account.
3
On 2 January 20.7, furniture and equipment to the amount of R225 000 was ordered. The
supplier, Payable K, delivered the furniture and equipment on 5 January 20.7 to AC Entity’s
premises. The invoice price is R225 000 and it was agreed with Payable K to pay the
outstanding amount on 30 January 20.7.
4
Trade inventories to the amount of R20 000 was ordered on 7 January 20.7 and it was
agreed with Payable L that the outstanding amount will be paid 30 days after delivery. On
25 January 20.7, Payable L delivered the trade inventories to AC Entity’s premises. The
invoice price is R20 000 and the invoice reflects that the amount is payable on 24 February
20.7.
5
On 30 January 20.7, the amount due to Payable K was paid.
Required:
a)
Provide journal entries to recognise the abovementioned transactions for January 20.7 in the
records (general journal) of AC Entity.
Note:
b)
•
Journal narrations are required.
•
The effect of the transaction on the accounting equation (A = L + E), must be provided.
Open appropriate accounts and post the journal entries in (a) above to the accounts.
98
Example 4.5 Solution
a) Journal entries
J1
20.7
2 Jan
Nr
A1
A2.1
E1
Land
Buildings
Capital
Recognise capital contribution by owner
Dr
200 000
1 000 000
Cr
1 200 000
Assets
=
Liabilities
+
Equity
Classification
+ 200 000
+1 000 000
=
0
+
+1 200 000
Capital
Remarks in respect of the journal
1
The classification column in the accounting equation bears reference to the equity
column. If a transaction changes equity, the detail of the component that changed
equity is provided in the classification column. There are four possibilities, namely
Capital, Retained earnings – income, Retained earnings – expense and Retained
earnings – drawings.
2
The reference number column of the journal entry (“Nr”) refers to the relevant account
numbers.
J2
20.7
2 Jan
Bank
Capital
Recognise capital contribution by the owner
Assets
+1 800 000
J3
20.7
5 Jan
=
=
Liabilities
0
+
+
Nr
A30
E1
Equity
+1 800 000
Furniture and equipment
Payable K
Recognise furniture and equipment received together
with accompanying liability
Assets
=
Liabilities
+
Equity
+225 000
=
+225 000
+
0
99
Dr
1 800 000
Cr
1 800 000
Classification
Capital
Nr
A5.1
K1
Dr
225 000
Cr
225 000
Classification
J4
20.7
25 Jan
Trade inventories
Payable L
Recognise trade inventories received together with
accompanying liability
Assets
=
Liabilities
+
Equity
+20 000
=
+20 000
+
0
J5
20.7
30 Jan
Payable K
Bank
Derecognise Payable K due to settlement of debt
Assets
=
Liabilities
+
Equity
- 225 000
=
- 225 000
+
0
Nr
A20
K2
Dr
20 000
Cr
20 000
Classification
Nr
K1
A30
Dr
225 000
Cr
225 000
Classification
b) Posting of journal entries to appropriate accounts
Dr
Date
20.7
2 Jan
A1 Land
Detail of contra
account
Capital
Nr
J1
Dr
Date
20.7
2 Jan
20.7
5 Jan
Capital
Nr
J1
20.7
25 Jan
Detail of contra
account
Nr
Amount
Detail of contra
account
Nr
Amount
Detail of contra
account
Nr
Amount
Detail of contra
account
Nr
Amount
200 000
Amount
Date
Cr
1 000 000
A5.1 Furniture and equipment
Detail of contra
account
Payable K
Nr
J3
Dr
Date
Cr
Date
A2.1 Buildings
Detail of contra
account
Dr
Date
Amount
Amount
Date
Cr
225 000
A20 Trade inventories
Detail of contra
account
Payable L
Nr
J4
Amount
Date
20 000
100
Cr
Dr
A30 Bank
Date
Detail of contra
account
Nr
20.7
2 Jan
Capital
J2
1 Feb
Balance
bd
Dr
Amount
Cr
Date
20.7
1 800 000 30 Jan
31 Jan
1 800 000
1 575 000
Detail of contra
account
Nr
Amount
J5
cf
225 000
1 575 000
1 800 000
Nr
Amount
J1
J1
J2
200 000
1 000 000
1 800 000
3 000 000
Detail of contra
account
Nr
Amount
Furniture and equipment
J3
Detail of contra
account
Nr
Payable K
Balance
E1 Capital
Date
Detail of contra
account
Nr
Amount
Cr
Date
20.7
2 Jan
Dr
Detail of contra
account
Land
Buildings
Bank
K1 Payable K
Date
20.7
30 Jan
Detail of contra
account
Bank
Nr
J5
Dr
Amount
Date
20.7
225 000 5 Jan
Cr
K2 Payable L
Date
Detail of contra
account
Nr
Amount
Date
20.7
25 Jan
225 000
Cr
Trade inventories
J4
Amount
20 000
Remarks in respect of the above
1
In Example 4.5 the reference columns of the accounts (“Nr”) were used to refer to the
unique number of the relevant journal. In this work, the reference column will usually be
used for this purpose.
2
The practical application of the double entry rules in respect of transaction number 3 is
as follows: Determine the items concerned, namely furniture and equipment and
payable. With reference to the respective definitions of the elements identify the
relevant elements, namely assets (furniture and equipment) and liabilities (payable).
Identify whether an increase or a decrease in the element occurred and then apply the
double entry rules, as set out in Table 4.1. The asset-item furniture and equipment
increased and therefore the furniture and equipment account is debited. The liabilitiesitem payable increased and therefore Payable K’s account is credited. This approach
must time and again be applied until the necessary skills in the application of the double
entry rules have been obtained.
101
3
The practical application of the double entry rules in respect of transaction number 5 is
as follows: Determine the items concerned, namely bank and payable. With reference
to the respective definitions of the elements identify the relevant elements, namely
assets (bank) and liabilities (payable). Identify whether an increase or a decrease in the
element occurred and then apply the double entry rules, as set out in Table 4.1. The
asset-item bank decreased and therefore the bank account is credited. The liabilitiesitem payables decreased and therefore Payable K’s account is debited. This approach
must time and again be applied until the necessary skills in the application of the double
entry rules have been obtained.
Example 4.6 Journalise income and expenses. Post transactions to accounts. Prepare a list
of account balances. Statement of profit or loss. Statement of changes in equity. Statement
of financial position
On 2 January 20.7, AC Entity commenced with activities. (AC Entity uses the perpetual inventory
system.)
On 1 February 20.7, the following balances appeared in the accounting records of the entity:
Land
Buildings
Furniture and equipment
Trade inventories
Bank
Capital
Retained earnings
Payable K
Payable L
Acc no
A1
A2.1
A5.1
A20
A30
E1
E2.1
K1
K2
Dr
200 000
1 000 000
225 000
20 000
1 575 000
3 020 000
Cr
3 000 000
0
0
20 000
3 020 000
During February 20.7, AC Entity incurred the following transactions:
1
On 1 February 20.7, a deposit to the amount of R20 000 was paid to the local authority for the
connection of water and electricity. The deposit is repayable with the disposal of the property.
2
On 3 February 20.7, trade inventories to the amount of R145 000 were purchased from
Payable M and it was agreed with the payable that the amount due would be paid within 30
days after delivery of the trade inventories. On 5 February 20.7, Payable M delivered the
trade inventories to AC Entity’s premises.
3
Trade inventories to the amount of R60 000 were purchased on 4 February 20.7 and it was
agreed with the supplier that payment would occur with delivery (COD). On 6 February 20.7,
the supplier delivered the trade inventories to AC Entity’s premises.
4
On 24 February 20.7, trade inventories were sold on credit to Receivable A for R96 000. The
trade inventories were delivered to Receivable A on the same day and it was agreed that the
amount due must be paid within 30 days after delivery. The cost price of the trade inventories
sold is R48 000.
5
On 24 February 20.7, a payment was made to Payable L for the amount due in respect of
trade inventories purchased on credit on 25 January 20.7.
102
6
On 28 February 20.7, trade inventories were sold for R64 000 cash and delivered on the
same day. The cost price of the trade inventories sold is R32 000.
7
Gross salaries to the amount of R15 000 was paid on 28 February 20.7.
8
On 28 February 20.7, a cheque to the amount of R12 000 was issued to the owner for
personal use.
9
The account for the use of water and electricity during February 20.7 was received
electronically on 28 February 20.7. An amount of R8 000 is payable before 24 March 20.7.
10
On 28 February 20.7, the owner deposited an additional R200 000 in AC Entity’s bank
account as an increase in capital.
Required:
a)
Provide journal entries to recognise the transactions in the records (general journal) of
AC Entity for the month ended 28 February 20.7.
Note:
•
Journal narrations are required.
•
The effect of the transaction on the accounting equation (A = L + E), must be provided.
The classification of the equity component must also be provided.
b)
Post the abovementioned journal entries to the relevant accounts of AC Entity and, where
necessary, balance these accounts.
c)
Prepare a list of account balances as at 28 February 20.7.
d)
Prepare a statement of profit or loss for AC Entity for the two months ended 28 February
20.7.
or stated differently
Present the relevant balances in the statement of profit or loss of AC Entity for the two
months ended 28 February 20.7.
e)
Prepare a statement of changes in equity for AC Entity for the two months ended 28 February
20.7.
or stated differently
Present the relevant balances in the statement of changes in equity of AC Entity for the two
months ended 28 February 20.7.
f)
Prepare a statement of financial position for AC Entity as at 28 February 20.7.
or stated differently
Present the relevant balances in the statement of financial position of AC Entity as at
28 February 20.7.
103
Example 4.6 Solution
a) Journal entries
J1
20.7
1 Feb
Nr
Deposit: water and electricity
Bank
Recognise payment of recoverable
electricity deposit
Assets
+20 000
- 20 000
J2
20.7
5 Feb
+
+
=
=
Liabilities
+145 000
+
+
=
=
Liabilities
0
+
+
Equity
0
=
=
Liabilities
0
+
+
Nr
A20
K3
104
Dr
145 000
Cr
145 000
Classification
Nr
A20
A30
Equity
0
Equity
+96 000
20 000
Classification
Equity
0
Receivable A
Sales
Recognise income from the sale of trade inventories
as well as the accompanying asset
Assets
+96 000
Cr
and
Trade inventories
Bank
Recognise trade inventories purchased for cash and
received
Assets
+60 000
- 60 000
J4
20.7
24 Feb
Liabilities
0
Dr
20 000
A30
water
Trade inventories
Payable M
Recognise trade inventories purchased and received
as well as accompanying liability
Assets
+145 000
J3
20.7
6 Feb
=
=
A23.4
Dr
60 000
Cr
60 000
Classification
Nr
D1
I1
Dr
96 000
Cr
96 000
Classification
Retained earnings – income
(sales)
J5
20.7
24 Feb
Cost of sales
Trade inventories
Recognise cost of inventories sold/delivered
Assets
- 48 000
J6
20.7
24 Feb
Equity
- 48 000
=
=
Liabilities
- 20 000
+
+
=
=
Liabilities
0
+
+
Equity
+64 000
=
=
Liabilities
0
+
+
Equity
- 32 000
Salaries and wages
Bank
Recognise payment of salaries for February 20.7
105
Dr
48 000
Cr
48 000
Classification
Retained earnings – expense
(cost of sales)
Nr
K2
A30
Equity
0
Cost of sales
Trade inventories
Recognise cost of inventories sold/delivered
Assets
- 32 000
J9
20.7
28 Feb
+
+
Dr
20 000
Cr
20 000
Classification
Nr
Bank
A30
Sales
I1
Recognise income from the cash sale of trade
inventories that were delivered on 28 Feb
Assets
+64 000
J8
20.7
28 Feb
Liabilities
0
Payable L
Bank
Derecognise Payable L due to settlement
Assets
- 20 000
J7
20.7
28 Feb
=
=
Nr
U1
A20
Dr
64 000
Cr
64 000
Classification
Retained earnings – income
(sales)
Nr
U1
A20
Dr
32 000
Cr
32 000
Classification
Retained earnings – expense
(cost of sales)
Nr
U3
A30
Dr
15 000
Cr
15 000
Assets
- 15 000
J10
20.7
28 Feb
+
+
Equity
- 15 000
Classification
Retained earnings – expense
(salaries)
Nr
E2.2
A30
=
=
Liabilities
0
+
+
Equity
- 12 000
=
=
Liabilities
+8 000
+
+
Equity
- 8 000
=
=
Liabilities
0
+
+
Cr
12 000
Nr
U4
K9
Dr
8 000
Cr
8 000
Classification
Retained earnings – Expense
(Water and electricity)
Bank
Capital
Recognise additional capital contribution by the owner
Assets
+200 000
Dr
12 000
Classification
Retained earnings – Drawings
Water and electricity
Payable: Local authority
Recognise water and electricity expense for February
20.7 and accompanying liability
Assets
0
J12
20.7
28 Feb
Liabilities
0
Drawings
Bank
Recognise distribution to owner
Assets
- 12 000
J11
20.7
28 Feb
=
=
Nr
A30
E1
Equity
+200 000
Dr
200 000
Cr
200 000
Classification
Capital
Remarks in respect of the abovementioned journals and accounting equation
1
As the transactions in this example were dually recognised, the total of all the debit
entries (Journals 1 to 12: R720 000) is equal to the total of all the credit entries
(Journals 1 to 12: R720 000).
2
It is also clear from this example that the dual recognition of the transactions causes the
accounting equation to remain in balance. The total movement on each element in
respect of Journals 1 to 12 is as follows:
Assets
+378 000
=
=
Liabilities
+133 000
+
+
106
Equity
+245 000
b) Posting of journal entries to appropriate accounts
Dr
Date
A1 Land
Detail of contra
account
Nr
20.7
1 Feb
Balance
bd
1 Mar
Balance
bd
Dr
Date
Nr
Balance
bd
1 Mar
Balance
bd
Dr
Nr
Balance
bd
1 Mar
Balance
bd
Dr
Nr
Balance
Payable M
Bank
bd
J2
J3
1 Mar
Balance
bd
Dr
cf
Amount
20.7
1 000 000 28 Feb
1 000 000
1 000 000
Amount
Date
20.7
225 000 28 Feb
225 000
225 000
Amount
Date
20.7
20 000 24 Feb
145 000 28 Feb
60 000
225 000
145 000
Nr
Bank
J1
1 Mar
Balance
bd
Dr
Amount
Date
20.7
20 000 28 Feb
20 000
20 000
Detail of contra
account
Nr
20.7
24 Feb Sales
J4
1 Mar
bd
Balance
Amount
Date
20.7
96 000 28 Feb
96 000
96 000
107
200 000
200 000
Balance
Nr
Amount
cf
1 000 000
1 000 000
Nr
Amount
Cr
Detail of contra
account
Balance
cf
225 000
225 000
Cr
Detail of contra
account
Cost of sales
Cost of sales
Balance
Nr
J5
J8
cf
Detail of contra
account
Balance
Amount
48 000
32 000
145 000
225 000
Cr
Nr
cf
D1 Receivable A
Detail of contra
account
Amount
Cr
Date
A23.4 Deposit: water and electricity
Detail of contra
account
20.7
1 Feb
Date
Balance
Nr
A20 Trade inventories
Detail of contra
account
20.7
1 Feb
5 Feb
6 Feb
Date
20.7
200 000 28 Feb
200 000
200 000
Detail of contra
account
A5.1 Furniture and equipment
Detail of contra
account
20.7
1 Feb
Date
Cr
Date
A2.1 Buildings
Detail of contra
account
20.7
1 Feb
Date
Amount
Amount
20 000
20 000
Cr
Detail of contra
account
Balance
Nr
cf
Amount
96 000
96 000
Dr
Date
A30 Bank
Detail of contra
account
20.7
1 Feb
Balance
28 Feb Sales
Capital
1 Mar
Balance
Nr
Amount
bd
J7
J12
bd
Dr
Date
20.7
28
Feb
Balance
Nr
Nr
J1
J3
J6
J9
J10
cf
20 000
60 000
20 000
15 000
12 000
1 712 000
1 839 000
Nr
Amount
Balance
bd
3 000 000
28 Feb
Bank
J12
1 Mar
Balance
bd
200 000
3 200 000
3 200 000
Nr
Amount
Trade inventories
Payable L
Salaries and wages
Drawings
Balance
1 839 000
1 712 000
Cr
Date
Amount
Date
20.7
0 1 Feb
0
1 Mar
cf
Detail of contra
account
Cr
Detail of contra
account
Balance
bd
Balance
bd
E2.2 Drawings
Detail of contra
account
Nr
J10
1 Mar
bd
Balance
Dr
Amount
Date
20.7
12 000 28 Feb
12 000
12 000
Nr
J6
Dr
Amount
Date
20.7
20 000 1 Feb
Balance
Nr
cf
Balance
Nr
cf
Amount
Date
20.7
145 000 5 Feb
Balance
Nr
bd
108
12 000
12 000
Amount
20 000
Cr
Detail of contra
account
Nr
Amount
Trade inventories
J2
145 000
Balance
bd
145 000
145 000
145 000
1 Mar
Amount
Cr
Detail of contra
account
K3 Payable M
Detail of contra
account
0
0
0
Cr
Detail of contra
account
K2 Payable L
Detail of contra
account
20.7
24 Feb Bank
20.7
28
Feb
Dep: water and electr
20.7
3 200 000 1 Feb
cf
20.7
28 Feb Bank
Date
Amount
20.7
1 575 000 1 Feb
64 000 6 Feb
200 000 24 Feb
28 Feb
Amount
Dr
Date
Nr
E2.1 Retained earnings
Detail of contra
account
20.7
28 Feb Balance
Date
Detail of contra
account
E1 Capital
Detail of contra
account
Dr
Date
Cr
Date
Dr
Date
20.7
28
Feb
K9 Payable: Local authority
Detail of contra
account
Balance
Nr
Amount
Date
20.7
8 000 28 Feb
cf
1 Mar
Dr
Date
20.7
28
Feb
Cr
Detail of contra
account
Nr
Water and electricity J11
8 000
Balance
8 000
bd
I1 Sales
Detail of contra
account
Balance
Nr
Amount
Cr
Date
20.7
160 000 24 Feb
cf
Detail of contra
account
Nr
Date
J4
96 000
28 Feb
Bank
J7
1 Mar
Balance
bd
64 000
160 000
160 000
U1 Cost of sales
Detail of contra
account
Nr
20.7
24 Feb Trade inventories
28 Feb Trade inventories
J5
J8
1 Mar
bd
Balance
Dr
Date
20.7
48 000 28 Feb
32 000
80 000
80 000
Nr
J9
1 Mar
bd
Balance
Dr
Cr
Detail of contra
account
Balance
Nr
cf
Amount
Date
20.7
15 000 28 Feb
15 000
15 000
Balance
Nr
Amount
Date
J11
20.7
8 000 28 Feb
bd
8 000
8 000
109
Amount
80 000
80 000
Cr
Detail of contra
account
Balance
Nr
cf
U4 Water and electricity
Detail of contra
account
20.7
28 Feb Payable: Local
authority
1 Mar
Date
U3 Salaries and wages
Detail of contra
account
20.7
28 Feb Bank
Date
Amount
Amount
Receivable A
160 000
Dr
Amount
Amount
15 000
15 000
Cr
Detail of contra
account
Balance
Nr
cf
Amount
8 000
8 000
c) List of account balances
AC Entity
List of account balances as at 28 February 20.7
Acc no
Land
Buildings
Furniture and equipment
Trade inventories
Receivable A
Deposit: Water and electricity
Bank
Capital
Retained earnings
Drawings
Payable L
Payable M
Payable: Local authority
Sales
Cost of sales
Salaries and wages
Water and electricity
A1
A2.1
A5.1
A20
D1
A23.4
A30
E1
E2.1
E2.2
K2
K3
K9
I1
U1
U3
U4
Dr
Cr
200 000
1 000 000
225 000
145 000
96 000
20 000
1 712 000
3 200 000
0
12 000
0
145 000
8 000
160 000
80 000
15 000
8 000
3 513 000
3 513 000
Remark in respect of the abovementioned list of account balances
1
Since the transactions in this example is dually recognised and the balance of an
account represents a summary of the net effect of the transactions on an account, the
total of all the debit balances (R3 513 000) agrees with the total of all the credit
balances (R3 513 000).
d) Presentation in the statement of profit or loss
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE TWO MONTHS ENDED 28 FEBRUARY 20.7
R
Sales
160 000
Cost of sales
(80 000)
Gross profit
80 000
Salaries and wages
(15 000)
Water and electricity
(8 000)
Profit for the period
57 000
110
e) Presentation in the statement of changes in equity
AC ENTITY
STATEMENT OF CHANGES IN EQUITY FOR THE TWO MONTHS ENDED 28 FEBRUARY 20.7
Retained
earnings
R
Capital
R
Balance at 1 January 20.7
Changes in equity for the period
Additional capital contribution by owner
Profit for the period
Distributions to owner (drawings)
Balance at the end of the period
0
Total
R
0
3 200 000
3 200 000
57 000
(12 000)
45 000
0
3 200 000
57 000
(12 000)
3 245 000
Remarks in respect of the abovementioned two financial statements
1
The reporting period is usually a year, except for the first reporting period which could
be shorter, e.g. only two months as in the case of this example.
2
The statement of profit or loss is a summary of the entity’s income and expenses for the
reporting period and indicates the performance of the entity. The income and expense
accounts are closed off against the retained earnings account. (Refer Chapter 7)
3
The statement of changes in equity provides detail of the changes that occurred in the
financing by the owner during the reporting period. The statement of changes in equity
is a summary of the changes that occurred in the capital account and retained earnings
account during the current reporting period.
111
f) Presentation in the statement of financial position
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.7
20.7
R
ASSETS
Non-current assets
Land
Buildings
Furniture and equipment
200 000
1 000 000
225 000
20 000
Other non-current assets
Total non-current assets
1 445 000
Current assets
Inventories
Trade receivables
Cash and cash equivalents
Total current assets
Total assets
145 000
96 000
1 712 000
1 953 000
3 398 000
EQUITY AND LIABILITIES
Equity
Capital
Retained earnings
Total equity
3 200 000
45 000
3 245 000
Current liabilities
Trade and other payables (145 000 + 8 000)
Total current liabilities
Total equity and liabilities
153 000
153 000
3 398 000
Remark in respect of the abovementioned statement of financial position
1
The statement of financial position was previously known as the
highlighted the fact that the double entry system caused the
(A = E + L). However, this financial statement now deals with
balancing. Consequently, a more appropriate/descriptive name
statement.
112
balance sheet since it
statement to balance
much more than just
was accepted for the
Chapter 5 Recognition of transactions and events in the
accounting records and the presentation of account
balances in the financial statements
Contents
Outline
The accounting process
Source documents
Assets
Cash purchases of assets
The transaction: Purchase of a delivery vehicle in cash
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Credit purchases of assets by utilising trade credit
The transaction: Purchase of trade inventories with trade credit
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Credit purchases of assets by utilising a supplier’s loan
The transaction: Purchase of machinery by utilising a supplier’s loan
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Expenses
Background
Nature of expenses
The economic benefits associated with an expense
Rent expense of buildings
Salaries to employees
Origin of expenses
Expenses incurred in cash
The transaction: Rent expense paid cash
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Bank charges
Advances for smaller expenses and petrol cards
113
Paragraph
1
4
10
13
13
16
18
19
19
20
23
26
29
32
33
33
34
37
40
43
46
47
47
48
51
54
54
58
61
63
65
67
69
72
74
75
75
76
79
82
86
Expenses incurred on credit
The transaction: Water and electricity purchase on credit
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Employee benefits expense
The transaction: Employee benefits expense incurred and paid
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Expenses resulting from the subsequent measurement of assets
Origin of such expenses
Initial measurement and subsequent measurement of assets
Depreciation expense
Nature of the depreciation expense
Depreciation methods
The event: Allotment of a portion of the cost price of equipment to the
depreciation expense
Source documents
Recognition of the event
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Bad debts
Nature of bad debts
The event: Write-off an amount due by Receivable A as irrecoverable
Source documents
Recognition of the event
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Bad debts recovered
Expenses resulting from the subsequent measurement of liabilities
Origin of such expenses
Initial measurement and subsequent measurement of liabilities
Interest expense on a bank loan
Nature of a bank loan and the associated cost/interest
The transaction: Interest expense on a bank loan
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
114
Paragraph
90
94
96
97
97
98
101
104
115
117
118
118
119
122
125
125
130
134
134
138
141
143
144
144
147
150
153
153
157
159
160
160
161
164
167
168
168
174
177
177
182
184
185
185
186
190
Interest expense on a supplier’s loan
Nature of a supplier’s loan
The transaction: Interest expense on a supplier’s loan
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Interest expense on a bank overdraft account
Nature of a bank overdraft account
The transaction: Interest expense on an overdraft bank balance
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Income
Cash sales of trade inventories
The transaction: Cash sale of trade inventories (perpetual inventory system)
Source documents
Recognition of the income resulting from the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Recognition of the expense resulting from the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Credit sales of trade inventories
The transaction: Credit sale of trade inventories (perpetual inventory system)
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Other income
Rent income
The transaction: Rent income received in cash
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Interest income on a term deposit
The transaction: Interest income on a term deposit
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
115
Paragraph
193
193
195
197
198
198
199
203
206
206
210
212
213
213
214
218
221
226
229
231
232
232
233
236
239
239
240
243
246
250
252
253
253
254
258
262
263
267
269
270
270
271
274
277
279
281
282
282
283
287
Interest income on favourable bank balance
The transaction: Interest income on a favourable bank balance
Source documents
Recognition of the transaction
Items/accounts and elements
Date and amount of initial recognition
Double entry rules
Annexure 1
Annexure 2
Annexure 3
Rent expense incurred in cash and
Water and electricity expense incurred on credit
Rent income received in cash
Application of definitions and recognition criteria
116
Paragraph
290
294
296
297
297
298
302
Page
229
231
232
Examples
Example
5.1
5.2
5.3
5.4
5.5
5.6
5.7
5.8
5.9
5.10
5.11
5.12
5.13
5.14
5.15
Purchase of assets (trade inventories, delivery vehicle and a fixed term deposit) in
cash
Purchase of trade inventories and a delivery vehicle by utilising trade credit. Purchase
of a machine by utilising a supplier’s loan
Expenses incurred in cash: rent, salaries and insurance
Cash expense: bank charges
Cash advances for incurring smaller administrative expenses as well as the use of a
garage card
Expenses incurred on credit: office supplies, telephone as well as water and
electricity
Recognition of the payroll
Depreciation expense
Depreciation expense
Bad debts expense and bad debts recovered
Bank loan
Machine purchased with a supplier’s loan
Cash and credit sales
A deposit required with the order
Rent income and interest income
117
Chapter 5 Recognition of transactions and events in the
accounting records and the presentation of account
balances in the financial statements
Outline
1
In this chapter, the Conceptual Framework 2010, the double entry rules and the financial
statements framework are applied in an integrated manner:
•
by recognising a variety of transactions and events in the accounting records; and
•
to provide useful information in general purpose financial statements.
2
A thorough knowledge of Chapters 2 to 4 is an essential requirement for the study of this
chapter.
3
The following represents a general view of the transactions and events that will be dealt with
in this chapter:
•
Cash purchases of assets;
•
Credit purchases of assets by utilising trade credit;
•
Credit purchases of assets by utilising a supplier’s loan;
•
Expenses incurred in cash;
•
Bank charges;
•
Advances for incurring smaller expenses and petrol cards;
•
Expenses incurred on credit;
•
Employee benefits expense;
•
Expenses resulting from the subsequent measurement of assets (depreciation and
doubtful debts);
•
Expenses resulting from the subsequent measurement of liabilities (interest expense);
•
Cash sales of trade inventories;
•
Credit sales of trade inventories;
•
Rent income; and
•
Income resulting from the subsequent measurement of assets (interest income).
118
The accounting process
4
5
A broad framework of the accounting process can schematically be presented as follows:
Capture
transactions and
events on
documents
Accumulate transactions and events
in the entity’s accounting records
Provide information
about the financial
position and performance
of the entity
Individual
transactions and
events are
captured on source
documents
Transactions and events are
recognised in journals where after
these journals are posted to
accounts in order to accumulate
information regarding the effect of
the transactions and events in
accounts
Present account
balances in general
purpose financial
statements
The accounting process entails the following in respect of each transaction/event:
•
Capture the transaction/event on a source document(s).
•
Identify the items/accounts brought about by the transaction/event as well as the
element(s) to which these items belong. (Refer to paragraphs 6 to 9 below.)
•
Identify the date on which the identified items satisfied the applicable definitions and
recognition criteria.
•
Identify the amount at which the identified items should initially be recognised.
•
Recognise the transaction/event in accordance with the double entry system on the
date on which the items satisfied the definition as well as recognition criteria of the
relevant element(s) (journalising and posting of journals to accounts).
•
Present the account balances as part of a line item in the financial statements for a
reporting period.
6
The identification of the items/accounts that are brought about by the transaction/event as
well as the element(s) to which these items belong is the basic information required to
recognise a transaction/event. The identification occurs with reference to the detail of the
transaction/event and the application of knowledge. Chapter 4 paragraph 6 contains a list of
accounts in respect of asset-items, liability-items, income-items, expense-items and the
remaining equity-items (capital and drawings) which can be referred to in this regard.
7
Take the following transaction as an applicable example:
On 3 January 20.7, AC Entity received an acquired delivery vehicle from a supplier and on
this day, paid the supplier and amount of R450 000 by means of an electronic fund transfer
(EFT).
119
8
The items/accounts brought about by the transaction are delivery vehicle (increase) and
cash (decrease). The accounts involved are therefore the delivery vehicles account and the
bank account. Every time that an item is identified, the identification is done with reference to
the element to which the item belongs. Delivery vehicle and cash belongs to the element
assets and therefore, from now on, in this chapter reference will be made to the asset-item
delivery vehicle and the asset item cash. In this regard the emphasis in Chapter 5 is
therefore the identification of the item and the element to which the item belongs. In addition
to the identification of the item and the element to which the item belongs, the emphasis in
Chapter 2 is to fundamentally indicate that the item satisfies the definition and recognition
criteria of the relevant element. The identification of an item belonging to an element implies
that the item fundamentally satisfies the definition of the relevant element. It is only
necessary to fundamentally motivate the identification if such an instruction was received.
This approach is also consistent with practice where an accountant will with ease, through
knowledge gained, correctly identify almost 100% of the items resulting from
transactions/events and only in certain cases fundamentally debate the outcome of the
transaction.
9
The emphasis in Chapter 5 is the recognition of transactions/events in the accounting
records. However, the reader must, through the application of the definition and recognition
criteria of the relevant element as well as the application of the information provided, be able
to fundamentally indicate if a specific item indeed satisfies the definition and recognition
criteria of the relevant element. In this regard there are several examples in Chapter 2 as
well as Annexure 3 at the end of Chapter 5.
Source documents
10
During the past 50 years, as part of the subject Auditing and in reaction to an ever changing
economic environment, special attention was given to (what is known in the subject as)
internal control procedures. The aim of internal control procedures is to protect and secure
an entity’s assets.
11
The following internal control procedures, amongst others, are applicable in respect of the
capturing of transactions/events:
•
Each transaction/event is captured on a source document or numerous source
documents.
•
Journalising of transactions/events takes place from source documents.
•
Each journal entry is provided with the unique number of the source document that
supports the transaction and the other way around.
(Internal control procedures are dealt with in the subject Auditing.)
120
12
The following table provides a summary of source documents that generally occurs.
Table 5.1
Source document
Remark
Requisition
An entity’s purchases are done by a purchases department.
Purchases are usually made from suppliers that appear on the
purchasing entity’s list of suppliers. When purchases are made,
a requisition for the required goods or services must be issued
and appropriately authorised.
Order
After the purchases department identified the best price and
supplier, an order is issued on the entity’s official order form and
provided to the supplier. The order contains a description of the
item(s) to be purchased, the quantity as well as the price. The
order forms are pre-numbered.
Purchase Invoice (from The invoice which is issued by the supplier is received together
supplier)
with the purchased item(s).
Goods received note
This source document is issued by the purchasing entity’s
warehouse. The person that receives the goods compares the
purchased item(s) and the quantities with the supplier’s invoice
and delivery note as well as with the relevant order to ensure
that there are no differences.
In the case of a COD (cash-on-delivery) purchase, the payment
occurs per cheque or per EFT (electronic fund transfer). The
payment occurs based on the invoice and the goods received
note.
In the case of a credit purchase, the purchases invoice and the
goods received note are forwarded to the purchasing entity’s
payables department.
Sales Invoice (issued by
supplier)
The sales invoice which is issued by the selling entity contains
detail of the item(s) that are sold, namely a description, the
quantity and the price.
Delivery note
This source document is issued by the selling entity. As proof
that the sold item(s) was delivered, the sales invoice is
supported by the delivery note, which was signed by the
purchasing entity as recognition of receipt of the goods. The
sales invoice can furthermore be supported by a goods received
note that was issued by the purchasing entity.
Bank statement
The bank statement is issued by the entity’s bank and can be
received monthly, weekly or daily.
The bank statement serves as source document for inter alia:
•
a direct electronic deposit of funds by, for instance,
customers or lessees; and
•
the recording of bank charges and interest charged or
granted by the bank.
121
Table 5.1
Source document
Remark
Copy of the written
instruction to the entity’s
bank to make payments
to, for instance,
suppliers.
If the written instruction to the bank occurs per cheque, then the
cheque-stub is the copy of the written instruction.
Water and electricity
account or Telephone
account
The statement for water and electricity is received monthly from
the local authority. The statement inter alia contains detail of the
utilisation of the services. The credit term can be up to 3 weeks.
If the written instruction to the bank occurs per EFT, then the
copy of the EFT instruction is applicable.
The instruction must furthermore be supported by other source
documents such as an invoice for services delivered, e.g.
repairs incurred in cash, or an invoice and a goods received
note for cash purchases of goods.
The statement for telecommunication is received monthly from
the telephone service provider. The statement inter alia contains
detail of the utilisation of the services. The credit term can be up
to 3 weeks.
Source documents for
events
Source documents for events such as the recognition of
depreciation and doubtful debts are supported by appropriately
authorised internal documents.
Assets
Cash purchases of assets
13
In this section, the application of the concepts, principles and rules in respect of the cash
purchase of an asset is dealt with.
14
When an asset is purchased in cash, the cash that is referred to is never cash such as cash
notes, but cash such as the issuing of a cheque or an electronic transfer. Internal control
procedures require that all cash received by an entity be banked in total on a daily basis and
that, to the extent that it is practically executable, all payments occur per cheque or per
electronic bank transfer between bank accounts. In paragraphs 86 to 89 of this chapter,
smaller payments, which may well occur in notes and coins, are dealt with.
15
The purchase of assets with a physical characteristic, such as vehicles, furniture, equipment
and trade inventories are recognised in the records of the purchasing entity on the date on
which the item satisfies the definition and recognition criteria of an asset. This is the date on
which the asset’s right of ownership (and also control) transfers to the purchasing entity. A
portion of the asset-item cash is derecognised simultaneously with the recognition of the
acquired asset.
The transaction: Purchase of a delivery vehicle in cash
16
The cash purchase of assets entail that cash funds are utilised to purchase an asset, other
than cash.
122
17
An example of such a transaction is as follows:
On 1 July 20.7, AC Entity issued a cheque to Supplier K in respect of the purchase of a new
delivery vehicle, which was delivered to AC Entity’s premises on the same day. The invoice
indicates the cost price of the delivery vehicle as R427 500 after accounting for a 5% cash
discount. As from 1 July 20.7, AC Entity has been using the delivery vehicle for the delivery
of sold trade inventories. The delivery vehicle was ordered on 15 June 20.7.
Source documents
18
The following source documents are relevant to the cash purchase of an asset:
•
Requisition;
•
Authorised order;
•
Invoice received from the supplier;
•
Goods received note (issued by AC Entity’s warehouse); and
•
Cheque-stub or a copy of the EFT instruction to the bank.
Recognition of the transaction
Items/accounts and elements
19 If a delivery vehicle is purchased in cash, the two items brought about by the transaction are
the asset-item delivery vehicle (increase) and the asset-item cash (decrease). The accounts
involved are therefore “Vehicles” and “Bank”. This transaction affects only the element
assets. (As set out in Chapter 2 paragraphs 177 to 184, the asset-item delivery vehicle
satisfies the definition and recognition criteria of an asset.)
Date and amount of initial recognition
20 An item can only be recognised as an asset if it satisfies the definition and recognition
criteria of an asset. A decrease in the asset-item cash is recognised on the day on which the
payment occurred, namely 1 July 20.7.
21
On 1 July 20.7, the supplier delivered the delivery vehicle to AC Entity in accordance with the
contract. This is also the date on which the delivery vehicle satisfied the definition and
recognition criteria of an asset.
22
The amount, at which the increase in the asset-item delivery vehicle should initially be
measured and recognised, is the historical cost price thereof, namely the cash price (invoice
price) of the asset to the amount of R427 500, which has already been reduced with cash
discount. The decrease in the asset-item cash is measured and recognised at the same
amount on 1 July 20.7.
Double entry rules
23 Since the increase in the asset-item delivery vehicle to the amount of R427 500 satisfied the
definition and recognition criteria of an asset on 1 July 20.7 and the accompanied decrease
in the asset-item cash to the amount of R427 500 occurred on the same day, the items have
to be recognised in the records of AC Entity on 1 July 20.7 in accordance with the double
entry system.
24
The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
123
25
The double entry rules in respect of the cash purchase of an asset such as a delivery vehicle
are as follows:
Debit Vehicles – that is the asset-item/account that increases
Credit Bank – that is the asset-item/account that decreases
and is supported by the following journal:
20.7
1 July
Dr
427 500
Vehicles
Bank
Cr
427 500
Assets
=
Liabilities
+
Equity
+427 500
=
0
+
0
Classification
- 427 500
Example 5.1 Purchase of assets (trade inventories, delivery vehicle and a fixed term
deposit) in cash
AC Entity’s current reporting period ends on 31 December 20.7. The entity makes use of the
perpetual inventory system.
On 1 December 20.7 the following accounts, amongst others, with the balances as indicated
below, appeared in the records of the entity:
Nr
A5.1
A20
A30
Furniture and equipment
Trade inventories
Bank
Dr
200 000
175 000
760 000
Cr
During December 20.7, AC Entity incurred inter alia the following transactions:
1
Trade inventories, which would be paid for upon delivery, was ordered on 1 December 20.7.
On 10 December 20.7, the goods, together with the invoice from the supplier, was delivered
to AC Entity’s premises. On the same day AC Entity issued a cheque to the supplier for the
amount as indicated on the invoice, namely R45 000. The invoice price has already been
reduced with a 5% cash discount.
2
A delivery vehicle, which would be paid for upon delivery, was ordered on 2 December 20.7.
On 15 December 20.7, the delivery vehicle was registered at the local authority in the name
of AC Entity and, together with the invoice from the supplier, delivered to AC Entity’s
premises. On the same day the amount as indicated on the invoice, namely R325 000, was
paid to the supplier by means of an electronic funds transfer.
3
On 31 December 20.7 an amount of R100 000 was invested in a fixed term deposit with the
bank by means of an electronic funds transfer. The term of the deposit is 12 months, which
ends on 30 December 20.8 and the interest rate is 8% per year.
124
Required:
a)
Identify the relevant source document(s) in respect of each of the transactions.
b)
Identify the relevant items/accounts and element(s) in respect of each of the transactions.
Note: It is not required in this subsection to indicate why the items satisfy the definition of
the relevant element. (In Annexure 3 at the end of this chapter, it is indicated that a
fixed term deposit satisfies the definition and recognition criteria of an asset.)
c)
Identify the date on which recognition in respect of each transaction must occur and motivate
briefly why the specific date was identified.
d)
Identify the amount at which initial measurement in respect of each of the transactions must
occur and motivate why this amount was identified.
e)
Provide journal entries to recognise the transactions in the records (general journal) of
AC Entity for the month ended 31 December 20.7.
Note: Journal narrations as well as the effect of the transaction on the accounting equation
are required.
f)
Open the relevant accounts, post the journal entries and balance the bank account.
g)
Indicate how each of the balances would be presented in the statement of financial position
of AC Entity as at 31 December 20.7.
Remarks in respect of Example 5.1’s set of facts
1
The account numbers are obtained from the list of accounts in Chapter 4.
2
Examples will often include accounts with balances. A balance of an account
represents a summary of the effect of transactions and events that have previously
been accumulated in the account. The balance on an asset or liability account is in
essence a summary of the effect of transactions and events which have, since the
inception of the entity, been accumulated in the account.
3
The transfer of funds from the entity’s bank account to a term deposit means that the
entity is of the opinion that, for the term of the deposit, the funds will not be required in
the execution of the entity’s operating activities. The interest rate on a term deposit can
be up to three percentage points higher than the interest rate on a favourable bank
balance.
4
Interest income on favourable bank balances and term deposits are dealt with later in
this chapter.
125
Example 5.1 Solution
a) to d)
Transaction 1
Cash purchases of trade
inventories
a) Source documents
•
•
•
•
Requisition.
Authorised order.
Invoice from supplier.
Goods received note
issued by the goods
received department of
AC Entity.
Delivery note from supplier
Cheque-stub.
Transaction 2
Cash purchases of a delivery
vehicle
•
•
•
•
Requisition.
Authorised order.
Invoice from supplier.
Goods received note
issued by the goods
received department of
AC Entity.
• Registration certificate of
•
the vehicle in the name of
•
AC Entity issued by the
local authority.
• Copy of the EFT instruction
to the bank.
b) Items/accounts and element(s) involved
Items and elements
Items and elements
Asset-item delivery vehicle
Asset-item trade inventories
(increase) and asset-item cash
(increase) and asset-item cash
(decrease)
(decrease)
Accounts
Trade inventories and Bank
Accounts
Vehicles and Bank
Transaction 3
Fixed term deposit
•
•
Written term deposit
agreement with bank.
(Loans from or to a bank
always have to be
supported by a written
agreement. A term
deposit at a bank is in
essence a loan to the
bank.)
Copy of the EFT
instruction to the bank.
Items and elements
Asset-item fixed term
deposit (increase) and
asset-item cash (decrease)
Accounts
Fixed term deposit and Bank
Transaction 1
Transaction 2
Transaction 3
Cash purchases of trade
inventories
Cash purchases of a delivery
vehicle
Fixed term deposit
c) Date of recognition
10 December 20.7
15 December 20.7
31 December 20.7
This date represents the date
on which the trade inventories
were delivered and therefore
the date on which AC Entity
obtained right of ownership
(control) of the trade
inventories. It consequently
becomes probable on this date
that the future sale of the trade
inventories will result in the
inflow of economic benefits to
the entity.
This date represents the date
on which the delivery vehicle
was delivered and therefore
the date on which AC Entity
obtained right of ownership
(control) of the delivery
vehicle. It consequently
becomes probable on this date
that the future utilisation of the
delivery vehicle will result in
the inflow of economic benefits
to the entity.
This date represents the
date on which AC Entity
transferred an amount to the
bank in accordance with the
agreement and therefore
obtained a right to claim
from the bank. It
consequently becomes
probable on this date that
future economic benefits will
flow to the entity.
This date is also the date on
which payment occurred.
This date is also the date on
which payment occurred.
126
This date is also the date on
which payment occurred.
d) Amount at which the assets should initially be measured
R45 000
R325 000
R100 000
This amount represents the
historical cost price of the
purchased trade inventories,
namely the invoice price after
cash discount was accounted
for, which is also the amount
with which the bank account
decreased.
This amount represents the
historical cost price of the
purchased delivery vehicle,
namely the invoice price,
which is also the amount with
which the bank account
decreased.
This amount represents the
historical cost price of the
fixed term deposit, namely
the amount invested as per
the agreement, which is
also the amount with which
the bank account
decreased.
e) Journal entries
J1
20.7
Nr
10 Dec Trade inventories
A20
Bank
A30
Recognise trade inventories purchased per invoice 123
and received (GRN456). Payment (cheque 789)
occurred with receipt of the goods.
Assets
=
Liabilities
+
Equity
+45 000
- 45 000
=
0
+
0
J2
20.7
15 Dec
Vehicles
Bank
Recognise a delivery vehicle purchased per invoice aaa
and received (GRN bbb). Payment (EFT ccc) occurred
with receipt of the vehicle.
Assets
=
Liabilities
+
Equity
+325 000
- 325 000
=
0
+
0
J3
20.7
31 Dec
Term deposit
Bank
Recognise the term deposit which is incurred for 12
months until 30 Dec 20.8 at 8% per year. See term
deposit agreement SB111
Assets
=
Liabilities
+
Equity
+100 000
- 100 000
=
0
+
0
127
Dr
45 000
Cr
45 000
Classification
Nr
A4.1
A30
Dr
325 000
Cr
325 000
Classification
Nr
A24
A30
Dr
100 000
Cr
100 000
Classification
f) Accounts
Dr
Date
20.7
15 Dec
A4.1 Vehicles
Contra account
Bank
Dr
Date
20.7
1 Dec
Nr
J2
20.7
1 Dec
10 Dec
Balance
Nr
bd
20.7
31 Dec
Balance
Bank
Nr
bd
J1
Nr
Amount
Contra account
Nr
Amount
Contra account
Nr
Amount
Contra account
Nr
Amount
Contra account
Nr
Amount
20.7
760 000 10 Dec Trade inventories
15 Dec Vehicles
31 Dec Term deposit
Balance
760 000
J1
J2
J3
cf
325 000
Amount
Date
Cr
200 000
Amount
Date
Cr
175 000
45 000
220 000
A24 Term deposit
Contra account
Bank
Nr
J3
Dr
Date
Cr
Contra account
A20 Trade inventories
Contra account
Dr
Date
Date
A5.1 Furniture and equipment
Contra account
Dr
Date
Amount
Amount
Date
Cr
100 000
A30 Bank
Contra account
Nr
20.7
1 Dec
Balance
bd
20.8
1 Jan
Balance
bd
Amount
Date
290 000
128
Cr
45 000
325 000
100 000
290 000
760 000
g) Presentation of balances
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
ASSETS
Non-current assets
Vehicles
Furniture and equipment
Total non-current assets
325 000
200 000
525 000
Current assets
Inventories
Term deposit
Cash and cash equivalents
Total current assets
Total assets
220 000
100 000
290 000
610 000
1 135 000
Remark in respect of Example 5.1’s solution
1
In the set of facts detail of furniture and equipment is provided in the form of a balance
on 1 December 20.7. Although there was no transaction in respect of furniture and
equipment during December 20.7, furniture and equipment must be presented as an
asset in the statement of financial position on 31 December 20.7.
Credit purchases of assets by utilising trade credit
26
In this section, the application of concepts, principles and rules in respect of the purchase of
an asset by making use of trade credit, is dealt with.
27
The credit purchase of goods is one of the distinctive characteristics of the modern economy.
The purchase of trade inventories and movable non-current assets such as furniture and
equipment and vehicles, often occur on credit. Payment in respect of the purchased product
does therefore not take place when the product is received since there is a credit term that
can first elapse before payment has to occur. Credit terms can be 30 days or 60 days or
sometimes even 90 days. This concession by suppliers to customers is referred to as trade
credit and during this credit term no interest is charged.
28
If an asset that was purchased on credit has already been delivered by the supplier, the
purchasing entity obtains control over the asset before payment occurs and the asset must
therefore be recognised in the purchasing entity’s records on the date of delivery. This
accounting phenomenon is known as accrual accounting. In the context of the purchase of
an asset by making use of trade credit, the gaining of control over the asset by utilising trade
credit and the subsequent settlement of the payable are separate transactions.
129
The transaction: Purchase of trade inventories with trade credit
29
The transaction entails that an asset is purchased by utilising trade credit.
30
An example of such a transaction is as follows:
On 1 July 20.7, AC Entity ordered trade inventories from Supplier K. On 16 July 20.7,
Supplier K delivered the trade inventories to AC Entity’s premises. The invoice indicates the
cost price of the trade inventories as R224 000. Payment must occur by 14 August 20.7.
31
Note that, in accordance with accrual accounting, the purchase of the trade inventories on
credit and the subsequent settlement of the debt are two separate transactions. Only the
purchase of the trade inventories is dealt with in this section.
Source documents
32
The following source documents are applicable to the credit purchase of an asset (only in
respect of the purchase):
•
Requisition;
•
Authorised order;
•
Invoice received from the supplier;
•
Delivery note from supplier; and
•
Goods received note (issued by AC Entity’s warehouse).
Recognition of the transaction
Items/accounts and elements
33 If trade inventories are purchased by utilising trade credit, the two items brought about by the
transaction are the asset-item trade inventories (increase) and the liabilities-item trade
payable (increase). The accounts involved are therefore “Trade inventories” and
“Payable K”. This transaction affects the element assets and the element liabilities. (As set
out in Chapter 2 paragraphs 164 to 176, the items trade inventories and trade payable
satisfy the definition and recognition criteria of an asset and a liability respectively.)
Date and amount of initial recognition
34 An item can only be recognised as an asset and an item can only be recognised as a liability
if the items satisfy the definition and recognition criteria of an asset and a liability
respectively.
35
On 16 July 20.7, Supplier K delivered the trade inventories to AC Entity in accordance with
the contract. This is also the date on which the trade inventories satisfied the definition and
recognition criteria of an asset and Payable K satisfied the definition and recognition criteria
of a liability.
36
The amount, at which the increase in the asset-item trade inventories should initially be
measured and recognised, is the historical cost price thereof, namely the invoice price of the
asset to the amount of R224 000. The increase in the liabilities-item Payable K is initially
measured and recognised at the same amount on 16 July 20.7.
130
Double entry rules
37
Since the increase in the asset-item trade inventories to the amount of R224 000 and the
increase in the liabilities-item Payable K to the amount of R224 000 satisfied the definition
and recognition criteria of an asset and a liability respectively on 16 July 20.7, the items have
to be recognised in the records of AC Entity on 16 July 20.7 in accordance with the double
entry system.
38
The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
39
The double entry rules in respect of the credit purchase of an asset such as trade inventories
are as follows:
Debit Trade inventories – that is the asset-item/account that increases
Credit Payable K – that is the liabilities-item/account that increases
and is supported by the following journal:
20.7
16 Jul
Dr
224 000
Trade inventories
Payable K
Cr
224 000
Assets
=
Liabilities
+
Equity
+224 000
=
+224 000
+
0
Classification
Credit purchases of assets by utilising a supplier’s loan
40
In this section, the application of concepts, principles and rules in respect of the purchase of
an asset by making use of a supplier’s loan, is dealt with.
41
Some suppliers of sophisticated assets (e.g. machinery) make credit available to the
purchasing entity in the form of a loan. A loan carries interest and the term of the loan is
longer than the term of normal trade credit.
42
If an asset that was purchased on credit has already been delivered by the supplier, the
purchasing entity obtains control over the asset before payment occurs and the asset must
therefore be recognised in the purchasing entity’s records on the date of delivery. In the
context of the purchase of an asset by making use of a supplier’s loan, the gaining of control
over the asset by utilising a supplier’s loan and the subsequent settlement of the loan are
separate transactions.
The transaction: Purchase of machinery by utilising a supplier’s loan
43
This transaction entails that an asset is purchased by utilising a supplier’s loan.
44
An example of such a transaction is as follows:
On 1 June 20.7, AC Entity entered into an agreement with Supplier L for the delivery of a
machine to AC Entity on 1 July 20.7. The cash price of the machine is R824 000 and is,
together with the accumulated interest, repayable on 31 December 20.9. The interest rate is
12% per year and the interest is added to the loan amount at the end of every six months.
The machine was delivered to AC Entity on 1 July 20.7.
131
45
Note that, in accordance with accrual accounting, the purchase of the machine on credit and
the subsequent settlement of the debt are two separate transactions. Only the purchase of
the machine is dealt with in this section. The recognition of interest on a loan is dealt with in
paragraphs 193 to 205 of this chapter and the settlement of a loan is dealt with in
Chapter 15.
Source documents
46
The following source documents are applicable to the credit purchase of an asset (only in
respect of the purchase):
•
Requisition;
•
Authorised order;
•
Loan agreement;
•
Invoice received from the supplier;
•
Delivery note from the supplier; and
•
Goods received note (issued by AC Entity’s warehouse).
Recognition of the transaction
Items/accounts and elements
47 If a machine is purchased by utilising a supplier’s loan, the two items brought about by the
transaction are the asset-item machine (increase) and the liabilities-item supplier’s loan from
Supplier L (increase). The accounts involved are therefore “Machinery” and “Loan from
Supplier L”. This transaction affects the element assets and the element liabilities. (As set
out in Annexure 3, the items machinery and supplier’s loan satisfy the definition and
recognition criteria of an asset and a liability respectively.)
Date and amount of initial recognition
48 An item can only be recognised as an asset and an item can only be recognised as a liability
if the items satisfy the definition and recognition criteria of an asset and a liability
respectively.
49
On 1 July 20.7, Supplier L delivered the machine to AC Entity in accordance with the
contract. This is also the date on which the machine satisfied the definition and recognition
criteria of an asset and the loan from Supplier L satisfied the definition and recognition
criteria of a liability.
50
The amount at which the increase in the asset-item machinery should initially be measured
and recognised, is the historical cost price thereof, namely the invoice price of R824 000.
The increase in the liabilities-item loan from Supplier L is measured and recognised at the
same amount on 1 July 20.7.
Double entry rules
51 Since the increase in the asset-item machinery to the amount of R824 000 and the increase
in the liabilities-item loan from Supplier L to the amount of R824 000 satisfied the definition
and recognition criteria of an asset and a liability respectively on 1 July 20.7, the items have
to be recognised in the records of AC Entity on 1 July 20.7 in accordance with the double
entry system.
52
The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
132
53
The double entry rules in respect of the purchase of an asset such as machinery by utilising
a supplier’s loan, are as follows:
Debit Machinery – that is the asset-item/account that increases
Credit Loan from Supplier L – that is the liabilities-item/account that increases
and is supported by the following journal:
20.7
1 Jul
Dr
824 000
Machinery
Loan from Supplier L
Cr
824 000
Assets
=
Liabilities
+
Equity
+824 000
=
+824 000
+
0
Classification
Example 5.2 Purchase of trade inventories and a delivery vehicle by utilising trade credit.
Purchase of a machine by utilising a supplier’s loan
AD Entity’s current reporting period ends on 31 December 20.7. The entity makes use of the
perpetual inventory system.
On 1 December 20.7 the following accounts, amongst others, with the balances as indicated
below, appeared in the records of the entity:
Vehicles
Furniture and equipment
Trade inventories
A4.1
A5.1
A20
Dr
290 000
225 000
275 000
Cr
During December 20.7, AD Entity incurred inter alia the following transactions:
1
On 2 December 20.7, trade inventories were ordered on credit from the supplier, Payable K.
On 12 December 20.7, the goods, together with the invoice from the supplier, were delivered
to AD Entity’s premises. The invoice indicates that the amount due is R75 000 and that this
amount is payable on or before 25 January 20.8.
2
On 3 December 20.7 a delivery vehicle was ordered on credit from the supplier, Payable L.
On 15 December 20.7, the delivery vehicle was registered at the local authority in the name
of AD Entity and, together with the invoice from the supplier, delivered to AD Entity’s
premises. The invoice indicates that the amount payable is R375 000 and that this amount is
payable on or before 30 January 20.8.
3
On 5 December 20.7 a contract for the purchase of a machine from Supplier V, by utilising a
loan from Supplier V, was signed. The cash price of the machine is R400 000. On
31 December 20.7 the machine was delivered to AD Entity’s premises. The amount due,
together with the interest at 9% per year, is payable on 30 December 20.8.
133
Required:
a)
With reference to transaction 3, explain the nature of accrual accounting.
b)
Identify in respect of each of the abovementioned transactions:
i)
the relevant source document(s);
ii)
the relevant items/accounts and element(s);
Note: It is not required in this subsection to indicate why the items satisfy the definition
of the relevant element. (As set out in Annexure 3, a supplier’s loan satisfies the
definition and recognition criteria of a liability.)
c)
iii)
the date on which recognition must occur and motivate briefly why the specific date
was identified; and
iv)
the amount at which initial measurement must occur and motivate briefly why this
amount was identified.
Provide journal entries to recognise the transactions in the records (general journal) of
AD Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transaction on the accounting equation
are required.
d)
Open the relevant accounts and post the journal entries.
e)
Indicate how each of the balances would be presented in the statement of financial position
of AD Entity as at 31 December 20.7.
Example 5.2 Solution
a)(i) Nature of accrual accounting
In accordance with accrual accounting, the effect of transactions that are incurred on credit, are
recorded in the accounting records when the transaction or event is incurred and not only at that
point of time when settlement takes place. The practical implication of accrual accounting is that
the purchase of an asset on credit, the receipt of a loan, the sale of trade inventories on credit, the
incurrence of an expense on credit and the subsequent settlement of the debt, are separate
transactions.
With reference to transaction 3, the machine and the accompanying supplier’s loan will therefore
be recognised on the day on which the definition and recognition criteria of an asset and a liability
have respectively been satisfied, namely on 31 December 20.7 (the day on which the machine
was delivered) and not only when the supplier’s loan is repaid, namely on 30 December 20.8.
134
b)
Transaction 1
Trade inventories purchased
with trade credit
Transaction 2
Delivery vehicle purchased
with trade credit
Transaction 3
Machine purchased with a
supplier’s loan
i) Source documents
•
•
•
•
•
Requisition.
Authorised order.
Invoice from Payable K.
Delivery note from
Payable K.
Goods received note
issued by the goods
received department of
AD Entity.
•
•
•
•
•
Requisition.
Authorised order.
Invoice from Payable L.
Goods received note
issued by the goods
received department of
AD Entity.
Registration certificate of
vehicle in the name of
AD Entity issued by the
local authority.
•
•
•
•
•
Requisition.
Authorised order.
Loan agreement/
Purchase contract
Invoice from Supplier V.
Goods received note
issued by the goods
received department of
AD Entity.
ii) Items/accounts and element(s) involved
Items and elements
Asset-item trade inventories
(increase) and liabilities-item
Payable K (increase)
Items and elements
Asset-item delivery vehicle
(increase) and liabilities-item
Payable L (increase)
Accounts
Trade inventories and
Payable K
Accounts
Vehicles and Payable L
Items and elements
Asset-item machinery
(increase) and liabilities-item
loan from Supplier V
(increase)
Accounts
Machinery and Loan from
Supplier V
iii) Date of recognition
12 December 20.7
This date represents the date
on which the trade inventories
were delivered in accordance
with the purchase contract
and therefore the date on
which AD Entity obtained right
of ownership (control) of the
trade inventories as well as
the date on which a legally
enforceable obligation
towards Payable K arose.
It consequently becomes
probable on this date that the
future sale of the trade
inventories will result in the
inflow of economic benefits to
the entity and that the
settlement of the debt will
result in the outflow of cash in
the future.
15 December 20.7
This date represents the date
on which the delivery vehicle
was delivered in accordance
with the purchase contract
and therefore the date on
which AD Entity obtained right
of ownership (control) of the
delivery vehicle as well as the
date on which a legally
enforceable obligation
towards Payable L arose.
It consequently becomes
probable on this date that the
future utilisation of the
delivery vehicle will result in
the inflow of economic
benefits to the entity and that
the settlement of the debt will
result in the outflow of cash in
the future.
135
31 December 20.7
This date represents the date
on which the machine was
delivered in accordance with
the agreement/ purchase
contract and therefore the
date on which AD Entity
obtained right of ownership
(control) of the machine as
well as the date on which a
legally enforceable obligation
towards Supplier V arose.
It consequently becomes
probable on this date that the
future utilisation of the
machine will result in the
inflow of economic benefits to
the entity and that the
settlement of the debt will
result in the outflow of cash in
the future.
Transaction 1
Trade inventories purchased
with trade credit
Transaction 2
Delivery vehicle purchased
with trade credit
Transaction 3
Machine purchased with a
supplier’s loan
iv) Amount at which the assets and liabilities should initially be measured
R75 000
This amount represents the
historical cost price of the
trade inventories, namely the
invoice price.
R375 000
This amount represents the
historical cost price of the
delivery vehicle, namely the
invoice price.
R400 000
This amount represents the
historical cost price of the
machine, namely the invoice
price, which is also the amount
in accordance with the
agreement/purchase contract.
c) Journal entries
J1
20.7
12 Dec
Nr
Trade inventories
A20
Payable K
K1
Recognise trade inventories purchased on credit per
invoice K123 and received (GRN456) as well as the
accompanying liability.
Assets
=
Liabilities
+
Equity
+75 000
=
+75 000
+
0
J2
20.7
15 Dec
Vehicles
Payable L
Recognise a delivery vehicle purchased on credit per
invoice L101 and received (GRN 460) as well as the
accompanying liability.
Assets
=
Liabilities
+
Equity
+375 000
=
+375 000
+
0
J3
20.7
31 Dec
Machinery
Loan from Supplier V
Recognise machinery purchased on credit per invoice
V222 and received (GRN 502) as well as the
accompanying liability (refer loan agreement KQ333).
Assets
=
Liabilities
+
Equity
+400 000
=
+400 000
+
0
136
Dr
75 000
Cr
75 000
Classification
Nr
A4.1
K2
Dr
375 000
Cr
375 000
Classification
Nr
A3.1
L4
Dr
400 000
Cr
400 000
Classification
d) Accounts
Dr
Date
20.7
31 Dec
A3.1 Machinery
Contra account
Nr
Loan from Supplier V J3
Dr
Date
20.7
1 Dec
15 Dec
20.7
1 Dec
Balance
Payable L
Nr
bd
J2
20.7
1 Dec
12 Dec
Balance
Nr
bd
Balance
Payable K
Nr
bd
J1
Amount
Contra account
Nr
Amount
Contra account
Nr
Amount
Contra account
Nr
Amount
400 000
Amount
Date
Cr
290 000
375 000
665 000
Amount
Date
225 000
Amount
Date
Cr
275 000
75 000
350 000
Contra account
Nr
Amount
Date
Cr
Contra account
Nr
20.7
12 Dec Trade inventories
J1
K2 Payable L
Contra account
Nr
Amount
Date
Dr
Nr
J2
L4 Loan from Supplier V
Contra account
Nr
Amount
Date
75 000
Amount
375 000
Cr
Contra account
20.7
31 Dec Machinery
137
Amount
Cr
Contra account
20.7
15 Dec Vehicles
Date
Cr
K1 Payable K
Dr
Date
Nr
A20 Trade inventories
Contra account
Dr
Date
Cr
Contra account
A5.1 Furniture and equipment
Contra account
Dr
Date
Date
A4.1 Vehicles
Contra account
Dr
Date
Amount
Nr
J3
Amount
400 000
e) Presentation of balances
AD ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
ASSETS
Non-current assets
Machinery
Vehicles
Furniture and equipment
Total non-current assets
400 000
665 000
225 000
1 290 000
Current assets
Inventories
Total current assets
Total assets
350 000
350 000
1 640 000
EQUITY AND LIABILITIES
Current liabilities
Trade and other payables (cr 75 000 cr 375 000)
Short term loans / Supplier’s loan
Total current liabilities
450 000
400 000
850 000
Remark in respect of the supplier’s loan
1
The supplier’s loan in this example is a short term loan since the term of the loan does
not exceed 12 months. The supplier’s loan therefore has to be presented as a current
liability. The description of the line item can be “Short term loan” or “Supplier’s loan”.
138
Expenses
Background
54
The statement of financial position deals with the assets, liabilities and equity of an entity
in a specific format. Detail of an entity’s assets and detail of the sources of finance (liabilities
and equity) that were used to acquire the assets can be obtained from the statement of
financial position.
55
The non-current assets of an entity create the physical capacity to carry out the operating
activities. Non-current assets are usually purchased by the entity by using funds made
available to the entity by the owner(s) and long term lenders.
56
Current assets and current liabilities mainly originate as a result of the entity’s operating
activities. For example, trade inventories are usually purchased on credit from trade
payables that finance the purchase of the inventories for a period of 30 to 60 days. Trade
inventories are however not sold immediately after the purchase thereof. It can take an
average of between 15 and 30 days before an inventory item is sold. Trade inventories are
sold in cash or on credit. Trade receivables arise from credit sales and it can take up to 30
days or longer before the trade receivables settle their debt. The cash received from
receivables and from cash sales will seldom synchronise with the need for cash in respect of
cash purchases or payments to payables.
57
An entity however needs more than only non-current assets and current assets to carry out
operating activities. The entity also needs employees, water and electricity, fuel, etc. An
entity must therefore, apart from the purchase of assets, also incur monthly expenses (e.g.
salaries, water and electricity, etc.).
Nature of expenses
58
Expenses relate to a specific reporting period and are mainly the result of the entity’s
operating activities and are incurred to earn or generate income.
59
The definition of expenses is as follows:
Expenses are decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants (Conceptual Framework
2010.4.25(b)).
60
As is known, expenses that are incurred during the reporting period, are debited against
appropriate expense accounts (temporary accounts), and not directly against retained
earnings. At the end of the reporting period the expense accounts are closed off against
retained earnings by debiting retained earnings and crediting the respective expense
accounts. Refer to the example of the rent expense account in Annexure 1 at the end of this
chapter. The effect of the closing off process is to reduce retained earnings with the
expenses as at the end of the year. The closing off process is dealt with in Chapter 7.
139
The economic benefits associated with an expense
61
An expense also holds economic benefits for the entity. As opposed to an asset, where the
economic benefits associated with an asset can flow to the entity over numerous years, the
economic benefits that an expense holds for the entity are usually limited to a period of one
month. An asset represents economic benefits that an entity expects to derive in future,
whereas economic benefits related to an expense have already been derived.
62
As an example of the above, consider the following two expenses that are discussed in the
paragraphs below: rent expense in respect of buildings and salaries to employees.
Rent expense of buildings
63
An example of a rent expense is as follows: On 2 January 20.7, AC Entity signed a short
term lease agreement to rent a business property with buildings at cost of R15 000 per
month. The rent expense for January 20.7 was paid on 2 January 20.7 whereafter the rent
payments are due on the first day of each month. AC Entity’s reporting period ends 31
December.
64
The rent paid on 2 January 20.7, holds economic benefits for the entity for January 20.7
only. The lease payment is not recognised as an asset, since the benefits of the lease
payment holds no future economic benefits after 31 January 20.7.
Salaries to employees
65
On 28 January 20.7, AC Entity paid salaries of R28 000 for the month. The payment of the
salaries to employees is a payment that occurs for the utilisation of the employees’ services
for the month of January 20.7, which has virtually expired.
66
Again the payment of salaries held economic benefits for the entity for January 20.7 only.
Salaries are therefore not recognised as an asset, since the payment of salaries for January
20.7 holds no future economic benefits after 31 January 20.7.
Origin of expenses
67
68
An entity’s expenses can, within the context of the accounting equation, be incurred in one of
three manners:
•
The expense is incurred in cash; or
•
The expense is incurred on credit; or
•
The expense arises from the subsequent measurement of assets and liabilities.
Expenses are subsequently dealt with, with reference to the way in which the expenses
originate.
Expenses incurred in cash
69
In this section, the application of concepts, principles and rules in respect of the incurrence
of expenses in cash is dealt with.
70
When an expense is incurred in cash, the cash that is referred to is never cash such as cash
notes, but cash such as the issuing of a cheque or an electronic transfer. Internal control
procedures require that all cash received by an entity be banked in total on a daily basis and
that, to the extent that it is practically executable, all payments occur per cheque or per
electronic bank transfer between bank accounts. At the end of this section, smaller
payments, which may well occur in notes and coins, are dealt with.
140
71
Examples of expenses that are usually incurred by utilising cash are rent expense, salaries
and insurance expense.
The transaction: Rent expense paid cash
72
This transaction entails that cash funds are utilised to incur an expense.
73
An example of such a transaction is as follows:
During 20.6, AC Entity entered into a short term lease agreement with Lessor VH in
accordance with which AC Entity rents a specific property. On 1 March 20.7, AC Entity paid
the rent for March 20.7 to the amount of R32 000 by means of an EFT.
Source documents
74
The following source documents are applicable in respect of the incurrence of an expense in
cash (e.g. a rent expense):
•
The short term lease agreement; and
•
Copy of the EFT instruction to the bank or the cheque-stub.
Recognition of the transaction
Items/accounts and elements
75 When rent is incurred in cash, the two items brought about by the transaction are the
expense-item rent (increase) and the asset-item cash (decrease). The accounts involved are
therefore “Rent expense” and “Bank”. This transaction affects the element expenses and the
element assets. (As set out in Annexure 3, the expense-item rent satisfies the definition of an
expense.)
Date and amount of initial recognition
76 An item that satisfies the definition of an expense is recognised when a decrease in future
economic benefits, associated with a decrease that occurred in an asset or an increase that
occurred in a liability, can be measured reliably. An expense that is incurred in cash is
therefore recognised simultaneously with the decrease in the associated asset-item cash.
The decrease in the asset-item cash is recognised on the date on which payment occurs.
77
The expense-item rent is consequently recognised simultaneously with the decrease in the
asset-item cash. The decrease in the asset-item cash is recognised on 1 March 20.7, the
date of payment.
78
The amount at which the decrease in the asset-item cash should initially be measured and
recognised, is the historical cost price thereof, namely the lease instalment as per the lease
agreement of R32 000. The increase in the expense-item rent is measured and recognised
at the same amount on 1 March 20.7.
Double entry rules
79 Since the increase in the expense-item rent to the amount of R32 000 (which causes a
decrease in retained earnings/equity) satisfied the definition and recognition criteria of an
expense on 1 March 20.7 and the accompanying decrease in the asset-item cash to the
amount of R32 000 occurred on the same day and can be measured reliably, the items have
to be recognised in the records of AC Entity on 1 March 20.7 in accordance with the double
entry system.
80
The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
141
81
The double entry rules in respect of an expense such as rent that is incurred in cash are as
follows:
Debit Rent expense – that is the expense-item/account that increases
Credit Bank – that is the asset-item/account that decreases
and is supported by the following journal:
20.7
1 March
Dr
32 000
Rent expense
Bank
Cr
32 000
Assets
=
Liabilities
+
Equity
Classification
- 32 000
=
0
+
- 32 000
Retained earnings – Expense
Example 5.3 Expenses incurred in cash: rent, salaries and insurance
AE Entity’s current reporting period ends on 31 December 20.7.
On 1 December 20.7 the following balances, amongst others, appeared in the records of the entity:
Acc
A5.1
A20
A30
D1
A23.5
E1
E2.1
E2.2
K1
U3
U8
U12
Furniture and equipment
Trade inventories
Bank
Receivable A
Rent deposit
Capital
Retained earnings – 1 Jan 20.7
Drawings
Payable K
Salaries and wages
Insurance
Rent expense
Dr
225 000
445 000
512 000
396 000
20 000
Cr
3 000 000
1 500 000
550 000
265 000
462 000
126 500
220 000
The following transactions that were incurred during December 20.7 are applicable:
1
Rent for December 20.7 was paid on 2 December 20.7 to Lessor VH by means of an
electronic transfer of funds.
On 2 January 20.6, AE Entity signed a lease agreement to rent five low value items for three
years from Lessor VH at a monthly lease expense of R20 000 in total, which is payable on
the second day of each month.
2
The insurance premium for December 20.7 was paid to the insurance company on
3 December 20.7 by means of an electronic transfer of funds.
The insurance contract for the year ended 31 December 20.7, was renewed on
27 December 20.6. The monthly insurance premium amounts to R11 500 and is payable on
the third day of each month.
3
The salaries for December 20.7 to the amount of R42 000 was paid on 30 December 20.7 by
means of an electronic transfer of funds.
142
Required:
a)
Explain the origin of the rent deposit account.
b)
Explain the meaning of the balance of R220 000 in respect of the rent expense account on
1 December 20.7.
c)
Explain why the balance of retained earnings is indicated as 1 January 20.7.
d)
Explain if drawings by the owner represent an expense for AE Entity.
e)
Identify in respect of each of the abovementioned transactions:
i)
the relevant source document(s);
ii)
the relevant items/accounts and element(s);
Note:It is not required in this subsection to indicate why the items satisfy the definition
of the relevant element.
f)
iii)
the date on which recognition must occur and motivate briefly why the specific date
was identified; and
iv)
the amount at which initial measurement must occur and motivate briefly why this
amount was identified.
Provide journal entries to recognise the abovementioned transactions in the records (general
journal) of AE Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transaction on the accounting equation
are required.
g)
Open the three expense accounts and the bank account, with the balances as at
1 December 20.7, post the journal entries to the accounts and balance the bank account.
h)
Indicate how each of the balances of the expense accounts would be presented in the
statement of profit or loss of AE Entity for the reporting period ended 31 December 20.7.
Example 5.3 Solution
a) Rent deposit
It is normal practice for a short term lease agreement to contain a stipulation that, with the
inception of the lease term, the lessee must pay a refundable deposit to the lessor. At the end of
the lease term the lessor repays the deposit, unless the lessee damaged the property or the leaseitem. In such a case, depending on the extent of the damage, the lessor will repay only a portion or
nothing of the deposit to the lessee.
(As set out in Annexure 3, the rent deposit paid satisfies the definition and recognition criteria of an
asset.)
b) The meaning of the balance of the rent expense account on 1 December 20.7
The rent expense account contains for each of the eleven months, January to November 20.7, a
debit of R20 000 per month which represents the rent expense paid in respect of each of the
eleven months. Hence, the debit balance of R220 000 (R20 000 x 11 months). The rent expense
for 20.6 and prior do not form part of 20.7’s rent expense account, since expenses are closed off
against retained earnings at the end of each reporting period.
(Note: refer to Annexure 1 at the end of this chapter for an example of a rent expense account for
twelve months.)
143
c) Why is the retained earnings balance indicated as 1 January 20.7
Transactions that affect retained earnings are accumulated during the reporting period in the
accounts that represent the components of retained earnings, namely income accounts, expense
accounts and the drawings account. The income accounts, expense accounts and the drawings
account are closed off against retained earnings at the end of the reporting period. Before this
closing off process of the stated accounts against retained earnings occur, the balance of retained
earnings will be the balance as brought down from the previous reporting date, in this example
1 January 20.7. (The closing off of income and expense accounts as well as the drawings account
is dealt with in Chapter 7.)
d) Drawings is a distribution to the owner, not an expense
Drawings are amounts that the owner withdraws from the entity for his personal use. Drawings by
the owner are accumulated in a drawings account during the reporting period and are closed off
against the retained earnings account at the end of each reporting period. Although drawings
decrease the retained earnings in the same way as an expense, it is not an expense and is
specifically excluded by the definition of an expense. Drawings are not incurred to generate
income, but represent a distribution to the owner.
e)
Transaction 1
Transaction 2
Transaction 3
Rent paid
Insurance premium paid
Salaries paid
i) Source documents
•
Lease agreement.
•
Insurance contract.
•
Written EFT instruction to
the bank.
•
Written EFT instruction to
the bank.
•
Schedule of salaries
(payroll), as authorised by
the owner.
•
Written EFT instruction to
the bank.
ii) Items/accounts and element(s) involved
Items and elements
Expense-item rent (increase)
and asset-item cash
(decrease)
Items and elements
Expense-item insurance
(increase) and asset-item
cash (decrease)
Items and elements
Expense-item salaries
(increase) and asset-item
cash (decrease)
Accounts
Accounts
Accounts
Rent expense and Bank
Insurance and Bank
Salaries and Bank
3 December 20.7
This date represents the date
on which the cash outflow
from AE Entity’s bank account
occurred.
A cash expense is recognised
simultaneously with the
decrease in bank.
30 December 20.7
This date represents the date
on which the cash outflow
from AE Entity’s bank account
occurred.
A cash expense is recognised
simultaneously with the
decrease in bank.
iii) Date of recognition
2 December 20.7
This date represents the date
on which the cash outflow
from AE Entity’s bank account
occurred.
A cash expense is recognised
simultaneously with the
decrease in bank.
144
Transaction 1
Rent paid
Transaction 2
Insurance premium paid
Transaction 3
Salaries paid
iv) Amount at which the expense should initially be measured
R11 500
R20 000
R42 000
This amount represents the
This amount represents the
This amount represents the
historical cost price of the
historical cost price of the
historical cost price of the
expense, namely the cash
expense, namely the cash
expense, namely the cash
price.
price.
price.
The cash price is the amount
The cash price is the amount
The cash price is the amount
with which the cash in the
with which the cash in the
with which the cash in the
bank decreases, namely the
bank decreases, namely the
bank decreases, namely the
monthly rent amount paid in
insurance amount paid in
amount of the salaries
accordance with the lease
accordance with the
schedule (payroll).
agreement.
insurance contract.
f) Journal entries
J1
20.7
2 Dec
Rent expense
Bank
Recognise rent expense for December 20.7
Assets
- 20 000
J2
20.7
3 Dec
Liabilities
0
+
+
Equity
- 20 000
Insurance
Bank
Recognise the insurance premium for December 20.7
Assets
- 11 500
J3
20.7
30 Dec
=
=
=
=
Liabilities
0
+
+
Equity
- 11 500
Salaries
Bank
Recognise the salaries for December 20.7
Nr
U12
A30
Dr
20 000
Cr
20 000
Classification
Retained earnings – Expense
(Rent)
Nr
U8
A30
Dr
11 500
Cr
11 500
Classification
Retained earnings – Expense
(Insurance)
Nr
U3
A30
Dr
42 000
Cr
42 000
Assets
=
Liabilities
+
Equity
Classification
- 42 000
=
0
+
- 42 000
Retained earnings – Expense
(Salaries)
145
g) Post journal entries to accounts
Dr
A30 Bank
Date
Contra account
Nr
20.7
1 Dec
Balance
bd
20.8
1 Jan
Balance
bd
Dr
Contra account
20.7
1 Dec
30 Dec
Balance
Bank
Nr
bd
J3
Dr
20.7
512 000 2 Dec
3 Dec
30 Dec
31 Dec
512 000
Contra account
Rent expense
Insurance
Salaries
Balance
Nr
Amount
J1
J2
J3
cf
20 000
11 500
42 000
438 500
512 000
438 500
Amount
Date
Cr
Contra account
Nr
Amount
Contra account
Nr
Amount
Contra account
Nr
Amount
462 000
42 000
504 000
U8 Insurance
Date
Contra account
Balance
Bank
Nr
bd
J2
Dr
Amount
Date
Cr
126 500
11 500
138 000
U12 Rent expense
Date
20.7
1 Dec
2 Dec
Cr
Date
U3 Salaries
Date
20.7
1 Dec
3 Dec
Amount
Contra account
Balance
Bank
Nr
bd
J1
Amount
Date
Cr
220 000
20 000
240 000
h) Presentation of the three expense accounts’ balances
AE ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
R
Sales
xxx
Cost of sales
(xxx)
Gross profit
xxx
Other income
xxx
Rent expense
(240 000)
Salaries and wages
(504 000)
Insurance
(138 000)
Profit for the year
xxx
146
Bank charges
82
Cheque accounts and the control over these accounts are dealt with in Chapter 10.
However, it is appropriate at this point to pay attention to the expense associated with the
use of a bank account. This expense is generally referred to as bank charges. Bank charges
is a further example of an expense that originates because cash in the bank decreases.
83
An entity opens a cheque account at a bank and deposits all receipts daily in the cheque
account at the bank. The entity gives the bank written instructions when funds in the cheque
account must, on behalf of the entity, be transferred/paid to a third party.
84
In the records of the entity, the transactions that affect cash/bank are recorded in the bank
account. The bank also maintains a record of each client’s cheque account, which is usually
referred to as a bank statement or cheque account statement. The entity receives a cheque
account statement from the bank on a daily, weekly or monthly basis. The entity can also
obtain electronic, real time access to the cheque account statements from the bank. The
entity compares the cheque account statement with the bank account in the entity’s records
to determine whether the bank acted properly with the entity’s funds.
85
Bank charges are levied per transaction. The bank takes funds from the entity’s cheque
account in order to compensate itself for the administration of the cheque account. Bank
charges are indicated as a monthly amount on the bank statement/cheque account
statement. Based on the bank charges, as reflected on the bank statement from the bank,
the entity must recognise the bank charges as a cash expense in the entity’s records. The
recognition usually occurs at the end of the month in respect of which the bank charges on
the cheque account statement were charged.
Example 5.4 Cash expense: bank charges
AF Entity’s current reporting period ends on 31 December 20.7. AF Entity’s financial statements for
20.7 will probably be approved for distribution on 25 February 20.8.
On 31 December 20.7 the following balances, amongst others, appeared in the records of the
entity:
Acc
A30
E1
E2.1
E2.2
K1
U3
U15
Bank
Capital
Retained earnings – 1 Jan 20.7
Drawings
Payable K
Salaries
Bank charges – 1 Dec 20.7
Dr
612 000
Cr
3 000 000
1 500 000
720 000
265 000
540 000
54 250
On 4 January 20.8 the cheque account statement for December 20.7 was received from
AF Entity’s bank. This statement indicates the bank charges for December 20.7 as R4 250.
147
Required:
a)
Identify the following in respect of the abovementioned transaction:
i)
the relevant source document(s);
ii)
the relevant items/accounts and element(s);
Note:It is not required in this subsection to indicate why the items satisfy the definition
of the relevant element. (As set out in Annexure 3, bank charges satisfy the
definition of an expense.)
b)
iii)
the date on which recognition must occur and motivate briefly why the specific date
was identified; and
iv)
the amount at which initial measurement must occur and motivate briefly why this
amount was identified.
Provide a journal entry to recognise the abovementioned transaction in the records (general
journal) of AF Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transaction on the accounting equation
are required.
c)
Open the bank charges account and the bank account with the balances as provided, post
the journal entry to the accounts and balance the bank account.
d)
Present the balance of the bank charges account in the statement of profit or loss of
AF Entity for the reporting period ended 31 December 20.7.
Remarks in respect of the dates in the set of facts
1
The reporting date is 31 December 20.7. This means that all assets, liabilities, income
and expenses that satisfy the definition and the recognition criteria of the relevant
element on 31 December 20.7, must be recognised in AF Entity’s records and also be
presented in one of AF Entity’s financial statements for the reporting period ended
31 December 20.7.
Another very important date when preparing financial statements, is the date on which
the owner(s) approve(s) the financial statements for distribution. Although entities try to
complete and approve financial statements for distribution as soon as possible, it may
take several months. Financial statements with a reporting date of 31 December 20.7
will typically be completed and approved for distribution on 28 February 20.8 or
31 March 20.8.
The records and financial statements in respect of the relevant reporting period are
completed during the period between the reporting date and the date of approval.
During this period, transactions in respect of the reporting period ended 31 December
20.7 will still be recognised (such as the bank charges for December 20.7). The
effective date of these transactions is however as at 31 December 20.7. However, the
assets, liabilities, income and expenses brought about by the transactions/events, had
to satisfy the definition and recognition criteria of the relevant elements on
31 December 20.7.
2
The retained earnings balance is indicated as 1 January 20.7, which means that the
income and expense accounts as well as the drawings account for 20.7 have not yet
been closed off against retained earnings.
3
The bank charges balance is indicated as 1 December 20.7, which means that the
expense for December 20.7 has not yet been recognised.
148
Example 5.4 Solution
a)
i) Source document(s)
Bank statement for December 20.7.
ii) Relevant items/accounts and
element(s)
Items and elements
Expense-item bank charges (increase) and asset-item
cash (decrease)
Accounts
Bank charges and Bank
iii) Date on which the transaction
must be recognised
31 December 20.7
Although the transaction will physically be journalised only
on 4 or 5 January 20.8, the effective date of the
journal/transaction must be 31 December 20.7, since this is
the date on which the cash outflow from AF Entity’s bank
account occurred. The payment is in respect of an expense
(bank charges) of which the accompanying economic
benefit, namely the use of a cheque account during
December 20.7, has already been utilised.
This cash expense is also recognised simultaneously with
the decrease in bank.
iv) Amount at which the
transaction should initially be
measured
R4 250
This amount represents the historical cost price of the
expense, namely the cash price.
The cash price is the amount at which cash in the bank
decreased according to the cheque account statement.
b) Journal entry
J1
20.7
31 Dec
Bank charges
Bank
Recognise bank charges for December 20.7
Nr
U15
A30
Dr
4 250
Cr
4 250
Assets
=
Liabilities
+
Equity
Classification
- 4 250
=
0
+
- 4 250
Retained earnings – Expense
(Bank charges)
149
c) Post journal entry to accounts
Dr
A30 Bank
Date
Contra account
Nr
20.7
31 Dec
Balance
bd
20.8
1 Jan
Balance
bd
Dr
Amount
Cr
Date
20.7
612 000 31 Dec
31 Dec
612 000
Contra account
Bank charges
Balance
Nr
Amount
J1
cf
4 250
607 750
612 000
607 750
U15 Bank charges
Date
20.7
1 Dec
31 Dec
Contra account
Balance
Bank
Nr
bd
J1
Amount
Date
Cr
Contra account
Nr
Amount
54 250
4 250
58 500
d) Presentation of the bank charges account
AF ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
R
Sales
Cost of sales
Gross profit
Other income
Rent expense
Salaries and wages
Insurance
Bank charges
Other administrative expenses
Profit for the year
xxx
(xxx)
xxx
xxx
(xxx)
(xxx)
(xxx)
(58 500)
(xxx)
xxx
Remark in respect of the presentation of bank charges
1
The balance of the bank charges account to the amount of R58 500 could also have
been presented as part of the line item “Other administrative expenses”.
150
Advances for smaller expenses and petrol cards
86
Internal control procedures require that all cash received by an entity be banked in total on a
daily basis and that, to the extent that it is practically executable, all payments occur per
cheque or per electronic bank transfer. The payment of smaller expenses usually occurs
either by means of the use of a cash advance system or by means of the use of a cash
card/debit card that is issued by a financial institution.
87
A cash advance system for smaller expenses is also traditionally referred to as petty cash.
The entity decides on the extent/limit of the advance, e.g. R5 000, which is placed under
control of an allocated employee. A cheque is issued to the relevant employee, who cashes
the cheque. The utilisation of the cash advance is limited by control procedures. For each
cash application an internal document is prepared and, where possible, supported by an
external document. The relevant employee keeps a record of the cash payments in an
appropriate format. At the end of each month, the advance is restored after a summary of
the expenses as well as the cash on hand have been reviewed by an appropriate person. If
the advance is depleted during a month, the advance is similarly restored.
88
Another approach which is increasingly used is a debit card on which the entity directly
deposits the advance as well as the replacement of the advance, electronically. The debit
card is assigned to a specific employee. The utilisation of the debit card is limited by means
of control procedures as well as by the fact that a cash withdrawal cannot be made with the
card. At the end of each month, the advance is restored after a summary of the expenses as
well as the cash available on the card have been reviewed by an appropriate person. If the
advance is depleted during a month, the advance is similarly restored. Within seven days
after the end of each month the financial institution sends a statement in respect of the debit
card to the entity’s accountant. This statement contains detail of the applications and
advance replacements. The statement is subsequently compared with the cardholder’s
summary.
89
With reference to the purchase of fuel for an entity’s delivery vehicles, the entity’s bank
issues a petrol/garage card to each of the entity’s drivers. This card can only be used for fuel
and oil purchases. A garage card is linked directly to an entity’s cheque account. The
purchased fuel is paid for at the point of sale by means of swiping/verifying the card through
a speed point, where after the amount is entered. The speed point produces a sales slip as
well as a duplicate on which the litres of fuel and the cost appears and on which the sales
person also records the vehicle’s registration number. The one slip is signed by the driver
and handed over to the sales person whilst the other slip is taken by the driver to
subsequently give it to the appropriate person in the payables department of the entity. As
soon as the sale is accepted by the speed point, the amount is recovered from the entity’s
cheque account. Every month the bank sends a garage card statement in respect of each
garage card to the entity’s accountant, where after it is forwarded to the appropriate person
in the payables department to thereby verify the purchases against the slips.
151
Example 5.5 Cash advances for incurring smaller administrative expenses as well as the
use of a garage card
On 1 December 20.7 the following balances, amongst others, appeared in the records of
AC Entity:
Nr
A30
A30.1
A30.2
U3
U7
U9
U19.1
Bank
Cash advance
Debit card advance
Salaries and wages
Office supplies
Fuel and maintenance
Administrative expenses
Dr
312 000
2 000
5 000
3 105 210
28 472
16 390
33 115
Cr
On 31 December 20.7 the cash advance was restored by supplying the cash advance cashier with
a cheque for R1 424. The advance was restored based on the following enumerative schedule,
which was prepared by the cashier:
20.7
4 Dec
17 Dec
28 Dec
Evidence nr.
47
48
49
Amount
620
204
600
1 424
Acc nr U3
Acc nr U7
Acc nr U19.1
620
204
600
600
204
620
On 31 December 20.7 the debit card advance was restored by depositing R2 270 into the debit
card by means of an EFT. The advance was restored based on the following enumerative
schedule, which was prepared by the cashier:
20.7
4 Dec
17 Dec
Evidence nr.
104
105
Amount
1 866
404
2 270
Acc nr U7
1 866
1 866
Acc nr U19.1
404
404
The bank statement for December 20.7, which was received on 4 January 20.8, indicates that the
entity’s garage card was used on 2 December 20.7 for the purchase of fuel to the amount of R480
and on 17 December 20.7 for the purchase of fuel to the amount of R530.
Required:
Provide journal entries to recognise the abovementioned transactions in the records (general
journal) of AC Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transactions on the accounting equation are
required.
Remark in respect of the set of facts of Example 5.5
1
For practical educational reasons, the number of times that the cash advance and the
debit card were utilised is limited.
152
2
The account numbers are obtained from the list of accounts in Chapter 4.
Example 5.5 Solution
Journal entries
J1
20.7
31 Dec
Salaries and wages
Office supplies
Administrative expenses
Cash advance
Recognise the utilisation of the cash advance for
December 20.7. Refer to the cash advance summary
for December 20.7.
Nr
U3
U7
U19
A30.1
Dr
Cr
600
204
620
1 424
Assets
=
Liabilities
+
Equity
Classification
- 1 424
=
0
+
- 1 424
Retained earnings – Expense
(Various, as above)
20.7
31 Dec
Cash advance
Bank
Recognise the cash advance paid to petty cash for
December 20.7.
Assets
=
Liabilities
+
Equity
+ 1 424
=
0
+
0
Nr
A30.1
A30
Dr
1 424
Cr
1 424
Classification
- 1 424
J2
20.7
Nr
31 Dec Office supplies
U7
Administrative expenses
U19
Debit card advance
A30.2
Recognise the utilisation of the debit card advance for
December 20.7. Refer to the debit card advance
summary for December 20.7.
153
Dr
1 866
404
Cr
2 270
Assets
=
Liabilities
+
Equity
Classification
- 2 270
=
0
+
- 2 270
Retained earnings – Expense
(Various, as above)
20.7
31 Dec
Debit card advance
Bank
Recognise the debit card advance paid to debit card
for December 20.7.
Assets
=
Liabilities
+
Equity
+ 2 270
=
0
+
0
Nr
A30.2
A30
Dr
2 270
Cr
2 270
Classification
- 2 270
J3
20.7
31 Dec
Fuel and maintenance
Bank
Recognise the purchase of fuel using the petrol
card for December 20.7.
Nr
U9
A30
Dr
1 010
Cr
1 010
Assets
=
Liabilities
+
Equity
Classification
- 1 010
=
0
+
- 1 010
Retained earnings – Expense
(Fuel and maintenance)
Remarks
1
The cash advance balance of R2 000, and the debit card advance balance of R5 000
on 31 December 20.7 are added to the bank balance on this date and are presented
as the line item cash and cash equivalents under the heading “Current assets” on the
statement of financial position at 31 December 20.7.
2
With the initial transfer of funds to the respective advance accounts, the bank account
is credited and the cash advance and debit card advance accounts are respectively
debited.
3
Although the items satisfy the definition and recognition criteria of an expense on 4, 17
and 28 December 20.7 respectively and should strictly speaking be recognised on
these dates, the date of the journal is the date on which the advance is restored. This
is done in order to simplify the administration process.
154
Expenses incurred on credit
90
In this section, the application of concepts, principles and rules in respect of the incurrence
of expenses on credit is dealt with.
91
Expenses are incurred during the execution of the entity’s operating activities in order to
generate income and include, amongst others, rent expense, insurance, water and
electricity, telephone expense and salaries. As already known, the non-cash purchase of
goods and services is one of the distinctive characteristics of the modern economy. Payment
in respect of the purchased product or service does therefore not take place with delivery of
the product or service since there is a credit term that can first elapse before payment has to
occur. Credit terms can be 30 days or 60 days or sometimes even 90 days. This concession
by suppliers to customers is referred to as trade credit and during this credit term no interest
is charged.
92
In accordance with accrual accounting, the incurrence of an expense on credit and the
subsequent settlement of the obligation are separate transactions.
93
Examples of expenses that are usually incurred on credit are the purchase of water and
electricity, office supplies, telephone services and the maintenance of a vehicle.
The transaction: Water and electricity purchased on credit
94
This transaction entails that an expense is incurred on credit.
95
An example of such a transaction is as follows:
On 4 July 20.7, AC Entity electronically received a statement for June 20.7 from the local
authority, Payable Jozi, in respect of the water and electricity utilised during June 20.7. The
amount due is R22 224 and is payable before 24 July 20.7.
Note: Only the expense is dealt with in this example.
Source documents
96
The following source documents are applicable in respect of the incurrence of an expense
on credit:
•
In the case of the utilisation of water and electricity – the statement from the local
authority, Payable Jozi;
•
In the case of the utilisation of telephone services – the statement from the local
telephone service provider, Payable Telkom;
•
In the case of office supplies purchased on credit – the order, the invoice and the
goods received note (issued by AC Entity); and
•
In the case of the incurrence of maintenance or repairs on credit – the order and the
invoice that is signed as an indication that the maintenance or repairs were performed
satisfactorily.
Recognition of the transaction
Items/accounts and elements
97 When water and electricity is incurred on credit, the two items brought about by the
transaction are the expense-item water and electricity (increase) and the liabilities-item
Payable Jozi (increase). The accounts involved are therefore “Water and electricity” and
“Payable Jozi”. This transaction affects the element expenses and the element liabilities. (As
set out in Chapter 2 Example 2.2 (c)(ii) and (c)(iii), the item Payable Jozi and the item water
and electricity satisfy the definition and recognition criteria of a liability and an expense
respectively.)
155
Date and amount of initial recognition
98 An item that satisfies the definition of an expense is recognised when a decrease in future
economic benefits, associated with a decrease that occurred in an asset or an increase that
occurred in a liability, can be measured reliably. An expense that is incurred on credit is
therefore recognised simultaneously with the increase in the associated liabilities-item
(Payable Jozi in this example). The increase in the liabilities-item is recognised on the date
on which the item satisfies the definition and recognition criteria of a liability.
99
On 4 July 20.7, AC Entity received a statement (as at 30 June 20.7) from Payable Jozi in
respect of water and electricity utilised by AC Entity during June 20.7. On 30 June 20.7 a
legal obligation arose towards Payable Jozi and on this date Payable Jozi satisfied the
definition and recognition criteria of a liability. The expense-item water and electricity is
consequently recognised simultaneously with the increase in the liabilities-item Payable Jozi,
thus on 30 June 20.7.
100 The amount at which the increase in the liabilities-item Payable Jozi should initially be
measured and recognised, is the historical cost price thereof, namely the cost of the water
and electricity to the amount of R22 224 utilised during June 20.7 as per the statement. The
increase in the expense-item water and electricity is measured and recognised at the same
amount on 30 June 20.7.
Double entry rules
101 Since the increase in the expense-item water and electricity to the amount of R22 224 (which
causes a decrease in retained earnings/equity) and the accompanying increase in the
liabilities-item Payable Jozi to the amount of R22 224 satisfied the definition and recognition
criteria of an expense and a liability respectively on 30 June 20.7, the items have to be
recognised in the records of AC Entity on 30 June 20.7 in accordance with the double entry
system.
102 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
103 The double entry rules in respect of an expense (such as water and electricity) that is
incurred on credit are as follows:
Debit Water and electricity – that is the expense-item/account that increases
Credit Payable Jozi – that is the liabilities-item/account that increases
and is supported by the following journal:
20.7
30 June
Dr
22 224
Water and electricity
Payable Jozi
Cr
22 224
Assets
=
Liabilities
+
Equity
Classification
0
=
+22 224
+
- 22 224
Retained earnings – Expense
(Water and electricity)
Remarks in respect of the journal
1
In accordance with accrual accounting the recognition of the expense and the
accompanying obligation (as reflected in this journal) is a separate transaction from the
settlement of the obligation. When the amount due to the payable is subsequently paid,
the payable’s account is debited and the bank account is credited.
156
Example 5.6 Expenses incurred on credit: office supplies, telephone as well as water and
electricity
AF Entity’s current reporting date is 31 December 20.7. On 1 December 20.7 the following
balances, amongst others, appeared in the records of the entity:
Acc
Bank
Furniture and equipment
Trade inventories
Receivable D
Capital
Retained earnings – 1 Jan 20.7
Payable O
Payable Jozi
Payable Telkom
Water and electricity
Telephone and communication
Office supplies
A30
A5.1
A20
D4
E1
E2.1
K5
K7
K10
U4
U6
U7
Dr
Cr
702 000
325 000
445 000
405 000
4 000 000
1 805 000
18 400
36 800
11 600
407 400
134 700
460 900
The following transactions that were incurred during December 20.7, are applicable:
1
On 9 December 20.7, stationery and other office supplies, together with an invoice for
R12 600 which is payable before 12 January 20.8, were delivered by Payable O to the
premises of AF Entity. These items were ordered by AF Entity on 28 November 20.7.
2
On 14 December 20.7, AF Entity pays an amount of R18 400 to Payable O and an amount
of R11 600 to Payable Telkom by means of electronic funds transfers.
3
On 28 December 20.7, AF Entity pays an amount of R36 800 to Payable Jozi by means of
an electronic funds transfer.
4
On 30 December 20.7, AF Entity electronically receives the following statements dated
30 December 20.7, for the month of December 20.7 from:
•
Payable Jozi for R37 200 in respect of the water and electricity utilised in December
20.7. This amount is payable on or before 28 January 20.8; and
•
Payable Telkom for R12 300 in respect of the telephone usage in December 20.7. This
amount is payable on or before 14 January 20.8.
157
Required:
a)
Identify the following in respect of transactions 1 and 4:
i)
the relevant source document(s);
ii)
the relevant items/accounts and element(s);
Note:It is not required in this subsection to indicate why the items satisfy the definition
of the relevant element.
b)
iii)
the date on which recognition must occur and motivate briefly why the specific date
was identified; and
iv)
the amount at which initial measurement must occur and motivate briefly why this
amount was identified.
Provide journal entries to recognise all the abovementioned transactions in the records
(general journal) of AF Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transactions on the accounting equation
are required.
c)
Open the three expense accounts, the bank account and the payables’ accounts, with the
balances as at 1 December 20.7, post the journal entries to the accounts and, where
applicable, balance the accounts.
d)
Present the balances of the three expense accounts in the statement of profit or loss of
AF Entity for the reporting period ended 31 December 20.7.
e)
Although expenses incurred decrease retained earnings, the retained earnings account is
not debited during the reporting period, but instead the relevant expense accounts are
debited. Explain why detail of expenses is accumulated in appropriate expense accounts in
this way.
Example 5.6 Solution
a)
Transaction 1
Office supplies purchased on
credit
Transaction 4(i)
Water and electricity expense
incurred on credit
Transaction 4(ii)
Telephone expense incurred
on credit
i) Source documents
•
Requisition.
•
Authorised order.
•
Invoice from Payable O.
•
Delivery note from
Payable O.
•
Goods received note
issued by AF Entity’s
goods received
department.
•
Statement for December
20.7 from Payable Jozi.
158
•
Statement for December
20.7 from Payable Telkom.
Transaction 1
Office supplies purchased on
credit
Transaction 4(i)
Water and electricity expense
incurred on credit
Transaction 4(ii)
Telephone expense incurred
on credit
ii) Items/accounts and element(s) involved
Items and elements
Expense-item office supplies
(increase) and liabilities-item
Payable O (increase)
Items and elements
Expense-item water and
electricity (increase) and
liabilities-item Payable Jozi
(increase)
Items and elements
Expense-item telephone
(increase) and liabilities-item
Payable Telkom (increase)
Accounts
Accounts
Accounts
Office supplies and Payable O
Water and electricity and
Payable Jozi
Telephone and
Payable Telkom
9 December 20.7
30 December 20.7
30 December 20.7
This date represents the date
on which the legal obligation
towards Payable O arose. An
expense incurred on credit is
recognised simultaneously
with the increase in the
accompanying liability.
This date represents the date
on which the legal obligation
towards Payable Jozi arose.
An expense incurred on credit
is recognised simultaneously
with the increase in the
accompanying liability.
This date represents the date
on which the legal obligation
towards Payable Telkom
arose. An expense incurred on
credit is recognised
simultaneously with the
increase in the accompanying
liability.
iii) Date of recognition
iv) Amount at which the expense should initially be recognised
R12 600
R37 200
R12 300
This amount represents the
historical cost price of the
expense, namely the cash
price (invoice price), which is
also the amount with which
Payable O increases.
This amount represents the
historical cost price of the
expense, namely the cash
price (amount as reflected on
the statement), which is also
the amount with which
Payable Jozi increases.
This amount represents the
historical cost price of the
expense, namely the cash
price (amount as reflected on
the statement), which is also
the amount with which
Payable Telkom increases.
b) Journal entries
J1
20.7
9 Dec
Office supplies
Payable O
Recognise stationery and other office supplies
purchased on credit per invoice O131 and received
(GRN 222)
Nr
U7
K5
Dr
12 600
Cr
12 600
Assets
=
Liabilities
+
Equity
Classification
0
=
+12 600
+
- 12 600
Retained earnings – Expense
(Office supplies)
159
J2
20.7
14 Dec
Payable O
Payable Telkom
Bank
Derecognise payables due to settlement of debt (refer
EFT 111)
Assets
=
Liabilities
+
Equity
- 30 000
=
- 30 000
+
0
J3
20.7
28 Dec
Payable Jozi
Bank
Derecognise payable Jozi due to settlement (EFT 112)
Assets
=
Liabilities
+
Equity
- 36 800
=
- 36 800
+
0
J4
20.7
30 Dec
Water and electricity
Payable Jozi
Recognise water and electricity expense for Dec 20.7
Nr
K5
K10
A30
Dr
18 400
11 600
Cr
30 000
Classification
Nr
K7
A30
Dr
36 800
Cr
36 800
Classification
Nr
U4
K7
Dr
37 200
Cr
37 200
Assets
=
Liabilities
+
Equity
Classification
0
=
+37 200
+
- 37 200
Retained earnings – Expense
(Water and electricity)
J5
20.7
30 Dec
Telephone and communication
Payable Telkom
Recognise telephone expense for December 20.7
Nr
U6
K10
Dr
12 300
Cr
12 300
Assets
=
Liabilities
+
Equity
Classification
0
=
+12 300
+
- 12 300
Retained earnings – Expense
(Telephone)
160
c) Post journal entries to accounts
Dr
Date
A30 Bank
Contra account
Nr
20.7
1 Dec
Balance
bd
20.8
1 Jan
Balance
bd
Dr
Date
20.7
14 Dec
31 Dec
20.7
28 Dec
31 Dec
Bank
Balance
Nr
J2
cf
20.7
14 Dec
31 Dec
Bank
Balance
Nr
J3
cf
20.7
1 Dec
30 Dec
Payable O
Payable Telkom
Payable Jozi
Balance
Nr
J2
J2
J3
cf
Bank
Balance
Nr
J2
cf
Amount
Balance
Payable Jozi
Nr
bd
J4
18 400
11 600
36 800
635 200
702 000
Cr
Date
20.7
18 400 1 Dec
12 600 9 Dec
31 000
20.8
1 Jan
Contra account
Nr
Amount
bd
J1
18 400
12 600
31 000
Balance
bd
12 600
Date
Cr
Contra account
20.7
36 800 1 Dec Balance
37 200 30 Dec Water and electricity
74 000
20.8
1 Jan
Balance
Amount
Date
Nr
Date
407 400
37 200
444 600
161
Amount
bd
J4
36 800
37 200
74 000
bd
37 200
Cr
Contra account
20.7
11 600 1 Dec Balance
12 300 30 Dec Telephone
23 900
20.8
1 Jan
Balance
Amount
Amount
Balance
Office supplies
Nr
Amount
bd
J5
11 600
12 300
23 900
bd
12 300
U4 Water and electricity
Contra account
Amount
635 200
K10 Payable Telkom
Contra account
Dr
Date
20.7
702 000 14 Dec
14 Dec
28 Dec
31 Dec
702 000
Contra account
K7 Payable Jozi
Contra account
Dr
Date
Cr
Date
K5 Payable O
Contra account
Dr
Date
Amount
Cr
Contra account
Nr
Amount
Dr
Date
20.7
1 Dec
30 Dec
U6 Telephone and communication
Contra account
Nr
Balance
Payable Telkom
bd
J5
Contra account
Nr
Dr
Date
20.7
1 Dec
9 Dec
Amount
Date
Cr
Contra account
Nr
Amount
Contra account
Nr
Amount
134 700
12 300
147 000
U7 Office supplies
Balance
Payable O
bd
J1
Amount
Date
Cr
460 900
12 600
473 500
d) Presentation of the expense accounts’ balances
AF ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
R
Sales
Cost of sales
Gross profit
Other income
Salaries and wages
Water and electricity
Telephone and communication
Office supplies
Profit for the year
xxx
(xxx)
xxx
xxx
(xxx)
(444 600)
(147 000)
(473 500)
xxx
e) Why expenses are accumulated in temporary accounts during the reporting period
An expense results in a decrease in retained earnings and should consequently be debited against
the retained earnings account.
However, if all expenses are debited against the retained earnings account during the reporting
period, useful information is lost. It would for instance not have been known what the telephone
expense was from 1 January 20.7 to 30 November 20.7 or to 31 December 20.7 if the telephone
expense was debited directly to retained earnings. To prepare the statement of profit or loss, it
would therefore have been necessary to analyse expenses debited against the retained earnings
account and to summarise and tabulate these per expense.
The accounting practice consequently developed to accumulate expenses during the reporting
period in appropriate expense accounts. The expense accounts are closed off to the retained
earnings account only on the reporting date by debiting the retained earnings account and
crediting the respective expense accounts with the balance on the expense account as at the
reporting date. The closing off procedures are dealt with in Chapter 7.
162
Employee benefits expense
104 The employee benefits expense is usually, besides cost of sales, the biggest expense item
of an entity. Employee benefits comprise of salaries and other cash benefits, such as inter
alia a housing allowance, but also the employer’s contributions to the employee’s medical
aid fund premiums and the employer’s contributions to a retirement or pension fund for the
employees. Leave in various forms is also part of employee benefits, e.g. holiday leave and
compassionate leave. Holiday leave can usually not be accumulated.
105 Entities in South Africa also act as agents for SARS (South African Revenue Services). In
accordance with progressive taxation scales, entities recover on a monthly basis income tax
from employees’ remuneration and then pay it over to SARS before the 7th day of the
following month. This system is known as the Pay As You Earn (PAYE) system and has
developed into a very effective system in South Africa. Income tax on individuals is a topic
that is dealt with in the subject field Taxation.
106 There are entities that, as part of their social responsibility, contribute to their employees’
medical aid fund premiums and retirement funding.
107 Entities mostly use a ‘total cost’ approach when they structure their employees’ remuneration
packages. In accordance with the total cost approach employees can, within certain limits,
decide on the composition of their remuneration. For example, a pensionable salary may not
be more than a maximum of 80% of the total remuneration.
108 An example of a permanent employee’s monthly salary slip/payslip can therefore be as
follows:
EMPLOYEE A
Gross remuneration
Pensionable salary
Non-pensionable allowance
Deductions
16 000 Medical aid fund
4 500
800 Pension fund
2 400
Employer contributions
Taxation
4 600
Pension fund
1 200 Total deductions
11 500
Medical aid fund
2 000
Gross remuneration
20 000 Net remuneration
8 500
Remarks in respect of the salary slip
1
The salary expense for the entity in respect of the relevant employee is R20 000, which
is also the gross remuneration of the employee.
2
The gross remuneration comprises a cash remuneration of R16 800 (R16 000 + R800)
as well as employer contributions of R3 200 (R1 200 + R2 000).
163
Remarks in respect of the salary slip (continue)
3
The employer pays the following deductions over to the relevant institutions, to the
benefit of the employee:
•
R4 500 is paid to the employee’s medical aid fund. (R2 000 comes from the
employer’s contribution and R2 500 comes from the employee’s cash
remuneration.)
•
R2 400 is paid to the employee’s pension fund. (R1 200 comes from the
employer’s contribution and the other R1 200 comes from the employee’s cash
remuneration.)
•
R4 600 is paid to SARS and comes from the employee’s cash remuneration.
4
The net remuneration (R8 500) is paid into the employee’s bank account.
5
The net remuneration is usually paid into the employees’ bank accounts during the last
week of the relevant month and the deductions are paid before the seventh day of the
following month.
109 Remuneration is a confidential matter between the employee and the employer and forms
part of the written employment contract. Entities use a separate subsystem to administrate
the remuneration of employees. This includes that employees are paid by means of
electronic bank transfers.
110 The salary subsystem provides a payroll that is used to recognise the components of
remuneration as well as the transfer/payment of deductions in the entity’s accounts.
111 Distinction is made between temporary employees and permanent employees. Temporary
employees are appointed for a few days or weeks. Permanent employees are usually
appointed up to the age of 60 to 65 years.
112 Temporary employees’ gross and net remuneration is the same amount and is usually paid
by means of an EFT. In exceptional circumstances, temporary employees are paid out of the
cash advance.
113 With reference to the remarks in respect of the salary slip above, it is clear that the salary
expense for permanent employees is recorded in accordance with accrual accounting.
Employee benefits expense is in the case of permanent employees an example of an
expense that arises due to an asset that decreases and due to liabilities that increase.
Subsequently the employee benefits of permanent employees are dealt with. For practical
educational reasons the employee benefits expense was, up to this stage, dealt with outside
the framework of a salary system.
114 On the pay day, a portion of the employee benefits expense (the net remuneration) is paid
into the respective employees’ bank accounts. In accordance with the employment contract
with each permanent employee a portion of the employees’ gross remuneration (medical aid
fund contribution and pension fund contribution) is retained to pay it over to the relevant
institution before the seventh day of the following month on behalf of and to the benefit of the
employees. In accordance with the PAYE system of the Income tax act, an appropriate
portion of the employees’ gross remuneration is retained to pay it over to SARS before the
seventh day of the following month on behalf of the employees. The deferment of the
payments until the first week of the coming month provides the entity with the necessary time
for verification purposes. Pension funds and SARS charge interest on any late payments
(payments that occur after the seventh day of the month in which it is due) that must be paid
by the employer.
164
The transaction: Employee benefits expense incurred and paid
115 This transaction entails that an expense is partially incurred in cash and partially incurred on
credit.
116 An example of such a transaction is as follows:
The table below represents a summary of the payroll of AC Entity for January 20.7.
R
Gross remuneration
Pensionable salary
Non-pensionable allowance
Employer contributions
Pension fund
Medical aid fund
Gross remuneration
R
Deductions
960 000 Medical aid fund
48 000 Pension fund
Taxation
72 000 Total deductions
120 000
1 200 000 Net remuneration
270 000
144 000
276 000
690 000
510 000
On 30 January 20.7, AC Entity paid a total amount of R510 000 in respect of net salaries of
individual employees by means of EFT’s. The deductions are payable on or before 7 February
20.7.
Source documents
117 The following source document is applicable in respect of the incurrence of employee
benefits expense:
•
An appropriately authorised payroll/salaries schedule.
Recognition of the transaction
Items/accounts and elements
118 When an employee benefits expense is incurred, the items brought about by the transaction
are the expense-item employee benefits (increase), the asset-item cash (decrease) and the
liabilities-items payables (increase). The accounts involved are therefore “Employee benefits
expense”, “Bank” and the accounts for each of the payroll creditors, namely “Medical aid
fund”, “Pension fund” and “SARS – PAYE”. This transaction affects the element expenses,
the element assets as well as the element liabilities. (As set out in Annexure 3, the item
employee benefits satisfy the definition of an expense and the items payroll creditors satisfy
the definition and recognition criteria of a liability.)
Date and amount of initial recognition
119 An item that satisfies the definition of an expense is recognised when a decrease in future
economic benefits, associated with a decrease that occurred in an asset or an increase that
occurred in a liability, can be measured reliably.
120 A portion of the employee benefits expense that is incurred in cash (the net remuneration of
R510 000) is therefore recognised simultaneously with the decrease in the associated assetitem cash. The decrease in the asset-item cash is recognised on 30 January 20.7, the date
of payment. The portion of the employee benefits expense that is incurred on credit (the
deductions of R690 000) is therefore recognised simultaneously with the increase in the
liabilities-items payroll creditors. The increase in the payroll creditors is recognised on
30 January 20.7. This is the date on which the creditors satisfied the definition and
recognition criteria of a liability since a legal obligation towards these creditors arose on this
date.
165
121 The amount at which the increase in the employee benefits expense should be measured
and recognised, is the historical cost price thereof, namely the total of the gross
remuneration column of the salaries schedule. This amount is determined with reference to
the employees’ employment contracts. The decrease in the asset-item cash as well as the
increase in the liabilities-items payroll creditors can be measured reliably at the historical
cost price thereof, namely the amount with which cash in the bank decreases and the
amount with which the creditors increase, as indicated on the salaries schedule on
30 January 20.7.
Double entry rules
122 Since the increase in the expense-item employee benefits to the amount of R1 200 000
(which causes in a decrease in retained earnings /equity) and the accompanying increase in
the liabilities-items payroll creditors to the amount of R690 000 satisfied the definition and
recognition criteria of an expense and a liability respectively on 30 January 20.7, and the
accompanying decrease in the asset-item cash to the amount of R510 000 occurred on the
same date and could be measured reliably, the items have to be recognised in the records of
AC Entity on 30 January 20.7 in accordance with the double entry system.
123 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
124 The double entry rules in respect of an expense (such as employee benefits) that is incurred
in cash and on credit are as follows:
Debit Employee benefits – that is the expense-item/account that increases
Credit Bank – that is the asset-item/account that decreases
Credit Payroll creditors (namely medical aid fund, pension fund and SARS – PAYE) – that is
the liabilities-items/accounts that increase
and is supported by the following journal:
20.7
30 Jan
Employee benefits (gross remuneration)
Bank (net remuneration)
Medical aid fund (appropriate amount)
Pension fund (appropriate amount)
SARS – PAYE (appropriate amount)
Dr
1 200 000
Cr
510 000
270 000
144 000
276 000
Assets
=
Liabilities
+
Equity
Classification
- 510 000
=
+690 000
+
- 1 200 000
Retained earnings – Expense
(Employee benefits)
166
Example 5.7 Recognition of the payroll
The following payroll of AS Entity for December 20.7 is produced by the salaries system.
AS ENTITY
PAYROLL FOR DECEMBER 20.7
EMPLOYEE
CASH REMUNERATION
Basic
Subtotal
Travel
NPA
allowance
EMPLOYER-
GROSS
remuneration
Medical Pension
DEDUCTIONS
Subtotal
CONTRIBUTIONS
PAYE
Medical Pension
NET
A
27 000
3 000
0
30 000
2 000
2 025
34 025 11 400
4 500
4 050 19 950
14 075
B
23 000
2 000
0
25 000
1 500
1 725
28 225
9 000
3 000
3 450 15 450
12 775
C
10 000
0 2 000
12 000
0
750
12 750
2 400
0
1 500
3 900
8 850
D
18 000
0
0
18 000
1 500
1 350
20 850
5 400
3 000
2 700 11 100
9 750
E
25 000
2 000
0
27 000
2 000
1 875
30 875 10 260
4 200
3 750 18 210
12 665
7 000 2 000 112 000
7 000
7 725
126 725 38 460 14 700
15 450 68 610
58 115
103 000
AS Entity’s pay day is 23 December 20.7 and the deductions were paid to the respective
institutions on 6 January 20.8.
Required:
a)
Provide a journal entry to recognise the abovementioned payroll for December 20.7 in the
records (general journal) of AS Entity.
b)
Provide a journal entry to recognise the settlement of the payroll creditors on 6 January 20.8
in the records (general journal) of AS Entity.
Example 5.7 Solution
a) Journal entry – recognise payroll for December 20.7
J1
20.7
23 Dec Employee benefits
Bank
Medical aid fund
Pension fund
SARS – PAYE
Recognise payroll for December 20.7
Nr
U3
A30
L11.7
L11.6
L11.5
Dr
126 725
Cr
58 115
14 700
15 450
38 460
Assets
=
Liabilities
+
Equity
Classification
- 58 115
=
+68 610
+
- 126 725
Retained earnings – Expense
(Employee benefits)
167
b) Journal entry – derecognise December 20.7 payroll creditors
J1
20.8
6 Jan
Medical aid fund
Pension fund
SARS – PAYE
Bank
Derecognise December 20.7 payroll payables due to
settlement
Assets
=
Liabilities
+
Equity
- 68 610
=
- 68 610
+
0
Nr
L11.7
L11.6
L11.5
A30
Dr
14 700
15 450
38 460
Cr
68 610
Classification
Expenses resulting from the subsequent measurement of assets
Origin of such expenses
125 In Accounting, distinction is made between transactions and events.
126 Up to now, the following expenses have been dealt with in this chapter: cash expenses
(paragraphs 69 to 89), credit expenses (paragraphs 90 to 103) as well as expenses incurred
partially in cash and partially on credit (paragraphs 104 to 124). Cash expenses as well as
credit expenses originate from transactions that the entity concludes with other entities and
individuals (third parties). Transactions with other entities and individuals always take on the
form of a contract between the parties, for example purchase contracts, service delivery
contracts, lease agreements, insurance contracts and employment contracts. Such
transactions always entail the exchange of goods or services at an agreed price. The agreed
price is either immediately payable or the payment is deferred to a later date due to the
utilisation of trade credit. The transactions dealt with up to now, could be typified as routine
transactions.
127 Apart from transactions, there are events that an entity accumulates in the accounting
records, in the same manner as transactions. These events do not entail an exchange of
goods or services for cash, but are mostly internal events. Internal events relate to the
process which is known in Accounting as subsequent measurement of assets and liabilities
and result in the recording of inter alia depreciation, bad debts and finance costs.
Consequently there is a third type of expense (other than cash and credit expenses), namely
expenses that originate due to the decrease in an asset, other than cash in the bank.
128 For purposes of presentation in the financial statements, assets are classified as current
assets and non-current assets. As already mentioned, non-current assets basically create
the capacity to execute operating activities, whilst current assets relate more to the operating
activities as such. Refer to the statement of financial position in Chapter 3.
168
129 However, for purposes of subsequent measurement, assets are furthermore classified as
financial and non-financial assets. A financial asset is an asset in respect of which a cash
amount will be received in terms of a contract. Financial assets originate from a contract
between two parties which is such that a financial asset arises in the one party’s records and
a financial liability arises in the other party’s records. (IAS 32.11) A financial liability is a
liability in respect of which a cash amount will be paid in terms of a contract. Examples of
such contracts are:
•
A contract for the sale/purchase of trade inventories on credit. A trade receivable
(financial asset) arises in the selling entity’s records and a trade payable (financial
liability) arises in the purchasing entity’s records. In Chapter 9 further attention is paid
to receivables and payables.
•
A term deposit agreement in accordance with which an entity invests an amount on a
term deposit at a bank. A term deposit (financial asset) arises in the depositor’s
records and an obligation (financial liability) arises in the bank’s records.
•
A contract between an entity and its bank in accordance with which the entity opens a
bank account at the bank. An asset bank (financial asset) arises in the entity’s records
(a favourable bank balance basically represents a loan to the bank with a varying
balance) and an obligation (financial liability) arises in the bank’s records.
Examples of non-financial assets are property, plant, equipment and trade inventories.
Initial measurement and subsequent measurement of assets
130 Most assets are, with the recognition thereof, initially measured at the historical cost price of
the asset. The initial measurement of an asset therefore occurs at the historical cost price.
On each reporting date, most assets have to be measured again. This measurement on
each reporting date is known as subsequent measurement.
131 Subsequent measurement in respect of non-financial assets, such as depreciable noncurrent assets (e.g. buildings, machinery and vehicles), occurs at depreciated cost, that is
the cost price of the depreciable non-current asset less the accumulated depreciation on the
depreciable non-current asset. Consequently, a depreciation expense arises.
132 Subsequent measurement in respect of financial assets, such as trade receivables and term
deposits, occurs at the amount that will probably be received. Consequently, a bad debts
expense arises in respect of trade receivables.
133 Subsequently, attention will be given on an introductory basis to the expenses depreciation
and bad debts. These expenses will be dealt with more comprehensively in Chapters 9 and
12.
Depreciation expense
Nature of the depreciation expense
134 As already known, the non-current assets of an entity (e.g. land, buildings, machinery,
equipment and vehicles) create the physical capacity to carry out operating activities. The
economic benefits included in non-current assets are utilised by the entity as the entity uses
the assets. Non-current assets, with the exception of land, therefore have a limited useful
life (life-span). Non-current assets with a limited useful life are known as depreciable noncurrent assets.
169
135 Up to now the utilisation of non-current assets by the entity has not been recognised in this
work. The correct way is to recognise a portion of the cost of each depreciable non-current
asset (therefore excluding land) over the useful life of the asset, as an expense during each
reporting period. This expense is referred to as depreciation and arises from the subsequent
measurement of depreciable non-current assets.
136 In Accounting the concept depreciation does not mean a depreciation in value, but the
allotment of a portion of the cost price of a depreciable non-current asset to an expense
named depreciation. Historically, there was however an era in Accounting where the
depreciation expense was indeed seen as a depreciation in the value of the relevant asset.
137 Depreciable non-current assets are, with the recognition thereof, initially measured and
therefore recognised at the historical cost price of the assets. The subsequent measurement
of depreciable non-current assets occurs on each reporting date at the depreciated cost
thereof. Depreciated cost of a depreciable non-current asset is the historical cost, as initially
recognised, less the accumulated depreciation, as recognised up to the current reporting
date.
Depreciation methods
138 There are various methods whereby the historical cost of a depreciable non-current asset
can be allocated to the depreciation expense, namely the straight-line method, the
diminishing balance method and a method which is based on the usage of the asset, for
example the units of production method. Initially only the straight-line method will be dealt
with.
139 In accordance with the straight-line method, the historical cost price of a depreciable noncurrent asset is apportioned/allocated in equal amounts (straight-line) as an expense over
the useful life of the asset. For example, the cost of a vehicle with a cost price of R250 000
and an estimated useful life of 5 years, is allotted as an expense at R50 000 (R250 000 ÷ 5)
per year. Depreciation is calculated separately for each class of depreciable non-current
assets, since the estimated useful life per class can differ considerably. The estimated useful
life of buildings can for instance be 20 years, the estimated useful life of furniture and
equipment
10 years and the estimated useful life of vehicles, 5 years.
140 Subsequently the application of concepts, principles and rules in respect of the depreciation
expense is dealt with.
The event: Allotment of a portion of the cost price of equipment to the depreciation
expense
141 The event entails that a portion of the cost of a depreciable non-current asset be allotted to
the depreciation expense.
142 An example of such an event is as follows:
On 2 January 20.7, AC Entity commenced with operating activities. On 2 January 20.7,
equipment that were purchased by AC Entity for R600 000 were received and put into
service. This transaction has already been correctly recognised in AC Entity’s accounting
records. On 31 December 20.7, the depreciation expense for 20.7 to the amount of R60 000
still has to be recognised in respect of equipment.
170
Source documents
143 The following source document is applicable in respect of the allotment of a depreciation
expense:
•
An appropriately authorised depreciation schedule.
Recognition of the event
Items/accounts and elements
144 When depreciation on equipment is recognised, the two items brought about by the event
are the expense-item depreciation on equipment (increase) and the asset-item equipment
(decrease). Refer to the paragraph directly below. The accounts involved are therefore
“Depreciation – equipment” and “Accumulated depreciation – equipment”. This event affects
the element expenses and the element assets. (As set out in Annexure 3, the expense-item
depreciation satisfies the definition of an expense.)
145 It is general accounting practice that the depreciable non-current asset account is not directly
credited. For each depreciable non-current asset account an accompanying accumulated
depreciation account is opened. For example, for equipment an account named accumulated
depreciation – equipment is opened. The accumulated depreciation account (for a specific
class of depreciable non-current assets) is part of the credit side of the specific non-current
asset account. This conduct ensures that the information in respect of the cost price of the
depreciable non-current assets remains intact and can therefore be disclosed. Disclose
means that information is provided in a note to the statement of financial position.
Depreciable non-current assets are dealt with comprehensively in Chapters 12 and 16.
146 The item accumulated depreciation therefore belongs to the element assets.
Date and amount of initial recognition
147 The increase in the expense-item depreciation on equipment, which satisfies the definition of
an expense, is recognised when a decrease in future economic benefits, associated with a
decrease in an asset (equipment in this example), can be measured reliably. The expenseitem depreciation on equipment is therefore recognised simultaneously with the decrease in
the associated asset-item equipment. The decrease in the asset-item equipment is
recognised if the decrease can be measured reliably. (The decrease can be measured
reliably as the amount calculated in accordance with the applicable depreciation method.)
148 In practice, the depreciation expense (on equipment in this example) is usually recognised at
the end of each month. With smaller entities, depreciation is recognised at the end of the
reporting period. The depreciation expense on equipment should therefore be recognised as
soon as the write-off/allotment of the cost of the asset has been appropriately authorised,
namely 31 December 20.7 in this example.
149 The amount at which the depreciation expense on equipment should be measured and
recognised, is in this example determined by the depreciation method as R60 000.
Remarks
1
In the case where the straight-line method is used to allot the cost of the asset, the
depreciation expense is calculated as follows:
Cost price of the depreciable non-current asset
Useful life of the depreciable non-current asset
2
This amount (R60 000) represents the amount of the journal. No estimated residual
value is accounted for at this stage.
171
Double entry rules
150 Since the increase in the expense-item depreciation on equipment to the amount of R60 000
satisfied the definition and recognition criteria of an expense on 31 December 20.7 and the
accompanying decrease in the asset-item equipment to the amount of R60 000 could be
reliably measured on the same day, the items have to be recognised in the records of
AC Entity on 31 December 20.7 in accordance with the double entry system.
151 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
152 The double entry rules in respect of the recognition of depreciation on equipment are as
follows:
Debit Depreciation – equipment – that is the expense-item/account that increases
Credit Accumulated depreciation – equipment – that is the asset-item/account that
decreases
and is supported by the following journal:
20.7
31 Dec
Depreciation – equipment
Accumulated depreciation – equipment
Dr
60 000
Cr
60 000
Assets
=
Liabilities
+
Equity
Classification
- 60 000
=
0
+
- 60 000
Retained earnings – Expense
(Depreciation)
Remarks in respect of the journal
1
The date of the journal is the reporting date, unless the entity recognises the
depreciation expense monthly or unless the asset is sold during the year (this aspect
will be dealt with in Chapter 12).
2
A depreciation expense account and an accompanying accumulated depreciation
account are opened for each of the depreciable non-current asset classes.
3
To credit the accumulated depreciation (on equipment) account (therefore increase the
account) in essence means to credit the asset (equipment) account (therefore
decrease the account).
Example 5.8 Depreciation expense
On 1 January 20.7, AD Entity commenced with operating activities.
During 20.6, the owner purchased land (with a cost price of R600 000) and buildings (with a cost
price of R1 800 000). On 1 January 20.7 the owner made the property available for the exclusive
use of the entity. The cost price of the property must be treated as part of the owner’s capital
contribution. On the same day, the owner deposited a further R2 500 000 into the entity’s cheque
account.
On 1 January 20.7, AD Entity purchased the following non-current assets in cash and on this date
also put these assets into service:
Delivery vehicle
R250 000
Furniture and equipment
R450 000
172
The estimated useful lives of the non-current assets are as follows:
Buildings
20 years
Delivery vehicle
5 years
Furniture and equipment
10 years
It is the entity’s policy to allot the cost of depreciable non-current assets to an expense on a
straight-line basis over the useful life of the assets.
Required:
a)
Provide journal entries to recognise all the abovementioned transactions and events in the
records (general journal) of AD Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transactions and events on the
accounting equation are required.
b)
Post these journal entries to the relevant ledger accounts.
c)
Present the relevant balances in the statement of profit or loss and the statement of financial
position of AD Entity for the reporting period ended 31 December 20.7.
d)
Discuss the difference between transactions and events.
Remark in respect of the set of facts of Example 5.8
1
Land is deemed to have an unlimited useful life and consequently no cost allocation in
respect of land takes place. Therefore no depreciation expense is recognised in
respect of land.
Example 5.8 Solution
a) Journal entries
J1
20.7
1 Jan
Land
Buildings
Bank
Capital
Recognise capital contribution by owner
Nr
A1
A2.1
A30
E1
Dr
600 000
1 800 000
2 500 000
Cr
4 900 000
Assets
=
Liabilities
+
Equity
Classification
+ 4 900 000
=
0
+
+ 4 900 000
Capital
OR
The capital contribution by the owner (J1) can also be recognised in two journals.
20.7
1 Jan
Land
Buildings
Capital
Recognise capital contribution by owner
Nr
A1
A2.1
E1
Dr
600 000
1 800 000
A30
E1
2 500 000
Cr
2 400 000
AND
Bank
Capital
Recognise capital contribution by owner
173
2 500 000
J2
20.7
1 Jan
Vehicles
Furniture and equipment
Bank
Recognise non-current assets purchased in cash
Assets
=
Liabilities
+
+ 700 000
=
0
+
Nr
A4.1
A5.1
A30
Equity
Dr
250 000
450 000
Cr
700 000
Classification
- 700 000
J3
20.7
31 Dec
Depreciation – buildings
Accumulated depreciation – buildings
Recognise the depreciation expense on buildings for
20.7
R1 800 000 ÷ 20
Nr
U20.1
A2.2
Dr
90 000
Cr
90 000
Assets
=
Liabilities
+
Equity
Classification
- 90 000
=
0
+
- 90 000
Retained earnings – Expense
(Depreciation)
J4
20.7
31 Dec
Depreciation – vehicles
Accumulated depreciation – vehicles
Recognise the depreciation expense on delivery
vehicles for 20.7
R250 000 ÷ 5
Assets
- 50 000
J5
20.7
31 Dec
=
=
Liabilities
0
+
+
Equity
- 50 000
Nr
U20.3
A4.2
=
=
Liabilities
0
+
+
Equity
- 45 000
174
Cr
50 000
Classification
Retained earnings – Expense
(Depreciation)
Nr
U20.4
Depreciation – furniture and equipment
Accumulated depreciation – furniture and equipment A5.2
Recognise the depreciation expense on furniture and
equipment for 20.7
R450 000 ÷ 10
Assets
- 45 000
Dr
50 000
Dr
45 000
Cr
45 000
Classification
Retained earnings – Expense
(Depreciation)
b) Post journal entries to accounts
Dr
Date
20.7
1 Jan
A1 Land
Contra account
Capital
Nr
J1
Dr
Date
20.7
1 Jan
Date
Capital
Nr
Amount
J1
1 800 000
Date
Nr
Bank
Dr
Date
Amount
Date
Nr
Amount
Date
J2
250 000
Dr
20.7
1 Jan
Dr
Date
Nr
Amount
Date
Bank
Nr
Amount
J2
450 000
Date
Nr
Amount
Date
Amount
Depreciation –
buildings
Cr
J3
Capital
Nr
J1
Amount
Date
20.7
2 500 000 1 Jan
1 Jan
31 Dec
Balance
bd
1 800 000
175
90 000
Cr
Contra account
Nr
Amount
Contra account
Nr
Amount
Cr
Depreciation – vehicles J4
Contra account
50 000
Cr
Nr
Amount
Contra account
Nr
Amount
Depreciation – furniture
and equipment
J5
Contra account
Nr
Amount
J2
J2
250 000
450 000
cf
1 800 000
2 500 000
Cr
A30 Bank
Contra account
2 500 000
20.8
1 Jan
Nr
A5.2 Accumulated depreciation – furniture and equipment
Contra account
Dr
20.7
1 Jan
Contra account
A5.1 Furniture and equipment
Contra account
20.7
31 Dec
Date
Amount
A4.2 Accumulated depreciation – vehicles
Contra account
20.7
31 Dec
Date
Nr
A4.1 Vehicles
Contra account
Amount
Cr
Contra account
A2.2 Accumulated depreciation – buildings
Contra account
Dr
20.7
1 Jan
Nr
600 000
20.7
31 Dec
Date
Cr
Contra account
A2.1 Buildings
Contra account
Dr
Date
Amount
45 000
Cr
Vehicles
Furniture and
equipment
Balance
Dr
Date
E1 Capital
Contra account
Nr
Amount
Date
20.7
1 Jan
Dr
Date
20.7
31 Dec
20.7
31 Dec
Accumulated
depreciation –
buildings
20.7
31 Dec
Amount
J1
J1
J1
600 000
1 800 000
2 500 000
4 900 000
Nr
J3
Amount
Date
Contra account
Nr
Amount
Nr
Amount
Nr
Amount
Cr
90 000
U20.3 Depreciation – vehicles
Contra account
Accumulated
depreciation –
vehicles
Dr
Date
Land
Buildings
Bank
Nr
U20.1 Depreciation – buildings
Contra account
Dr
Date
Cr
Contra account
Nr
J4
Amount
Date
Contra account
Cr
50 000
U20.4 Depreciation – furniture and equipment
Contra account
Accumulated
depreciation – furniture
and equipment
Nr
J5
Amount
Date
Contra account
Cr
45 000
c) Presentation of balances
AD ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
R
Sales
Cost of sales
Gross profit
Other income
///
Depreciation (dr 90 000 dr 50 000 dr 45 000)
///
xxx
(xxx)
xxx
xxx
(xxx)
(185 000)
(xxx)
Profit for the year
xxx
176
AD ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
ASSETS
Non-current assets
Land
Buildings (dr 1 800 000 cr 90 000)
Vehicles (dr 250 000 cr 50 000)
Furniture and equipment (dr 450 000 cr 45 000)
Total non-current assets
600 000
1 710 000
200 000
405 000
2 915 000
Current assets
Cash and cash equivalents
Total current assets
1 800 000
1 800 000
EQUITY AND LIABILITIES
Equity
Capital
4 900 000
d) Difference between transactions and events
A transaction occurs between an entity and a third party and entails the exchange of goods or
services at an agreed amount. The legal form of a transaction is always a contract.
Events especially relate to the process which is known in Accounting as the subsequent
measurement of assets and liabilities and result in the recording of inter alia depreciation, bad
debts and finance costs.
Remarks in respect of the solution of Example 5.8
1
The collective noun that is used in Accounting for non-current assets of a physical
nature is “Property, plant and equipment” (PPE). The cost price less accumulated
depreciation of a depreciable PPE-item is known as the carrying amount of the
relevant item or, more descriptive, as the depreciated cost of the relevant item. In
Chapter 12, this aspect is dealt with more comprehensively.
2
In Accounting, a depreciable PPE-item is initially measured (recognised) at the
historical cost price thereof. Subsequent measurement (on each reporting date) occurs
at the depreciated cost (carrying amount) of the item.
177
Example 5.9 Depreciation expense
On 31 December 20.8 the following balances, amongst others, appeared in the records of
AD Entity:
Nr
Land (cost price)
A1
Buildings (cost price)
A2.1
Accumulated depreciation – buildings (1 Jan 20.8)
A2.2
Vehicles (cost price)
A4.1
Accumulated depreciation – vehicles (1 Jan 20.8)
A4.2
Furniture and equipment (cost price)
A5.1
Accumulated depreciation – furniture and equipment (1 Jan 20.8) A5.2
Capital
E1
Retained earnings (1 Jan 20.8)
E2.1
Drawings
E2.2
Sales
I1
Cost of sales
U1
Salaries and wages
U3
Water and electricity
U4
Telephone and communication
U6
Insurance
U8
Administrative expenses
U19
Dr
600 000
1 800 000
Cr
90 000
250 000
50 000
450 000
45 000
6 000 000
1 020 000
720 000
6 500 000
2 600 000
1 350 000
435 000
350 000
275 000
575 000
Additional information
1
The estimated useful lives of the non-current assets are as follows:
Buildings
20 years
Vehicles
5 years
Furniture and equipment
10 years
It is the entity’s policy to allot the cost of depreciable non-current assets to an expense on a
straight-line basis over the useful life of the assets.
2
The cost allocation (depreciation expense) for 20.8 still has to be recognised.
3
During 20.8 the owner deposited a further R1 100 000 into the entity’s cheque account. This
transaction has already been recognised.
Required:
a)
Recognise the depreciation expense in the records (general journal) of AD Entity for the
reporting period ended 31 December 20.8.
Note:Journal narrations as well as the effect of the event on the accounting equation are
required.
b)
Prepare the statement of profit or loss and the statement of changes in equity of AD Entity
for the reporting period ended 31 December 20.8.
c)
Present the relevant balances in the statement of financial position of AD Entity as at
31 December 20.8.
178
d)
i)
Explain the concept depreciated cost; and
ii)
Give your opinion regarding the extent of the owner’s drawings for 20.8.
Remark in respect of the set of facts of Example 5.9
1
Example 5.9 builds on the 20.7 amounts of Example 5.8.
Example 5.9 Solution
a) Journal entry – depreciation expense for 20.8
J1
20.8
31 Dec
Depreciation – buildings
Accumulated depreciation – buildings
Recognise the depreciation expense on buildings for
20.8
R1 800 000 ÷ 20
Nr
U20.1
A2.2
Dr
90 000
Cr
90 000
Assets
=
Liabilities
+
Equity
Classification
- 90 000
=
0
+
- 90 000
Retained earnings – Expense
(Depreciation)
J2
20.8
31 Dec
Depreciation – vehicles
Accumulated depreciation – vehicles
Recognise the depreciation expense on delivery
vehicles for 20.8
R250 000 ÷ 5
Nr
U20.3
A4.2
Dr
50 000
Cr
50 000
Assets
=
Liabilities
+
Equity
Classification
- 50 000
=
0
+
- 50 000
Retained earnings – Expense
(Depreciation)
J3
20.8
31 Dec
Nr
U20.4
Depreciation – furniture and equipment
Accumulated depreciation – furniture and equipment A5.2
Recognise the depreciation expense on furniture and
equipment for 20.8
R450 000 ÷ 10
Dr
45 000
Cr
45 000
Assets
=
Liabilities
+
Equity
Classification
- 45 000
=
0
+
- 45 000
Retained earnings – Expense
(Depreciation)
179
b) Statement of profit or loss and statement of changes in equity
AD ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.8
R
Sales
6 500 000
Cost of sales
(2 600 000)
Gross profit
3 900 000
Salaries and wages
(1 350 000)
Water and electricity
(435 000)
Telephone and communication
(350 000)
Insurance
(275 000)
Depreciation (dr 90 000 dr 50 000 dr 45 000)
(185 000)
Other administrative expenses
(575 000)
Profit for the year
730 000
AD ENTITY
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.8
Balance at 31 December 20.7
Capital
Retained
earnings
Total
R
R
R
4 900 000
1 020 000
5 920 000
Changes in equity for 20.8
Additional capital contribution by owner
1 100 000
1 100 000
Profit for the year
730 000
730 000
Distribution to owner (drawings)
(720 000)
(720 000)
Balance at 31 December 20.8
6 000 000
180
1 030 000
7 030 000
c) Presentation of balances in the statement of financial position
AD ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
20.8
R
ASSETS
Non-current assets
Land
600 000
Buildings (dr 1 800 000 (cr 90 000 cr 90 000))
1 620 000
Vehicles (dr 250 000 (cr 50 000 cr 50 000))
150 000
Furniture and equipment (dr 450 000 (cr 45 000 cr 45 000))
360 000
Total non-current assets
2 730 000
EQUITY AND LIABILITIES
Equity
Capital
6 000 000
Retained earnings
1 030 000
Total equity
7 030 000
e)(i) Depreciated cost
In Accounting, depreciable non-current assets are initially measured (recognised) at the historical
cost price thereof. The subsequent measurement of a non-current asset, which takes place at
each subsequent reporting date, occurs at the depreciated cost of the item. Depreciated cost is the
cost price of the relevant depreciable non-current asset less the balance on the relevant
accumulated depreciation account. Depreciated cost is also referred to as the carrying amount of
the relevant asset.
e)(ii) Extent of drawings
The entity is a sole proprietor and the drawings are most probably the owner’s main source of
income. It will usually happen that the owner will withdraw a relatively big portion of the profit for
the current year for personal use. It is however necessary that a substantial amount of the current
year’s profit is not withdrawn by the owner. The total assets of an entity are financed by the owner
(capital and retained earnings) as well as by external parties such as trade payables and the
providers of loans. During the current reporting period, the owner withdrew R720 000 of the profit
of R730 000 and this is too much. If it is however taken into account that the balance of retained
earnings at the beginning of the year amounted to R1 020 000, then it seems as though the owner
withdrew amounts in previous years in a responsible manner.
Remark in respect of the solution of Example 5.9
1
This example does not require the journal entries to be posted to the relevant
accounts. However, to be able to answer the question (specifically (b) and (c) of the
question), the journals have to be posted to the relevant accounts and these accounts
have to be balanced. (It is suggested that this is done as part of calculations by
drawing up informal T-accounts and then informally posting the amounts therein.)
181
Bad debts
Nature of bad debts
153 If trade inventories are sold to a customer on credit, payment does not take place with the
delivery of the trade inventories to the customer since there is a credit term that can elapse
before the payment has to take place. A credit term can be 30 days or 60 days or sometimes
even 90 days.
154 The credit legislation in South-Africa requires that the credit provider (the selling entity in this
instance), obtains predetermined information regarding the customer before a trade credit
limit is granted to the customer. Despite the preventative measures of the credit legislation, it
often still happens that a receivable cannot pay the outstanding amount. The reasons for this
could be that the trade receivable is dishonest (the trade receivable “disappears”) or the
trade receivable experiences financial problems due to economic factors.
155 As soon as it becomes probable (after repeated warnings) that a trade receivable is not
going to settle its debt, the receivable no longer satisfies the definition of an asset, since it is
no longer probable that economic benefits will flow from the trade receivable. Such debt by a
trade receivable is known as bad debts. If it is probable that a trade receivable is not going
to pay, the trade receivable (an asset) must be derecognised by writing it off as an expense.
The expense is known as a bad debts expense. This expense is another example of an
expense that originates due to an asset other than cash (a trade receivable) that decreases.
(For further examples, refer to the expenses depreciation and cost of sales.)
156 Subsequently the application of concepts, principles and rules in respect of the bad debts
expense is dealt with.
The event: Write-off an amount due by Receivable A as irrecoverable
157 The event entails that the amount due by a trade receivable is written off as irrecoverable.
158 An example of such an event is as follows:
On 30 September 20.7, the credit manager of AC Entity approved the write-off of
Receivable A’s debt to the amount of R34 500 as irrecoverable. The debt arose in
February 20.7 and was still outstanding after repeated warnings.
Source documents
159 The following source document is applicable in respect of the recognition of bad debts:
•
A document (supported by proof of warnings or similar actions) that authorises the
write-off and that is signed by the owner or the credit manager.
Recognition of the event
Items/accounts and elements
160 If Receivable A cannot settle its outstanding debt and must be written off as irrecoverable,
the two items brought about by the event are the expense-item bad debts (increase) and the
asset-item Receivable A (decrease). The accounts involved are therefore “Bad debts” and
“Receivable A”. This event affects the element expenses and the element assets. (As set out
in Annexure 3, the expense-item bad debts satisfies the definition of an expense.)
182
Date and amount of initial recognition
161 The increase in the expense-item bad debts, which satisfies the definition of an expense, is
recognised when a decrease in future economic benefits, associated with a decrease in an
asset (Receivable A in this example), can be measured reliably. The expense-item bad
debts is therefore recognised simultaneously with the decrease in the associated asset-item
Receivable A. The decrease in the asset-item Receivable A is recognised when the
decrease can be measured reliably, namely when the write-off of the debt is appropriately
authorised.
162 The expense-item bad debts is recognised simultaneously with the derecognition of the
asset-item Receivable A, and specifically on the day on which the write-off of the trade
receivable’s debt is appropriately authorised, namely 30 September 20.7 in this example.
163 The amount, at which the bad debts expense should be measured and recognised, is the
amount at which Receivable A decreases, namely the amount of the authorised write-off of
R34 500 on 30 September 20.7.
Double entry rules
164 Since the increase in the expense-item bad debts to the amount of R34 500 satisfied the
definition and recognition criteria of an expense on 30 September 20.7 and the
accompanying decrease in the asset-item Receivable A to the amount of R34 500 could be
reliably measured on the same day, the items have to be recognised in the records of
AC Entity on 30 September 20.7 in accordance with the double entry system.
165 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
166 The double entry rules in respect of the recognition of bad debts are as follows:
Debit Bad debts – that is the expense-item/account that increases
Credit Receivable A – that is the asset-item/account that decreases
and is supported by the following journal:
20.7
30 Sep
Assets
- 34 500
Dr
34 500
Bad debts
Receivable A
=
=
Liabilities
0
Cr
34 500
+
+
Equity
- 34 500
Classification
Retained earnings – Expense
(Bad debts)
Bad debts recovered
167 It sometimes happens that, in respect of bad debts written off, a payment or partial payment
is subsequently received. This subsequent receipt particularly occurs in the case where a
receivable’s estate was liquidated due to insolvency. If a receivable cannot pay the amounts
of its debt to numerous entities due to solvency reasons, one or more of the creditors of the
receivable may apply for the receivable to be placed under liquidation. The Master appoints
a liquidator which realises (sells) the assets of the receivable, where after the creditors are
paid partially or in full. For example, if the assets of a receivable are sold for R100 000 and
the creditors of the receivable amount to a total of R400 000, 25c (R100 000/R400 000) will
be paid to each creditor for each rand that is owed to the relevant creditor. The 25c is known
as a liquidation-dividend or a liquidation-distribution.
183
Example 5.10 Bad debts expense and bad debts recovered
On 31 December 20.7 the following balances, amongst others, appeared in the records of
AC Entity:
Acc
A20
D1
D2
D3
A30
I1
U2
U3
U11
Trade inventories
Receivable A
Receivable B
Receivable C
Bank
Sales
Cost of sales
Salaries and wages
Bad debts
Dr
980 000
450 000
380 000
35 500
702 150
Cr
6 750 000
2 700 000
1 450 000
168 500
The following transaction and event still have to be recognised:
1
On 31 December 20.7, after fruitless warnings over a period of six month, the credit manager
authorised the write-off of Receivable C’s debt as irrecoverable.
2
The cheque account statement for December 20.7 indicates an electronic deposit of R4 000
on 31 December 20.7 from AB Executors, the liquidator of Receivable E’s insolvent estate.
Receivable E’s debt of R16 000 has previously been written off as irrecoverable. The
liquidation-distribution is 25c in the Rand.
Required:
a)
Recognise the transaction and event in the records (general journal) of AC Entity for the
reporting period ended 31 December 20.7.
Note:Journal narrations, with a reference to the source document(s), as well as the effect of
the transaction/event on the accounting equation are required.
b)
Open the accounts affected by the journal entries and subsequently post the journal entries
to these accounts.
c)
Present the balances in the financial statements of AC Entity for the reporting period ended
31 December 20.7.
d)
Explain the concept liquidation-distribution/liquidation-dividend.
184
Example 5.10 Solution
a) Journal entries
J1
20.7
31 Dec
Nr
U11
D3
Bad debts
Receivable C
Derecognise Receivable C as per authorisation from
the credit manager – see email dated 31 Dec 20.7
Dr
35 500
Cr
35 500
Assets
=
Liabilities
+
Equity
Classification
- 35 500
=
0
+
- 35 500
Retained earnings – Expense
(Bad debts)
J2
20.7
31 Dec
Bank
Bad debts
Recognise liquidation-dividend deposited by
AB Executors (cheque account statement number 657)
in respect of Receivable E previously written off
Nr
A30
U11
Dr
4 000
Cr
4 000
Assets
=
Liabilities
+
Equity
Classification
+4 000
=
0
+
+4 000
Retained earnings – Expense
(decrease) (Bad debts)
b) Post journal entries to accounts
Dr
Date
20.7
31 Dec
A30 Bank
Contra account
Balance
Bad debts
Nr
Amount
bd
J2
702 150
4 000
706 150
Nr
Amount
Dr
Date
20.7
31 Dec
20.7
31 Dec
Cr
Contra account
Nr
Amount
Contra account
Nr
Amount
D3 Receivable C
Contra account
Balance
bd
Dr
Date
Date
Date
20.7
35 500 31 Dec
Cr
Bad debts
J1
U11 Bad debts
Contra account
Balance
Receivable C
Nr
Amount
Date
bd
J1
20.7
168 500 31 Dec
35 500
204 000
185
35 500
Cr
Contra account
Bank
Retained earnings
Nr
Amount
J2
4 000
200 000
204 000
c) Presentation of balances in the financial statements
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
R
6 750 000
(2 700 000)
4 050 000
(1 450 000)
(200 000)
(xxx)
XXX
Sales
Cost of sales
Gross profit
Salaries and wages
Bad debts (dr 168 500 dr 35 500 cr 4 000)
///
Profit for the year
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
ASSETS
Current assets
Inventories
Trade receivables (dr 450 000 dr 380 000 dr 35 500 cr 35 500)
Cash and cash equivalents
Total current assets
980 000
830 000
706 150
2 516 150
d) Liquidation-distribution/liquidation-dividend
It sometimes happens that, in respect of bad debts written off, a payment or partial payment is
subsequently received. This subsequent receipt particularly occurs in the case where a
receivable’s estate was liquidated due to insolvency. If a receivable cannot pay the amounts of its
debt to numerous entities due to solvency reasons, one or more of the creditors of the receivable
may apply for the receivable to be placed under liquidation. The Master appoints a liquidator which
realises (sells) the assets of the receivable, where after the creditors are paid partially or in full. For
example, if the assets of a receivable are sold for R100 000 and the creditors of the receivable
amount to a total of R400 000, 25c (R100 000/R400 000) will be paid to each creditor for each
rand that is owed to the relevant creditor. The 25c is known as a liquidation-dividend or a
liquidation-distribution.
Expenses resulting from the subsequent measurement of liabilities
Origin of such expenses
168 Loans by financial institutions to entities play a substantial role in the economy. Today it is
common for entities to make use of loans to finance the purchase of assets. Financing as
topic is dealt with comprehensively in the subject field Financial Management.
169 The incurrence of a supplier’s loan for the purchase of an asset has been dealt with
previously in this chapter. The nature of the utilisation of a bank loan as well as a bank
overdraft facility is dealt with in the paragraphs below.
186
170 In this section, the interest expense arising from the utilisation of loans will be dealt with from
the perspective of the borrower. The cost associated with the utilisation of the borrowed
funds is known as interest. The recording of interest results in an increase in the liability
(loan) and simultaneously the occurrence of an interest expense.
171 For purposes of presentation in the financial statements, liabilities are classified as current
liabilities and non-current liabilities. Liabilities are the interest of external parties in the
assets of the entity. Non-current liabilities represent loans incurred by the entity that is
payable 12 months after the current reporting date. Such loans are usually incurred to
finance the purchase of non-current assets by the entity. Current liabilities are liabilities that
are payable within 12 months from the current reporting date. Current liabilities mainly
comprise trade and other payables. Refer to the statement of financial position in Chapter 3.
172 Loans are, with reference to the initial loan term, divided into two types of loans. Loans with
an initial term of shorter than twelve months are short term loans and are presented in the
statement of financial position as short term loans under the heading “Current liabilities”.
Loans with an initial term of longer than twelve months are long term loans and are
presented as non-current liabilities in the statement of financial position. The portion of a
long term loan that is payable within 12 months from the reporting date, is presented in the
statement of financial position in the line item “Current portion of long term loan” under the
heading “Current liabilities”. An example in this regard is as follows: AC Entity’s current
reporting date is 31 December 20.7. On 1 January 20.7, AC Entity incurred a loan with a
loan term of 18 months. This loan will be presented in AC Entity’s statement of financial
position as at 31 December 20.7 in the line item “Current portion of long term loan” under the
heading “Current liabilities”.
173 However, for purposes of subsequent measurement, liabilities are furthermore classified
as financial and non-financial liabilities. A financial liability is a liability in respect of which
a cash amount will be paid in terms of a contract. Examples of financial liabilities are trade
and other payables as well as interest bearing debt such as loans and a bank overdraft
account. An example of a non-financial liability is a provision payable, which is dealt with in
Chapter 19. Also refer back to paragraph 129.
Initial measurement and subsequent measurement of liabilities
174 Most liabilities are, with the initial recognition thereof, measured at the historical cost price of
the liability. The historical cost price of a liability in the case of payables is the invoice
amount and in the case of loans, it is the amount received in cash. On each reporting date,
most liabilities have to be measured again. This measurement on each reporting date is
known as subsequent measurement.
175 Subsequent measurement in respect of interest bearing financial liabilities occurs at the
amortised cost (that is the primary debt plus accumulated interest less payments).
Subsequent measurement of trade and other payables occurs at the outstanding invoice
amount.
176 The interest expense on a bank loan, a supplier’s loan and bank overdraft are subsequently
dealt with. Loans are dealt with in more detail in Chapter 15.
187
Interest expense on a bank loan
Nature of a bank loan and the associated cost/interest
177 A bank loan represents the borrowing of an amount at agreed terms, as contained in the
written agreement between the bank and the entity. Bank loans are often utilised to
supplement the cash funds of the entity. An entity’s main source of cash is usually payments
made by receivables and cash sales. These receipts are utilised to settle outstanding
payables and to pay operating expenses such as salaries. The receipts and payments are
not necessarily synchronised. Consequently, the entity also has to obtain cash from another
source, namely from financing such as bank loans.
178 At the time of the initial recognition of a bank loan, the bank account is debited and the bank
loan is credited with the amount borrowed. The loan agreement stipulates that interest must
be charged at a specific rate. Consequently, the loan amount/obligation that must be repaid
increases as the interest accrues over the loan term, in accordance with the loan agreement.
In accordance with a loan agreement, the obligation therefore comprises two components,
namely the capital borrowed and the interest accrued.
179 It is common that loans with a term longer than one year are repaid in equal, monthly
instalments. Each instalment comprises a capital portion, which reduces the outstanding
primary debt, and an interest portion, which redeems the interest that accrued. Loans with
such capital redemption are dealt with in Chapter 15.
180 In respect of loans with a term of up to three years, there are however sometimes variations
of how the primary debt and the interest should be settled. Examples of these variations are
as follows:
•
Interest on the primary debt is paid monthly or bi-annually and the primary debt is
repaid in one amount at the end of the loan term; or
•
The interest and the primary debt are repaid in one amount at the end of the loan term.
181 In this section only a bank loan of which the primary debt and the interest is payable at the
end of the loan term, is dealt with. For practical reasons, the interest that accrues on the
bank loan is added to the debt at the end of every six (or sometimes twelve) months. At the
end of every six/twelve months an increase in the liability (loan) will therefore be recognised
as a result of the interest that accrues. Refer to the interest schedule of Example 5.11
hereafter.
The transaction: Interest expense on a bank loan
182 This transaction entails that, in accordance with a loan agreement, interest accrues on a
bank loan that has already been incurred and received.
183 An example of such a transaction is as follows:
AC Entity’s current reporting date is 31 December 20.7. On 25 June 20.7, AC Entity signed a
loan agreement in respect of the incurrence of a bank loan of R500 000. The interest rate is
12% per year and the interest is added to the primary debt every six months. The interest
and the primary debt is repayable in one amount on 31 December 20.9, the end of the loan
term. On 1 July 20.7, the loan amount was paid into AC Entity’s cheque account. The
interest expense for 20.7 still has to be recognised.
Note: Only the recognition of the accrued interest on 31 December 20.7, is dealt with in this
example.
188
Source documents
184 The following source documents are applicable in respect of the recognition of interest
accrued on a bank loan:
•
The loan agreement; and
•
The loan statement from the bank that indicates the interest.
Recognition of the transaction
Items/accounts and elements
185 When interest on a bank loan is charged by the bank and recognised by the borrower
(entity), the two items brought about by the transaction are the expense-item interest on
bank loan (increase) and the liabilities-item bank loan (increase). The accounts involved are
therefore “Interest expense on bank loan” and “Bank loan”. This transaction affects the
element expenses and the element liabilities. (As set out in Annexure 3, the liabilities-item
increase in bank loan satisfies the definition and recognition criteria of a liability and the
expense-item interest on bank loan satisfies the definition of an expense.)
Date and amount of initial recognition
186 The interest expense on the bank loan results from the subsequent measurement of the
bank loan. Subsequent measurement of the bank loan at amortised cost causes an increase
in the liabilities-item bank loan and an increase in the expense-item interest on bank loan
due to the interest that accrued.
187 An item that satisfies the definition of an expense is recognised when a decrease in future
economic benefits, associated with a decrease that occurred in an asset or an increase that
occurred in a liability, can be measured reliably. An expense that arises due to the
subsequent measurement of a liability is therefore recognised simultaneously with the
increase in the associated liabilities-item (bank loan in this example). The increase in the
liabilities-item is recognised on the date on which the item satisfies the definition and
recognition criteria of a liability.
188 As at 31 December 20.7, interest to the amount of R500 000 accrued on the bank loan at
12% per year in accordance with the loan agreement. On 31 December 20.7 a legal
obligation arose towards the bank and on this date the increase in the bank loan satisfied the
definition and recognition criteria of a liability. The expense-item interest on bank loan is
consequently recognised simultaneously with the increase in the liabilities-item bank loan,
thus on 31 December 20.7.
189 The amount at which the increase in the liabilities-item bank loan should be measured and
recognised, is the amount of the accrued interest as calculated in accordance with the loan
agreement, namely R30 000 (R500 000 x 12% x 6/12). The increase in the expense-item
interest on bank loan is measured and recognised at the same amount on 31 December
20.7.
Double entry rules
190 Since the increase in the expense-item interest on bank loan to the amount of R30 000
(which causes a decrease in retained earnings/equity) and the accompanying increase in the
liabilities-item bank loan to the amount of R30 000 satisfied the definition and recognition
criteria of an expense and a liability respectively on 31 December 20.7, the items have to be
recognised in the records of AC Entity on 31 December 20.7 in accordance with the double
entry system.
189
191 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
192 The double entry rules in respect of the recognition of interest that accrued on a bank loan,
are as follows:
Debit Interest expense on bank loan – that is the expense-item/account that increases
Credit Bank loan – that is the liabilities-item/account that increases and is supported by the
following journal:
20.7
31 Dec
Dr
30 000
Interest expense on bank loan
Bank loan
Cr
30 000
Assets
=
Liabilities
+
Equity
Classification
0
=
+30 000
+
- 30 000
Retained earnings – Expense
(Interest expense)
Remark in respect of the journal
1
The date of the journal above is the date on which the interest is added to the primary
debt in accordance with the agreement.
2
The bank loan is initially measured and recognised at the cash amount received. The
subsequent measurement of the bank loan occurs at the amortised cost thereof
(R530 000), namely the primary debt (R500 000) plus accumulated interest (R30 000).
Example 5.11 Bank loan
AL Entity’s current reporting date is 31 December 20.7.
AL Entity incurred a bank loan for R500 000 to supplement the entity’s working capital. The
relevant stipulations of the loan agreement, which was signed on 18 December 20.6, are as
follows:
•
The primary debt is R500 000.
•
The interest rate is 12% per year and the interest is added annually to the primary debt on
31 December (in other words, the interest is compounded yearly).
•
The loan term is 36 months.
•
The primary debt and interest is repayable in one amount, namely R702 464, on
31 December 20.9.
•
A notarial bond that is registered over AL Entity’s trade inventories serves as security for the
bank loan.
The R500 000 was transferred into AL Entity’s current bank account on 2 January 20.7, by means
of an electronic transfer.
190
The interest schedule for the loan is as follows:
Date
Detail
2 Jan 20.7
31 Dec 20.7
31 Dec 20.8
31 Dec 20.9
Interest at
12% per year
Primary debt
Interest
Interest
Interest
Amortised cost of
the loan
60 000
67 200
75 264
202 464
R
500 000
560 000
627 200
702 464
Remarks in respect of the abovementioned interest schedule
1
The interest is calculated on an annual compound basis. This means that the
accumulated interest for a year is added to the primary debt at the end of the year in
order to obtain the amortised cost of the loan on the relevant date. In practice, the
interest would be added monthly. In this work, for practical educational reasons, it is
accepted that the interest on loans are added annually or bi-annually. The interest on
the loans is therefore compounded annually or bi-annually.
2
At the initial recognition, the loan is measured at the historical cost thereof, namely
R500 000. The subsequent measurement of the loan occurs at the amortised cost and
would therefore be measured at the following amounts on the dates as indicated:
31 December 20.7 R560 000;
31 December 20.8 R627 200; and
31 December 20.9 R702 464.
3
The interest expense is recognised every year on the date on which the interest is
added to the primary debt in accordance with the loan agreement.
4
The total interest on the loan, namely R202 464, accrues in accordance with the
stipulations of the agreement. The total interest on the loan is allocated to each interest
period as an expense over the loan term by applying the interest rate in the loan
agreement. This method is known as the effective interest rate method. The total
interest cannot be recognised as an expense on day one, since interest accrues over
the duration of the agreement. This is also in line with the accrual basis of Accounting.
5
It clearly transpires from the interest schedule that the accrual of interest can over time
be substantial. One should be able to interpret and account for such a redemption/
interest schedule.
Required:
a)
Recognise, by means of journal entries, the bank loan and the interest expense in the
records (general journal) of AL Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transaction/event on the accounting
equation are required.
b)
Open the loan account and the interest expense account in the records of AL Entity and post
the journals in (a) above to these accounts.
191
c)
Present the balances of the loan account and the interest expense account in the
appropriate financial statements of AL Entity for the reporting period ended 31 December
20.7.
d)
Recognise the interest expense in the records (general journal) of AL Entity for the reporting
periods ended 31 December 20.8 and 31 December 20.9.
Note:Journal narrations as well as the effect of the transaction/event on the accounting
equation are required.
e)
As stipulated in the loan agreement, the bank recovered the amount due in respect of the
loan and interest from AL Entity’s current bank account, on 31 December 20.9. Recognise
this transaction in the records (general journal) of AL Entity for the reporting period ended
31 December 20.9.
Note:Journal narrations as well as the effect of the transaction/event on the accounting
equation are required.
f)
Post the journals for (d) and (e) above to the loan account in the records of AL Entity.
g)
Present the balance of the bank loan in the statement of financial position of AL Entity as at
31 December 20.8.
Example 5.11 Solution
a) Journal entries
J1
20.7
2 Jan
Bank
Bank loan
Recognise bank loan received. Refer to loan agreement
C77
Assets
=
Liabilities
+
Equity
+500 000
=
+500 000
+
0
J2
20.7
31 Dec
Interest expense on bank loan
Bank loan
Recognise interest expense for the period 1 Jan 20.7 to
31 Dec 20.7. Refer to loan agreement C77
R500 000 x 12%
Nr
A30
L2
Dr
500 000
Cr
500 000
Classification
Nr
U30.2
L2
Dr
60 000
Cr
60 000
Assets
=
Liabilities
+
Equity
Classification
0
=
+60 000
+
- 60 000
Retained earnings – Expense
(Interest expense)
192
b) Post journal entries to accounts
Dr
L2 Bank loan
Date
20.7
31 Dec
Contra account
Balance
Nr
cf
Amount
Date
20.7
560 000 2 Jan
31 Dec
Cr
Contra account
Nr
Bank
Interest expense
on bank loan
J1
J2
560 000
500 000
60 000
560 000
20.8
1 Jan
Dr
Amount
Balance
bd
560 000
U30.2 Interest expense on bank loan
Date
20.7
31 Dec
Contra account
Bank loan
Nr
Amount
J2
Date
Contra account
Cr
Nr
Amount
60 000
c) Presentation in the appropriate financial statements
AL ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
R
Sales
Cost of sales
Gross profit
Salaries and wages
////
Interest expense
Profit for the year
xxx
(xxx)
xxx
(xxx)
(60 000)
XXX
AL ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
EQUITY AND LIABILITIES
Non-current liabilities
Long term loans (cr 500 000 cr 60 000)
560 000
Remark in respect of the presentation
1
The long term loan is initially measured at the historical cost thereof, namely the
amount borrowed and received in accordance with the loan agreement. The
subsequent measurement of the loan occurs at the amortised cost of the loan, namely
the primary debt (R500 000) plus accumulated interest (R60 000).
193
d) Journal entries in respect of interest expense for 20.8 and 20.9
J3
20.8
31 Dec
Nr
U30.2
Interest expense on bank loan
Bank loan
L2
Recognise interest expense for the period 1 Jan 20.8 to
31 Dec 20.8. Refer to loan agreement C77
R560 000 x 12%
Assets
0
J4
20.9
31 Dec
=
=
Liabilities
+67 200
+
+
Equity
- 67 200
Dr
67 200
67 200
Classification
Retained earnings – Expense
(Interest expense)
Nr
Dr
75 264
U30.2
Interest expense on bank loan
Bank loan
L2
Recognise interest expense for the period 1 Jan 20.9 to
31 Dec 20.9. Refer to loan agreement C77
R627 200 x 12%
Assets
0
=
=
Liabilities
+75 264
+
+
Cr
Equity
- 75 264
Cr
75 264
Classification
Retained earnings – Expense
(Interest expense)
e) Journal entry in respect of settlement of loan
J5
20.9
31 Dec
Bank loan
Bank
Derecognise loan due to settlement. Refer to loan
agreement C77
Assets
- 702 464
=
=
Liabilities
- 702 464
+
+
Equity
0
Nr
L2
A30
Dr
702 464
Cr
702 464
Classification
f) Post journal entries to accounts
Dr
Date
L2 Bank loan
Contra account
Nr
20.8
31 Dec
Balance
cf
20.9
31 Dec
Bank
J5
Amount
Date
20.8
627 200 1 Jan
31 Dec
627 200
20.9
702 464 1 Jan
31 Dec
702 464
194
Cr
Contra account
Nr
Amount
Balance
Interest expense
bd
J3
560 000
67 200
627 200
Balance
Interest expense
bd
J4
627 200
75 264
702 464
g) Presentation in the statement of financial position
AL ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
20.8
R
EQUITY AND LIABILITIES
Non-current liabilities
Long term loans
0
Current liabilities
Current portion of long term loans (cr 500 000 cr 60 000 cr 67 200)
627 200
Interest expense on a supplier’s loan
Nature of a supplier’s loan
193 Some suppliers of sophisticated assets (e.g. machinery) provide credit to the purchasing
entity in the form of a loan. A supplier’s loan carries interest and the term of the loan is
longer than the term of normal trade credit.
194 In this section only a supplier’s loan of which the primary debt and the interest are repayable
in one amount at the end of the loan term, is dealt with. For the recognition of the asset, refer
to paragraphs 40 to 53.
The transaction: Interest expense on a supplier’s loan
195 This transaction entails that, in accordance with a purchase contract, interest accrues on a
supplier’s loan that has already been incurred.
196 An example of such a transaction is as follows:
On 1 June 20.7, AC Entity entered into an agreement with Supplier L for the delivery of a
machine to AC Entity on 1 July 20.7. The cash price of the machine is R824 000 and is,
together with the accumulated interest, repayable on 31 December 20.9. The interest rate is
12% per year and the interest is added to the loan amount at the end of every six months.
On 1 July 20.7 the machine was delivered to AC Entity.
Note: Only the recognition of the accrued interest on 31 December 20.7, is dealt with in this
example.
Source documents
197 The following source documents are applicable in respect of the recognition of interest
accrued on a supplier’s loan:
•
Loan agreement/purchase contract; and
•
The loan statement from the supplier, which indicates the interest.
Recognition of the transaction
Items/accounts and elements
198 When interest is charged on a supplier’s loan, the two items brought about by the transaction
are the expense-item interest on supplier’s loan (increase) and the liabilities-item supplier’s
loan (increase). The accounts involved are therefore “Interest expense on supplier’s loan”
and “Loan from Supplier L”. This transaction affects the element expenses and the element
liabilities.
195
Date and amount of initial recognition
199 The interest expense on the supplier’s loan results from the subsequent measurement of the
supplier’s loan. Subsequent measurement of the supplier’s loan at amortised cost causes an
increase in the liabilities-item supplier’s loan and an increase in the expense-item interest on
supplier’s loan due to the interest that accrued.
200 An item that satisfies the definition of an expense is recognised when a decrease in future
economic benefits, associated with a decrease that occurred in an asset or an increase that
occurred in a liability, can be measured reliably. An expense that arises due to the
subsequent measurement of a liability is therefore recognised simultaneously with the
increase in the associated liabilities-item (supplier’s loan in this example). The increase in
the liabilities-item is recognised on the date on which the item satisfies the definition and
recognition criteria of a liability.
201 As at 31 December 20.7, interest to the amount of R824 000 accrued on the supplier’s loan
at 12% per year in accordance with the loan agreement/purchase contract. On 31 December
20.7 a legal obligation arose towards Supplier L and on this date the increase in the
supplier’s loan satisfied the definition and recognition criteria of a liability. The expense-item
interest on supplier’s loan is consequently recognised simultaneously with the increase in the
liabilities-item supplier’s loan, thus on 31 December 20.7.
202 The amount at which the increase in the liabilities-item supplier’s loan should be measured
and recognised, is the amount of the accrued interest as calculated in accordance with the
loan agreement/purchase contract, namely R49 440 (R824 000 x 12% x 6/12). The increase
in the expense-item interest on supplier’s loan is measured and recognised at the same
amount on 31 December 20.7.
Double entry rules
203 Since the increase in the expense-item interest on supplier’s loan to the amount of R49 440
(which causes a decrease in retained earnings/equity) and the accompanying increase in the
liabilities-item supplier’s loan to the amount of R49 440 satisfied the definition and
recognition criteria of an expense and a liability respectively on 31 December 20.7, the items
have to be recognised in the records of AC Entity on 31 December 20.7 in accordance with
the double entry system.
204 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
205 The double entry rules in respect of the recognition of interest that accrued on a supplier’s
loan, are as follows:
Debit Interest expense on supplier’s loan – that is the expense-item/account that increases
Credit Loan from Supplier L – that is the liabilities-item/account that increases and is
supported by the following journal:
20.7
31 Des
Dr
49 440
Interest expense on supplier’s loan
Loan from Supplier L
Cr
49 440
Assets
=
Liabilities
+
Equity
Classification
0
=
+49 440
+
- 49 440
Retained earnings – Expense
(Interest expense)
196
Remarks in respect of the journal
1
The date of the journal above is the date on which the interest is added to the primary
debt in accordance with the agreement.
2
The supplier’s loan is initially measured and recognised at the cash price of the asset
received by the entity. The subsequent measurement of the supplier’s loan occurs at
the amortised cost (R873 440) thereof, namely the primary debt (R824 000) plus
accumulated interest (R49 440).
Example 5.12 Machine purchased with a supplier’s loan
AL Entity’s reporting date is 31 December. The information below in respect of the year ended
31 December 20.7, has reference.
AL Entity purchased machinery for R800 000. Supplier K, the supplier of the machinery, provided
credit to AL Entity in the form of a loan.
The relevant stipulations of the loan agreement are as follows:
•
The primary debt is R800 000.
•
The interest rate is 10% per year and the interest is calculated by making use of the
compounded interest rate method.
•
The interest is added annually to the primary debt on 31 December.
•
The loan term is 36 months.
•
Interest that will be charged over the term of the loan amounts to R264 800.
•
The primary debt and interest are repayable in one amount on 31 December 20.9.
•
The machinery serves as security for the supplier’s loan.
The interest schedule for the supplier’s loan is as follows:
Date
Detail
2 Jan 20.7
31 Dec 20.7
31 Dec 20.8
31 Dec 20.9
Primary debt
Interest
Interest
Interest
Interest at
10% per year
Amortised cost of
the loan
80 000
88 000
96 800
264 800
R
800 000
880 000
968 000
1 064 800
On 2 January 20.7, the machinery was delivered and put into service, and the loan was also
utilised on this day.
Depreciation on machinery is written off in accordance with the straight-line method over the
estimated useful life thereof, namely 5 years.
Remarks in respect of abovementioned interest schedule
1
The interest is calculated on an annual compounded basis. This means that the
accumulated interest for a year is added to the primary debt at the end of the year in
order to obtain the amortised cost of the loan on the relevant date.
197
2
At the initial recognition, the loan is measured at the historical cost thereof, namely
R800 000. The subsequent measurement of the loan occurs at the amortised cost and
would therefore be measured at the following amounts on the dates as indicated:
31 December 20.7 R880 000;
31 December 20.8 R968 000; and
31 December 20.9 R1 064 800.
3
The interest expense is recognised every year on the date on which the interest is
added to the primary debt in accordance with the loan agreement.
4
The total interest on the loan, namely R264 800, accrues in accordance with the
stipulations of the agreement. The total interest on the loan is allocated to each interest
period as an expense over the loan term by applying the interest rate in the loan
agreement. This method is known as the effective interest rate method. The total
interest cannot be recognised as an expense on day one, since interest accrues over
the duration of the agreement. This is also in line with the accrual basis of Accounting.
Required:
a)
Recognise the supplier’s loan, the interest expense and the depreciation on the machinery in
the records (general journal) of AL Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transaction/events on the accounting
equation are required.
b)
Open the supplier’s loan account and the interest expense account in the records of
AL Entity and post the journals in (a) above to these accounts.
c)
Present the balances of the following accounts in the appropriate financial statements of
AL Entity for the reporting period ended 31 December 20.7:
d)
•
Interest expense;
•
Depreciation;
•
Machinery; and
•
Supplier’s loan.
Recognise the interest expense in the records (general journal) of AL Entity for the reporting
periods ended 31 December 20.8 and 31 December 20.9.
Note:Journal narrations as well as the effect of the transaction/events on the accounting
equation are required.
e)
On 31 December 20.9, AL Entity settled the loan and the accompanying interest with an
electronic transfer of funds. Recognise this transaction in the records (general journal) of
AL Entity for the reporting period ended 31 December 20.9.
Note:Journal narrations as well as the effect of the transaction/events on the accounting
equation are required.
f)
Post the journals for (d) and (e) above to the loan account in the records of AL Entity.
g)
Present the balance of the supplier’s loan in the statement of financial position of AL Entity
as at 31 December 20.8.
198
Example 5.12 Solution
a) Journal entries
J1
20.7
2 Jan
Machinery
Loan from Supplier K
Recognise utilisation of loan for the purchase of a
machine. Refer to loan agreement D99
Assets
=
Liabilities
+
Equity
+800 000
=
+800 000
+
0
J2
20.7
31 Dec
Interest expense on supplier’s loan
Loan from Supplier K
Recognise interest expense for 20.7. Refer to loan
agreement D99
R800 000 x 10%
Nr
A3.1
L4
Dr
800 000
Cr
800 000
Classification
Nr
U30.3
L4
Dr
80 000
Cr
80 000
Assets
=
Liabilities
+
Equity
Classification
0
=
+80 000
+
- 80 000
Retained earnings – Expense
(Interest expense)
J3
20.7
31 Dec
Depreciation – machinery
Accumulated depreciation – machinery
Recognise depreciation on machinery for 20.7
R800 000 ÷ 5
Nr
U20.2
A3.2
Dr
160 000
Cr
160 000
Assets
=
Liabilities
+
Equity
Classification
- 160 000
=
0
+
- 160 000
Retained earnings – Expense
(Depreciation)
b) Post journal entries to accounts
Dr
Date
20.7
2 Jan
A3.1 Machinery
Contra account
Loan from
Supplier K
Nr
J1
Amount
Date
800 000
199
Cr
Contra account
Nr
Amount
Dr
Date
A3.2 Accumulated depreciation – machinery
Contra account
Nr
Amount
Date
20.7
31 Dec
Dr
Date
20.7
31 Dec
20.7
31 Dec
Balance
20.7
31 Dec
Nr
cf
J3
Amount
160 000
Amount
Date
20.7
880 000 2 Jan
31 Dec
880 000
20.8
1 Jan
Cr
Contra account
Nr
Amount
Machinery
Interest expense
J1
J2
800 000
80 000
880 000
Balance
bd
880 000
U20.2 Depreciation – machinery
Contra account
Accumulated
depreciation –
machinery
Dr
Date
Depreciation machinery
Cr
Nr
L4 Loan from Supplier K
Contra account
Dr
Date
Contra account
Nr
J3
Amount
Date
Contra account
Cr
Nr
Amount
Nr
Amount
160 000
U30.3 Interest expense on supplier’s loan
Contra account
Loan from
Supplier K
Nr
J2
Amount
Date
Contra account
Cr
80 000
c) Presentation in the appropriate financial statements
AL ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
R
Sales
Cost of sales
Gross profit
Salaries and wages
////
Depreciation
Interest expense
Profit for the year
xxx
(xxx)
xxx
(xxx)
(160 000)
(80 000)
XXX
200
AL ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
ASSETS
Non-current assets
Machinery (dr 800 000 cr 160 000)
640 000
EQUITY AND LIABILITIES
Non-current liabilities
Long term loans (cr 800 000 cr 80 000)
880 000
d) Journal entries – interest expense for 20.8 and 20.9
J4
20.8
31 Dec Interest expense on supplier’s loan
Loan from Supplier K
Recognise interest expense for the period 1 Jan 20.8
to 31 Dec 20.8. Refer to loan agreement D99
R880 000 x 10%
Assets
0
J5
20.9
31 Dec
=
=
Liabilities
+88 000
+
+
Equity
- 88 000
Nr
U30.3
Cr
L4
88 000
Classification
Retained earnings – Expense
(Interest expense)
Nr
Interest expense on supplier’s loan
Loan from Supplier K
Recognise interest expense for the period 1 Jan 20.9
to 31 Dec 20.9. Refer to loan agreement D99
R968 000 x 10%
Dr
88 000
U30.3
Dr
96 800
Cr
L4
96 800
Assets
=
Liabilities
+
Equity
Classification
0
=
+96 800
+
- 96 800
Retained earnings – Expense
(Interest expense)
e) Journal entry – settlement of loan
J6
20.9
31 Dec Loan from Supplier K
Bank
Derecognise loan due to settlement. Refer to loan
agreement D99
Assets
=
Liabilities
+
Equity
- 1 064 800
=
- 1 064 800
+
0
201
Nr
L4
A30
Dr
1 064 800
Cr
1 064 800
Classification
f) Post journal entries to accounts
Dr
Date
L4 Loan from Supplier K
Contra account
Nr
20.8
31 Dec
Balance
cf
20.9
31 Dec
Bank
J6
Amount
Date
20.8
968 000 1 Jan
31 Dec
968 000
20.9
1 064 800 1 Jan
31 Dec
1 064 800
Cr
Contra account
Nr
Amount
Balance
Interest expense
bd
J4
880 000
88 000
968 000
Balance
Interest expense
bd
J5
968 000
96 800
1 064 800
g) Presentation in the statement of financial position
AL ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
20.8
R
EQUITY AND LIABILITIES
Non-current liabilities
Long term loans
0
Current liabilities
Current portion of long term loans (cr 800 000 cr 80 000 cr 88 000)
968 000
Interest expense on a bank overdraft account
Nature of a bank overdraft account
206 A bank account is usually an account with a debit balance in the entity’s records. In essence,
the bank owes funds to the entity. It can however be agreed with the bank to have an
overdraft facility. An overdraft facility enables the entity to give instructions to the bank
regarding the appropriation of funds, which is more than the funds in the bank account. An
entity that does not have an overdraft facility can only make payments from the bank account
to the extent that there are funds in the bank account.
207 If, with the approval from the bank (by the bank granting an overdraft facility), the bank
account becomes overdrawn, the bank account in the entity’s records shows a credit
balance. A bank overdraft account is a liability and more specifically, a current liability. The
bank account balance of an entity with an overdraft facility can often fluctuate between a
debit balance and a credit balance. The description of the bank account remains “bank” and
does not vary between “bank” and “bank overdraft”. If the balance of the bank account is in
overdraft on the reporting date, the bank account is presented in the statement of financial
position as bank overdraft under the heading “Current liabilities”. If reference is made to bank
overdraft in this work, reference is made to a bank account with a credit balance in the
entity’s records.
202
208 The detail of the overdraft facility is recorded in a written agreement between the bank and
the entity. An unutilised overdraft facility is naturally not a liability. The bank reviews the
overdraft facility at least once a year. The entity has to provide security. Often the owner of a
sole proprietor will personally provide the security. The security often takes the form of an
encumbrance of the entity’s trade inventories in favour of the bank. The encumbrance of
trade inventories occurs by registering a notarial bond, in favour of the bank, over the trade
inventories. If the entity does not comply with the terms of the overdraft facility, the bank may
realise the trade inventories of the entity to the extent of the amount due. Also refer to
paragraph 129.
209 If an entity indeed utilises the overdraft facility, the bank will charge interest, which will
appear on the monthly cheque account statement from the bank. Interest on a bank
overdraft account is an example of an expense that arises due to a liability that increases.
The interest expense results from the subsequent measurement of the bank overdraft. The
interest expense is recognised on the day on which the interest is charged on the bank’s
cheque account statement.
The transaction: Interest expense on an overdraft bank balance
210 This transaction entails that interest accrues on an overdraft bank balance in accordance
with a contract between the bank and the entity.
211 An example of such a transaction is as follows:
The bank statement of AC Entity for July 20.7, which was received electronically from the
bank, indicates that on 31 July 20.7 the bank added interest to the amount of R4 628 to the
overdraft bank balance.
Source documents
212 The following source document is applicable in respect of the recognition of interest accrued
on an overdraft bank balance:
•
The bank statement from the bank for the relevant month.
Recognition of the transaction
Items/accounts and elements
213 When interest is charged on an overdraft bank balance, the two items brought about by the
transaction are the expense-item interest on bank overdraft (increase) and the liabilities-item
bank overdraft (increase). The accounts involved are therefore “Interest expense on bank
overdraft” and “Bank”. This transaction affects the element expenses and the element
liabilities.
Date and amount of initial recognition
214 The interest expense on an overdraft bank balance results from the subsequent
measurement of the bank overdraft. Subsequent measurement of the bank overdraft at
amortised cost causes an increase in the liabilities-item bank overdraft and an increase in
the expense-item interest on bank overdraft due to the interest that accrued.
215 An item that satisfies the definition of an expense is recognised when a decrease in future
economic benefits, associated with a decrease that occurred in an asset or an increase that
occurred in a liability, can be measured reliably. An expense that arises due to the
subsequent measurement of a liability is therefore recognised simultaneously with the
increase in the associated liabilities-item (bank overdraft in this example). The increase in
the liabilities-item bank overdraft is recognised on the date on which the item satisfies the
definition and recognition criteria of a liability.
203
216 As at 31 July 20.7, interest accrued on the overdraft bank balance in accordance with the
agreement with the bank. On 31 July 20.7 a legal obligation arose towards the bank and on
this date the increase in the overdraft bank balance satisfied the definition and recognition
criteria of a liability. The expense-item interest on bank overdraft is consequently recognised
simultaneously with the increase in the liabilities-item bank overdraft, thus on 31 July 20.7.
217 The amount at which the increase in the liabilities-item bank overdraft should be measured
and recognised, is the amount of the accrued interest as calculated by the bank and
reflected on the bank statement, namely R4 628. The increase in the expense-item interest
on bank overdraft is measured and recognised at the same amount on 31 July 20.7.
Double entry rules
218 Since the increase in the expense-item interest on bank overdraft to the amount of R4 628
(which causes a decrease in retained earnings/equity) and the accompanying increase in the
liabilities-item bank overdraft to the amount of R4 628 satisfied the definition and recognition
criteria of an expense and a liability respectively on 31 July 20.7, the items have to be
recognised in the records of AC Entity on 31 July 20.7 in accordance with the double entry
system.
219 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
220 The double entry rules in respect of the recognition of interest that accrued on an overdraft
bank balance, are as follows:
Debit Interest expense on bank overdraft – that is the expense-item/account that increases
Credit Bank – that is the liabilities-item/account that increases
and is supported by the following journal:
20.7
31 Jul
Dr
4 628
Interest expense on bank overdraft
Bank
Cr
4 628
Assets
=
Liabilities
+
Equity
Classification
0
=
+4 628
+
- 4 628
Retained earnings – Expense
(Interest expense)
Remarks in respect of the journal
1
The date of the journal above is the date on which the interest is charged on the
cheque account statement of the bank.
2
The subsequent measurement of the bank overdraft occurs at the amortised cost
thereof, namely the debt plus accumulated interest.
3
The description of the bank account remains “bank” and does not vary between “bank”
and “bank overdraft” as the balance fluctuates between a debit balance and a credit
balance.
204
Income
221 In the execution of an entity’s operating activities, an entity incurs costs such as cost of
sales, salaries, water and electricity, etcetera. Expenses relate to a specific reporting period
and are incurred to generate income.
222 Income also has reference to a specific reporting period and is the result of the operating
activities of an entity. As indicated by the definition, income is increases in economic benefits
during the accounting period in the form of inflows or enhancements of assets (such as trade
receivables) or decreases of liabilities that result in increases in equity (retained earnings),
other than those relating to contributions from equity participants (Conceptual Framework
2010.4.25(a)). Sales are the main income-item of a trading entity and represent the gross
inflow of economic benefits resulting from the sale of trade inventories by an entity.
223 Subsequently the following income-items are dealt with: sales (for cash or on credit), rent
income and interest income.
224 As is known, income that is incurred during the reporting period, are credited against
appropriate income accounts (temporary accounts), and not directly against retained
earnings. At the end of the reporting period the income accounts are closed off against
retained earnings by crediting retained earnings and debiting the respective income
accounts. Refer to the example of the rent income account in Annexure 2 at the end of this
chapter. The effect of the closing off process is to increase retained earnings with the income
as at the end of the year. The closing off process is dealt with in Chapter 7.
225 An item that satisfies the definition of income is recognised when an increase in future
economic benefits related to an increase in an asset or a decrease of a liability has arisen
that can be measured reliably (Conceptual Framework 2010.4.47). An income-item is
therefore recognised simultaneously with/at the same time as the increase in the associated
asset (cash or for example trade receivables) and the associated asset is recognised if the
asset-item satisfies the definition and recognition criteria of an asset. The income-item is
measured at the same amount at which the increase in the asset-item is measured.
Cash sales of trade inventories
226 In this section the application of concepts, principles and rules in respect of the cash sale of
trade inventories is dealt with.
227 Cash sales originate from transactions where an entity sells trade inventories to a customer
for cash on the premises of the entity (over-the-counter-sales) or delivers the goods to the
customer and the customer pays immediately (COD (cash-on-delivery) sales).
228 The payment does not necessarily take place in the form of notes and coins, but can also
occur electronically through the utilisation of debit and credit cards or the payment can occur
per EFT or per cheque. The acceptance of cheques for cash sales is, due to an increasing
occurrence of cheque fraud, falling into disuse.
The transaction: Cash sale of trade inventories (perpetual inventory system)
229 This transaction entails that trade inventories are sold for cash to a customer.
205
230 An example of such a transaction is as follows:
On 10 January 20.7, AC Entity sold trade inventories for R14 000 cash. AC Entity uses the
perpetual inventory system. The cost price of the goods sold is R6 720.
Source documents
231 The following source document is applicable in respect of the cash sale of trade inventories:
•
A cash invoice prepared by the terminal at the point of sale.
Recognition of the income resulting from the transaction
Items/accounts and elements
232 When trade inventories are sold for cash (and the entity uses the perpetual inventory
system), the items brought about by the transaction are the income-item sales (increase), the
asset-item cash (increase), the expense-item cost of sales (increase) and the asset-item
trade inventories (decrease). Subsequently, only the income part of the transaction, namely
sales and cash, is dealt with. The accounts involved are therefore “Sales” and “Bank”. This
part of the transaction affects the element income and the element assets. (As set out in
Chapter 2 paragraphs 150 and 151, the item cash satisfies the definition and recognition
criteria of an asset and as set out in Chapter 2 paragraphs 221 and 222, the item sales
satisfies the definition and recognition criteria of income.)
Date and amount of initial recognition
233 An item that satisfies the definition of income is recognised when an increase in future
economic benefits associated with an increase that occurred in an asset, can be measured
reliably. An income-item that is incurred in cash is therefore recognised simultaneously with
the increase in the associated asset-item cash. The increase in the asset-item cash is
recognised on the date on which it satisfies the definition and recognition criteria of an asset.
234 The increase in the income-item sales is therefore recognised simultaneously with the
increase in the asset-item cash. The increase in the asset-item cash is recognised on
10 January 20.7, the date on which cash satisfied the definition and recognition criteria of an
asset.
235 The amount at which the increase in the asset-item cash should initially be measured and
recognised, is the historical cost price thereof, namely the invoice price to the amount of
R14 000. The increase in the income-item sales is measured and recognised at the same
amount on 10 January 20.7.
Double entry rules
236 Since the increase in the income-item sales to the amount of R14 000 (which causes an
increase in retained earnings/equity) and the accompanying increase in the asset-item cash
to the amount of R14 000 satisfied the definition and recognition criteria of income and an
asset respectively on 10 January 20.7, the items have to be recognised in the records of
AC Entity on 10 January 20.7 in accordance with the double entry system.
237 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
206
238 The double entry rules in respect of the cash sale of trade inventories are as follows:
Debit Bank – that is the asset-item/account that increases
Credit Sales – that is the income-item/account that increases
and is supported by the following journal:
20.7
10 Jan
Dr
14 000
Bank
Sales
Cr
14 000
Assets
=
Liabilities
+
Equity
Classification
+14 000
=
0
+
+14 000
Retained earnings – Income
(Sales)
Recognition of the expense resulting from the transaction
Items/accounts and elements
239 As already mentioned, another two items are brought about by the transaction if the entity
uses the perpetual inventory system, namely the expense-item cost of sales (increase) and
the asset-item trade inventories (decrease). Subsequently only the expense part of the
transaction, namely cost of sales and trade inventories, is dealt with. The accounts involved
are therefore “Cost of sales” and “Trade inventories”. This part of the transaction affects the
element expenses and the element assets. (As set out in Chapter 2 paragraphs 228 and
229, the expense-item cost of sales satisfies the definition and recognition criteria of an
expense.)
Date and amount of initial recognition
240 The increase in the expense-item cost of sales, which satisfies the definition of an expense,
is recognised when a decrease in future economic benefits, associated with a decrease in an
asset (trade inventories in this example), can be measured reliably. The expense-item cost
of sales is therefore recognised simultaneously with the decrease in the associated assetitem trade inventories. The decrease in the asset-item trade inventories is recognised when
the decrease can be measured reliably, namely the day on which the trade inventories are
handed over to the customer.
241 The expense-item cost of sales is recognised simultaneously with the derecognition of the
asset-item trade inventories, and specifically on the day on which the trade inventories are
handed over to the customer, namely 10 January 20.7 in this example.
242 The amount at which the expense-item cost of sales should be measured and recognised, is
the amount at which the decrease in trade inventories is measured, namely the cost of the
trade inventories sold as calculated by the perpetual inventory system, that is R6 720.
Double entry rules
243 Since the increase in the expense-item cost of sales to the amount of R6 720 (which causes
a decrease in retained earnings/equity) satisfied the definition and recognition criteria of an
expense on 10 January 20.7 and the accompanying decrease in the asset-item trade
inventories to the amount of R6 720 occurred on the same day and can be measured
reliably, the items have to be recognised in the records of AC Entity on 10 January 20.7 in
accordance with the double entry system.
207
244 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
245 The double entry rules in respect of the recognition of cost of sales are as follows:
Debit Cost of sales – that is the expense-item/account that increases
Credit Trade inventories – that is the asset-item/account that decreases
and is supported by the following journal:
20.7
10 Jan
Dr
6 720
Cost of sales
Trade inventories
Cr
6 720
Assets
=
Liabilities
+
Equity
Classification
- 6 720
=
0
+
- 6 720
Retained earnings – Expense
(Cost of sales)
Credit sales of trade inventories
246 In this section the application of concepts, principles and rules in respect of the credit sale of
trade inventories is discussed.
247 Credit sales of trade inventories are one of the main characteristics of the post-modern
economy. If trade inventories are sold to a customer on credit, payment does not take place
with the delivery of the trade inventories to the customer since there is a credit term that can
elapse before the payment has to take place. A credit term can be 30 days or 60 days or
sometimes even 90 days. This concession by suppliers to customers is referred to as trade
credit and during this credit term no interest is charged.
248 As already known, the credit legislation in South Africa requires that the credit provider (the
selling entity in this instance), obtains predetermined information regarding the customer
before a trade credit limit is granted to the customer. The credit legislation’s aim is to protect
the credit supplier and especially the credit-taker. In the context of the credit sale of trade
inventories, the credit sale and the subsequent cash flow are separate transactions.
249 In accordance with accrual accounting, the effect of credit transactions is recognised when
the historical event, which causes control of an asset or the rise of a legal obligation,
occurred and not when the resulting cash inflow or cash outflow occurred. The practical
implication is that an income (sales) that is generated by means of a credit transaction is
recognised when the accompanying trade receivable (asset) qualifies for recognition in
accordance with the recognition criteria.
The transaction: Credit sale of trade inventories (perpetual inventory system)
250 This transaction entails that trade inventories are sold on credit to a pre-approved customer.
208
251 An example of such a transaction is as follows:
On 15 March 20.7, AC Entity sold trade inventories for R24 000 on credit to Receivable A.
The goods were delivered on the same day to Receivable A. AC Entity uses the perpetual
inventory system. The cost price of the goods sold is R9 600.
Source documents
252 The following source documents are applicable in respect of the credit sale of trade
inventories:
•
An order from the customer;
•
A sales invoice issued by the selling entity;
•
A delivery note issued by the selling entity and signed by the customer; and
•
A copy of the goods received note issued by the customer.
Recognition of the transaction
Items/accounts and elements
253 When trade inventories are sold on credit (and the entity uses the perpetual inventory
system), the items brought about by the transaction are the income-item sales (increase), the
asset-item cash (increase), the expense-item cost of sales (increase) and the asset-item
trade inventories (decrease). The accounts involved are therefore “Sales”, “Receivable A”,
“Cost of sales” and “Trade inventories”. This transaction affects the element income, the
element assets and the element expenses. (As set out in Chapter 2 paragraphs 238 and
239, the item trade receivable (Receivable A) satisfies the definition and recognition criteria
of an asset and as set out in Chapter 2 paragraphs 221 and 222 as well as 228 and 229, the
item sales and the item cost of sales satisfies the definition and recognition criteria of income
and an expense respectively.)
Date and amount of initial recognition
254 An item that satisfies the definition of income is recognised when an increase in future
economic benefits associated with an increase that occurred in an asset, can be measured
reliably. The increase in the income-item sales is therefore recognised simultaneously with
the increase in the asset-item Receivable A. The increase in the asset-item Receivable A is
recognised on 15 March 20.7, the date on which the receivable satisfied the definition and
recognition criteria of an asset.
255 The amount at which the increase in the asset-item Receivable A should initially be
measured and recognised, is the historical cost price thereof, namely the invoice price to the
amount of R24 000. The increase in the income-item sales is measured and recognised at
the same amount.
256 An item that satisfies the definition of an expense, is recognised when a decrease in future
economic benefits, associated with a decrease in an asset (trade inventories in this
example), can be measured reliably. The expense-item cost of sales is therefore recognised
simultaneously with the derecognition of the asset-item trade inventories, and specifically on
the day on which the trade inventories are delivered to the customer, namely 15 March 20.7
in this example.
257 The amount at which the expense-item cost of sales should be measured and recognised, is
the amount at which the decrease in trade inventories is measured, namely the cost of the
trade inventories sold as calculated by the perpetual inventory system, that is R9 600.
209
Double entry rules
258 Since the increase in the income-item sales to the amount of R24 000 (which causes an
increase in retained earnings/equity) and the accompanying increase in the asset-item
Receivable A to the amount of R24 000 satisfied the definition and recognition criteria of
income and an asset respectively on 15 March 20.7, the items have to be recognised in the
records of AC Entity on 15 March 20.7 in accordance with the double entry system.
259 Since the increase in the expense-item cost of sales to the amount of R9 600 (which causes
a decrease in retained earnings/equity) satisfied the definition and recognition criteria of an
expense on 15 March 20.7 and the accompanying decrease in the asset-item trade
inventories to the amount of R9 600 occurred on the same day and can be measured
reliably, the items have to be recognised in the records of AC Entity on 15 March 20.7 in
accordance with the double entry system.
260 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
261 The double entry rules in respect of the credit sale of trade inventories (by an entity that uses
the perpetual inventory system) are as follows:
Debit Receivable A – that is the asset-item/account that increases
Credit Sales – that is the income-item/account that increases
as well as
Debit Cost of sales – that is the expense-item/account that increases
Credit Trade inventories – that is the asset-item/account that decreases
and is supported by the following journals:
20.7
15 March
Dr
24 000
Receivable A
Sales
Cr
24 000
Assets
=
Liabilities
+
Equity
Classification
+24 000
=
0
+
+24 000
Retained earnings – Income
(Sales)
as well as
20.7
15 March
Dr
9 600
Cost of sales
Trade inventories
Cr
9 600
Assets
=
Liabilities
+
Equity
Classification
- 9 600
=
0
+
- 9 600
Retained earnings – Expense
(Cost of sales)
210
Example 5.13 Cash and credit sales
AE Entity’s current reporting period ends on 31 December 20.7. AE Entity uses the perpetual
inventory system.
On 26 December 20.7 the following balances, amongst others, appeared in the records of
AE Entity:
Buildings (cost price) (useful life 20 years)
Accumulated depreciation – buildings (1 Jan 20.7)
Vehicles (cost price) (useful life 5 years)
Accumulated depreciation – vehicles (1 Jan 20.7)
Furniture and equipment (cost price) (useful life 10 years)
Accumulated depreciation – furniture & equipment (1 Jan 20.7)
Trade inventories
Receivable A
Receivable B
Receivable C
Receivable D
Bank
Capital
Retained earnings (1 Jan 20.7)
Drawings
Payable K
Payable L
Payable Jozi
Sales
Cost of sales
Employee benefits
Water and electricity
Telephone and communication
Insurance
Bad debts
Bank charges
Administrative expenses
Acc
A2.1
A2.2
A4.1
A4.2
A5.1
A5.2
A20
D1
D2
D3
D4
A30
E1
E2.1
E2.2
K1
K2
K7
I1
U1
U3
U4
U6
U8
U11
U15
U19
Dr
1 800 000
Cr
180 000
250 000
100 000
450 000
90 000
466 000
450 000
320 000
280 000
44 000
512 000
6 000 000
1 020 000
600 000
275 000
240 000
40 500
6 500 000
2 600 000
1 230 000
435 000
350 000
275 000
185 000
34 500
575 000
The following transactions/events still have to be recognised in the records of AE Entity:
1
On 28 December 20.7, trade inventories that were ordered from Payable K on 18 December
20.7, were received. The invoice amounts to R160 000 and is payable on or before
26 January 20.8.
2
The amount due to Payable Jozi in respect of the utilisation of water and electricity during
November 20.7, namely R21 000, was paid on 28 December 20.7 by means of an electronic
funds transfer.
3
The amount due by Receivable A was paid directly into AE Entity’s bank account on
29 December 20.7 by means of an electronic funds transfer.
4
Cash sales of R250 000 were deposited into the bank account on 30 December 20.7. The
cost of the trade inventories sold is R100 000.
211
5
On 30 December 20.7 trade inventories were sold on credit to Receivable B and also
delivered on this day. The invoice indicates the amount as R375 000 and is payable on or
before 28 January 20.8. The cost of the trade inventories sold is R150 000.
6
The December 20.7 net salaries to the amount of R120 000 were paid on 30 December
20.7. The following represents a summary of the payroll schedule for December 20.7:
Gross remuneration
Pensionable salaries
Deductions
185 000 Medical aid fund
Pension fund
Taxation
13 875 Total deductions
15 000
213 875 Net remuneration
Employer contributions
Pension fund
Medical aid fund
Gross remuneration
20 250
27 750
45 875
93 875
120 000
7
The cheque account statement for December 20.7 was received on 30 December 20.7. The
statement indicates the bank charges as R3 200.
8
On 31 December 20.7 the credit manager approved the write-off of Receivable D’s account
as irrecoverable.
9
On 31 December 20.7 the owner deposited a further R500 000 as a capital contribution into
the entity’s bank account.
10
Depreciation for the year ended 31 December 20.7 still has to be recognised as at
31 December 20.7 by applying the straight-line method.
Required:
a)
Indicate, by means of journal entries, how transactions/events 1, 2, 5, 6, 8 and 10 (only in
respect of buildings) should be recognised in the records (general journal) of AE Entity for
the reporting period ended 31 December 20.7.
Note:Journal narrations, with a reference to the source document(s), as well as the effect of
the transaction/event on the accounting equation are required.
b)
After accounting for the additional information, prepare the statement of profit or loss and the
statement of changes in equity of AE Entity for the reporting period ended 31 December
20.7.
Example 5.13 Solution
a) Journal entries
J1 (Transaction 1)
20.7
28 Dec Trade inventories
Payable K
Recognise trade inventories purchased on credit per
invoice K773. See GRN848 for receipt of goods.
Assets
=
Liabilities
+
Equity
+160 000
=
+160 000
+
0
212
Nr
A20
K1
Dr
160 000
Cr
160 000
Classification
J2 (Transaction 2)
20.7
28 Dec Payable Jozi
Bank
Derecognise Payable Jozi due to settlement per
EFT123
Assets
=
Liabilities
+
Equity
- 21 000
=
- 21 000
+
0
Nr
K7
A30
Dr
21 000
Cr
21 000
Classification
J3 (Transaction 5)
20.7
30 Dec Receivable B
Sales
Recognise credit sales per invoice AE9190
Nr
D2
I1
Dr
375 000
Cr
375 000
Assets
=
Liabilities
+
Equity
Classification
+375 000
=
0
+
+375 000
Retained earnings – Income
(Sales)
J4 (Transaction 5)
20.7
30 Dec Cost of sales
Trade inventories
Recognise cost of sales. Refer to invoice AE9190 and
delivery note DN456.
Nr
U1
A20
Dr
150 000
Cr
150 000
Assets
=
Liabilities
+
Equity
Classification
- 150 000
=
0
+
- 150 000
Retained earnings – Expense
(Cost of sales)
J5 (Transaction 6)
20.7
30 Dec Employee benefits
Bank
Medical aid fund contributions
Pension fund contributions
SARS – PAYE
Recognise payroll for December 20.7 as well as
accompanying liabilities
Nr
U3
A30
L11.7
L11.6
L11.5
Dr
213 875
Cr
120 000
20 250
27 750
45 875
Assets
=
Liabilities
+
Equity
Classification
- 120 000
=
+93 875
+
- 213 875
Retained earnings – Expense
(Employee benefits)
213
J6 (Event 8)
20.7
31 Dec Bad debts
Receivable D
Derecognise Receivable D due to its irrecoverability.
Refer to letter of approval AE 222 by credit manager.
Nr
U11
D4
Dr
44 000
Cr
44 000
Assets
=
Liabilities
+
Equity
Classification
- 44 000
=
0
+
- 44 000
Retained earnings – Expense
(Bad debts)
J7 (Event 10 – buildings)
20.7
31 Dec Depreciation – buildings
Accumulated depreciation – buildings
Recognise depreciation on buildings for 20.7. Refer to
authorised depreciation schedule.
90 000 = 1 800 000 ÷ 20
Nr
U20.1
Dr
90 000
Cr
A2.2
90 000
Assets
=
Liabilities
+
Equity
Classification
- 90 000
=
0
+
- 90 000
Retained earnings – Expense
(Depreciation)
b) Statement of profit or loss and statement of changes in equity
AE ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Sales (cr 6 500 000 cr 250 000 cr 375 000)
Cost of sales (dr 2 600 000 dr 100 000 dr 150 000)
Gross profit
Salaries and wages (dr 1 230 000 dr 213 875)
Water and electricity
Telephone and communication
Insurance
Depreciation (dr 90 000 dr 50 000 dr 45 000)
Bad debts (dr 185 000 dr 44 000)
Bank charges (dr 34 500 dr 3 200)
Other administrative expenses
Profit for the year
214
R
7 125 000
(2 850 000)
4 275 000
(1 443 875)
(435 000)
(350 000)
(275 000)
(185 000)
(229 000)
(37 700)
(575 000)
744 425
AE ENTITY
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.7
Capital
R
6 000 000
Balance at 31 December 20.6
Changes in equity for 20.7
Additional capital contribution by owner
Profit for the year
Distribution to owner (drawings)
Balance at 31 December 20.7
Retained
earnings
R
1 020 000
Total
R
7 020 000
500 000
6 500 000
744 425
(600 000)
1 164 425
500 000
744 425
(600 000)
7 664 425
Calculations:
Dr
Cost of sales
2 600 000
100 000
150 000
2 850 000
Cr
Dr
Salaries
1 230 000
213 875
1 443 875
Cr
Dr
Bad debts
185 000
44 000
229 000
Cr
Dr
Cr
Bank charges
34 500
3 200
37 700
Dr
Sales
Cr
6 500 000
250 000
375 000
7 125 000
Remark in respect of the abovementioned calculations
1
The abovementioned calculations (informal T-accounts) can also merely be done
between brackets next to the line item in the relevant financial statement – refer to the
financial statements.
Example 5.14 A deposit required with the order
On 1 July 20.7, AC Entity (a wholesaler) received an order from Receivable D (a retailer) for 25
units of a specialised item at an agreed price of R4 000 per unit, together with a deposit of
R60 000. Due to the nature of the item, AC Entity does not keep stock of this item. AC Entity
ordered the number of units from Manufacturer K and consequently expected Receivable D to pay
AC Entity 60% of the invoice price with the order.
On 24 July 20.7, AC Entity received the relevant goods from the manufacturer at an invoice price
of R56 000, which is payable on or before 23 August 20.7. On 28 July 20.7, AC Entity delivered
the goods, together with the invoice, to the premises of Receivable D. The invoice price is
R100 000 and the remaining amount, after accounting for the deposit of R60 000, is payable on or
before 27 August 20.7. AC Entity uses the perpetual inventory system.
Required:
a)
Recognise the above transactions in the records (general journal) of AC Entity. Provide a
brief motivation for each of the journals.
b)
Recognise the above transactions in the records (general journal) of D Entity (Receivable D).
Provide a brief motivation for each of the journals.
215
Example 5.14 Solution
a) AC Entity journal entries
J1
20.7
1 Jul
Bank
Receivable D
Recognise deposit received with the order. Receipt K607
Assets
=
Liabilities
+
Equity
+60 000
=
+60 000
+
0
Dr
60 000
Cr
60 000
Classification
Motivation for above approach
On 1 July 20.7, AC Entity’s bank account must be debited with R60 000 since the amount was
received on this day. (Refer to Chapter 2 paragraphs 150 and 151 where it is indicated that cash
received satisfies the definition and recognition criteria of an asset.)
In order to decide which account must be credited, it is necessary to argue within the context of the
accounting equation:
•
Capital (equity) did not change since the deposit does not represent a capital contribution.
•
Retained earnings (equity) did not change since the deposit does not satisfy the definition of
income and the income-item sales can therefore not be recognised on 1 July 20.7. An
income-item that satisfies the definition of income is recognised when an increase in future
economic benefits related to an increase in an asset or decrease of a liability has arisen that
can be measured reliably (Conceptual Framework 2010.4.47).
•
The only alternative is therefore that a liability must be credited. The deposit received has
the nature of a loan (received). By referring to the definition and recognition criteria of a
liability, it can be indicated that the deposit received must be recognised as a liability. The
appropriate account to credit is Receivable D’s account. D Entity (Receivable D) is under the
current circumstances, until the inventory items are delivered, a payable of AC Entity. This
liability is derecognised on the day on which the inventory items are delivered (see
journal J3).
J2
20.7
24 Jul
Trade inventories
Manufacturer K
Received trade inventories ordered. Purchased per invoice
K773. Refer GRN848 for receipt of items.
Assets
+56 000
=
=
Liabilities
+56 000
+
+
Equity
0
Dr
56 000
Cr
56 000
Classification
Motivation for above approach
Trade inventories purchased on credit and the accompanying trade payable are recognised if the
trade inventories satisfy the definition and recognition criteria of an asset and if the trade payable
satisfies the definition and recognition criteria of a liability. It can be indicated that these
requirements are met. (Refer to Chapter 2 paragraphs 167 to 170.)
216
J3
20.7
28 Jul
Dr
100 000
Receivable D
Sales
Recognise credit sale per invoice AC9190 on day of
delivery
Cr
100 000
Assets
=
Liabilities
+
Equity
Classification
+100 000
=
0
+
+100 000
Retained earnings – Income
(Sales)
Motivation for above approach
An item that satisfies the definition of income is recognised when an increase in future economic
benefits associated with an increase that occurred in an asset, can be measured reliably. The
increase in the income-item sales is therefore recognised simultaneously with the increase in the
associated asset-item Receivable D. The increase in the asset-item Receivable D is recognised
when it satisfies the definition and recognition criteria of an asset, namely 28 July 20.7 in this
example. As set out in Chapter 2 paragraphs 238 and 239, the item trade receivable
(Receivable D) satisfies the definition and recognition criteria of an asset and as set out in
Chapter 2 paragraphs 221 and 222, the item sales satisfies the definition and recognition criteria of
income. (The recognition of income from the sale of trade inventories is comprehensively dealt
with in Chapter 22.)
J4
20.7
28 Jul
Cost of sales
Trade inventories
Recognise cost of sales. Refer invoice AC9190 and
delivery note DN456.
Dr
56 000
Cr
56 000
Assets
=
Liabilities
+
Equity
Classification
- 56 000
=
0
+
- 56 000
Retained earnings – Expense
(Cost of sales)
Motivation for above approach
An item that satisfies the definition of an expense, is recognised when a decrease in future
economic benefits, associated with a decrease that occurred in an asset (trade inventories in this
example), can be measured reliably. The expense-item cost of sales is therefore recognised
simultaneously with the derecognition of the associated asset-item trade inventories, and
specifically on the day on which the trade inventories are delivered to the customer, namely
28 July 20.7 in this example. (As set out in Chapter 2 paragraphs 228 and 229 cost of sales
satisfies the definition and recognition criteria of an expense.)
217
b) D Entity journal entries
J1
20.7
1 Jul
Payable AC
Bank
Recognise deposit paid with the order. Cheque 1234
Assets
=
+60 000
=
Liabilities
+
Equity
+
0
Dr
60 000
Cr
60 000
Classification
-60 000
Motivation for above approach
On 1 July 20.7, D Entity’s bank account must be credited with R60 000 since the amount was paid
on this day. In order to decide which account must be debited, it is necessary to argue within the
context of the accounting equation:
•
Capital (equity) did not change.
•
Retained earnings (equity) did not change since the payment does not represent drawings
and since the payment was not made in respect of an expense.
•
Liabilities did not change.
•
The only alternative is that an asset must be debited. Trade inventories cannot be debited
since the inventories have not yet been received. The deposit paid has the nature of a loan
(made) to AC Entity. By referring to the definition and recognition criteria of an asset it can
be indicated that the deposit paid must be recognised as an asset. The appropriate account
to debit is Payable AC’s account. AC Entity is, under the current circumstances, until the
inventory items are delivered, a receivable of D Entity. This asset is derecognised on the day
on which the credit purchase of the inventory items is recognised (see journal J2).
J2
20.7
28 Jul
Trade inventories
Payable AC
Recognise trade inventories purchased per invoice AC9190
on day of delivery
Assets
=
Liabilities
+
+100 000
=
+100 000
+
Equity
Motivation for above approach
Refer to the motivation for journal J2 in AC Entity’s records.
218
Dr
100 000
Cr
100 000
Classification
Other income
262 Entities usually have, in addition to the main income-item sales, also other income that
arises from the utilisation of an entity’s assets by another party. In this section the following is
dealt with as examples of such income-items: rent income (because the entity rents out a
part of its buildings) and interest income (on a term deposit as well as on the favourable
balance of the entity’s bank account).
Rent income
263 If an entity does not utilise the entity’s property to its full capacity, a portion thereof can be
rented out. The renting out of property must take place in accordance with the stipulations of
a written lease agreement between the parties. Each of the two parties involved recognise
the lease transaction in the relevant entity’s records. For the lessee it is about the recognition
of a rent expense incurred in cash. (Refer to Example 5.3). For the lessor it is about the
recognition of rent income received in cash. (Refer to Example 5.15 that follows). With
regards to rent income, the lessor of property incurs certain expenses such as assessment
rates and maintenance of the buildings. These expenses are recognised when it is incurred.
The letting of property is comprehensively dealt with in Chapter 18.
264 The lease agreement will inter alia deal with the deposit, the lease amount that must be paid
monthly at the beginning of each month as well as the lease term.
265 It is normal practice that a lease agreement contains a stipulation that, at inception of the
lease term, the lessee pays a refundable deposit to the lessor. At the end of the lease term,
the lessor repays the deposit to the lessee, except if the lessee damaged the property/lease
item. In such an instance, depending on the extent of the damage, the lessor will repay only
a portion or nothing of the deposit to the lessee. The lessee recognises a rent deposit paid
as an asset since it satisfies the definition as well as the recognition criteria of an asset.
(Refer to Annexure 3). The lessor recognises a rent deposit received as a liability since it
satisfies the definition as well as the recognition criteria of a liability.
266 Subsequently the application of concepts, principles and rules in respect of rent income is
dealt with.
The transaction: Rent income received in cash
267 This transaction entails that an entity rents out a tangible non-current asset to a third party in
accordance with a written lease agreement.
268 An example of such a transaction is as follows:
During June 20.7, AC Entity concluded a written lease agreement to rent out an unutilised
portion of the entity’s property to the lessee, H Entity. AC Entity’s bank statement indicates
on 1 July 20.7 a direct deposit of R12 000 by H Entity, being the lease instalment for
July 20.7.
Source documents
269 The following source documents are applicable in respect of the renting out of a non-current
asset with a physical characteristic:
•
The written lease agreement; and
•
The relevant bank statement or a copy of the EFT or deposit by the lessee.
219
Recognition of the transaction
Items/accounts and elements
270 When a tangible non-current asset (e.g. buildings) is rented out, the two items brought about
by the transaction are the income-item rent income (increase) and the asset-item cash
(increase). The accounts involved are therefore “Rent income” and “Bank”. This transaction
affects the element income and the element assets. (As set out in Chapter 2 paragraphs 150
and 151, the item cash satisfies the definition and recognition criteria of an asset and as set
out in Chapter 2 paragraphs 255 and 256, the item rent income satisfies the definition and
recognition criteria of income.)
Date and amount of initial recognition
271 An item that satisfies the definition of income is recognised when an increase in future
economic benefits associated with an increase that occurred in an asset, can be measured
reliably. An income-item that is incurred in cash is therefore recognised simultaneously with
the increase in the associated asset-item cash. The increase in the asset-item cash is
recognised on the date on which it satisfies the definition and recognition criteria of an asset.
272 The increase in the income-item rent income is therefore recognised simultaneously with the
increase in the asset-item cash. The increase in the asset-item cash is recognised on 1 July
20.7, the date on which cash satisfied the definition and recognition criteria of an asset.
273 The amount at which the increase in the asset-item cash should initially be measured and
recognised, is the historical cost price thereof, namely the lease amount of R12 000 as
stipulated in the lease agreement. The increase in the income-item rent income is measured
and recognised at the same amount on 1 July 20.7.
Double entry rules
274 Since the increase in the income-item rent income to the amount of R12 000 (which causes
an increase in retained earnings/equity) and the accompanying increase in the asset-item
cash to the amount of R12 000 satisfied the definition and recognition criteria of income and
an asset respectively on 1 July 20.7, the items have to be recognised in the records of
AC Entity on 1 July 20.7 in accordance with the double entry system.
275 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
276 The double entry rules in respect of rent income received in cash are as follows:
Debit Bank – that is the asset-item/account that increases
Credit Rent income – that is the income-item/account that increases
and is supported by the following journal:
20.7
1 Jul
Dr
12 000
Bank
Rent income
Cr
12 000
Assets
=
Liabilities
+
Equity
Classification
+12 000
=
0
+
+12 000
Retained earnings – Income
(Rent income)
220
Interest income on a term deposit
277 If an entity has a favourable bank balance that is more than what would be required in the
short term to carry out the entity’s operating activities, the entity can consider transferring
funds from the bank account to a fixed term deposit at the bank. The motivation for the
investment of funds in a fixed term deposit is that the interest rate on a term deposit can be
up to three percentage points higher than the interest rate on a favourable bank balance. A
term deposit is a financial asset. (Refer to paragraph 129.) The interest usually accrues
evenly over the term of the deposit and will be reflected similarly by the bank on the
statement for the term deposit.
278 Subsequently the application of concepts, principles and rules in respect of interest income
on a term deposit is dealt with.
The transaction: Interest income on a term deposit
279 This transaction entails that, in accordance with an agreement, interest accrues on a term
deposit which have already been made.
280 An example of such a transaction is as follows:
On 1 July 20.7, AC Entity invested R800 000 for one year. (This transaction has already
been recognised.) The interest rate is 8% per year and interest is calculated on a simple
basis. The capital plus interest will be paid into AC Entity’s bank account on 30 June 20.8.
AC Entity’s current reporting date is 31 December 20.7. Appropriate interest income for 20.7
still has to be recognised.
Source documents
281 The following source document is applicable in respect of the recognition of interest income
on a term deposit:
•
The statement from the bank for the period of the term deposit.
Recognition of the transaction
Items/accounts and elements
282 When interest is earned on a term deposit, the two items brought about by the transaction
are the income-item interest income on term deposit (increase) and the asset-item term
deposit (increase). The accounts involved are therefore “Interest income on term deposit”
and “Term deposit”. This transaction affects the element income and the element assets. (As
set out in Annexure 3, the item increase in term deposit satisfies the definition and
recognition criteria of an asset and the item interest income on term deposit satisfies the
definition of income.)
Date and amount of initial recognition
283 The interest income on the term deposit results from the subsequent measurement of the
term deposit. Subsequent measurement of the term deposit at amortised cost causes an
increase in the asset-item term deposit and an increase in the income-item interest on term
deposit due to the interest that accrued.
284 An item that satisfies the definition of income is recognised when an increase in future
economic benefits associated with an increase that occurred in an asset, can be measured
reliably. An income-item that arises due to the subsequent measurement of an asset is
therefore recognised simultaneously with the increase in the associated asset-item (term
deposit in this example). The increase in the asset-item term deposit is recognised on the
date on which it satisfies the definition and recognition criteria of an asset.
221
285 The increase in the income-item interest income on term deposit is recognised
simultaneously with the increase in the associated asset-item term deposit. The increase in
the asset-item term deposit is recognised on 31 December 20.7, the date on which the
increase in the term deposit satisfied the definition and recognition criteria of an asset.
286 The amount at which the increase in the asset-item term deposit should be measured and
recognised, is the amount of the accrued interest as calculated in accordance with the
agreement, namely R32 000 (R800 000 x 8% x 6/12). The increase in the income-item
interest on term deposit is measured and recognised at the same amount on 31 December
20.7.
Double entry rules
287 Since the increase in the income-item interest income on term deposit to the amount of
R32 000 (which causes an increase in retained earnings/equity) and the accompanying
increase in the asset-item term deposit to the amount of R32 000 satisfied the definition and
recognition criteria of income and an asset respectively on 31 December 20.7, the items
have to be recognised in the records of AC Entity on 31 December 20.7 in accordance with
the double entry system.
288 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
289 The double entry rules in respect of the recognition of interest income on a term deposit are
as follows:
Debit Term deposit – that is the asset-item/account that increases
Credit Interest income on term deposit– that is the income-item/account that increases
and is supported by the following journal:
20.7
31 Dec
Assets
+32 000
Term deposit
Interest income on a term deposit
=
=
Liabilities
0
+
+
Equity
+32 000
Dr
32 000
Cr
32 000
Classification
Retained earnings – Income
(Interest income)
Remarks in respect of the journal
1
The term deposit was measured with initial recognition at the historical cost price
thereof, namely R800 000.
2
The subsequent measurement of a financial asset, such as a term deposit, occurs on
the reporting date at amortised cost. Amortised cost of a term deposit is the historical
cost (R800 000), increased with the accumulated interest income/interest income that
accrued (R32 000).
Interest income on favourable bank balance
290 As already known, internal control procedures require that an entity deposits total cash
receipts in the entity’s current bank account (cheque account) on a daily basis. All payments
by the entity occur from the bank account. No material amounts are paid with cash notes or
cash coins. When the entity wants to utilise some of the cash in the bank, for instance to pay
rent, an instruction is given to the bank to make the payment on behalf of the entity. The
instruction from an entity to its bank can be given in the form of a cheque, over the counter,
telephonically or electronically.
222
291 A current bank account is usually an account with a debit balance in the entity’s records. The
bank balance of an entity with an overdraft facility can vary frequently between a debit
balance and a credit balance in the entity’s records. A bank account with a debit balance in
the entity’s records in essence means that the bank owes the amount to the entity. Banks
consequently adds an interest amount to the entity’s funds in the bank account at the end of
each month. The interest is calculated at a relatively low interest rate on favourable
balances. The interest appears on the cheque account statement that is received from the
bank for the relevant month.
292 This interest addition is known as interest income from the entity’s point of view. Interest
income is a further example of an income that is received in cash.
293 Subsequently the application of concepts, principles and rules in respect of interest income
on a favourable bank balance is dealt with.
The transaction: Interest income on a favourable bank balance
294 This transaction entails that, in accordance with an agreement with the bank, interest
accrues on the daily varying favourable balance of the current bank account.
295 An example of such a transaction is as follows:
The bank statement of AC Entity for July 20.7, which was received electronically from the
bank, indicates that on 31 July 20.7 the bank added interest to the amount of R2 214 to the
favourable balance.
Source documents
296 The following source document is applicable in respect of the recognition of interest income
on a favourable bank balance:
•
The bank statement from the bank for a specific month.
Recognition of the transaction
Items/accounts and elements
297 When interest is earned on a favourable bank balance, the two items brought about by the
transaction are the income-item interest income on favourable bank balance (increase) and
the asset-item bank (increase). The accounts involved are therefore “Interest income on
favourable bank balance” and “Bank”. This transaction affects the element income and the
element assets.
Date and amount of initial recognition
298 The interest income on the favourable bank balance results from the subsequent
measurement of the daily varying favourable balance of the current account. Subsequent
measurement of the favourable bank balance at amortised cost causes an increase in the
asset-item bank and an increase in the income-item interest on favourable bank balance due
to the interest that accrued.
299 An item that satisfies the definition of income is recognised when an increase in future
economic benefits associated with an increase that occurred in an asset, can be measured
reliably. An income-item that arises due to the subsequent measurement of an asset is
therefore recognised simultaneously with the increase in the associated asset-item
(favourable bank balance in this example). The increase in the asset-item bank is recognised
on the date on which it satisfies the definition and recognition criteria of an asset.
300 The increase in the income-item interest income on favourable bank balance is recognised
simultaneously with the increase in the associated asset-item bank. The increase in the
asset-item bank is recognised on 31 July 20.7, the date on which the increase in the
favourable bank balance satisfied the definition and recognition criteria of an asset.
223
301 The amount at which the increase in the asset-item bank should be measured and
recognised, is the amount of the accrued interest as reflected on the bank statement on
31 July 20.7, namely R2 214. The increase in the income-item interest on favourable bank
balance is measured and recognised at the same amount on 31 July 20.7.
Double entry rules
302 Since the increase in the income-item interest income on favourable bank balance to the
amount of R2 214 (which causes an increase in retained earnings/equity) and the
accompanying increase in the asset-item bank to the amount of R2 214 satisfied the
definition and recognition criteria of income and an asset respectively on 31 July 20.7, the
items have to be recognised in the records of AC Entity on 31 July 20.7 in accordance with
the double entry system.
303 The double entry rules bring about that, in respect of each transaction/event, the dual effect
of the transaction/event on the accounting equation is accounted for by debiting at least one
account and crediting at least one other account.
304 The double entry rules in respect of the recognition of interest income on a favourable bank
balance are as follows:
Debit Bank – that is the asset-item/account that increases
Credit Interest income on favourable bank balance – that is the income-item/account that
increases
and is supported by the following journal:
20.7
31 Jul
Bank
Interest income on a favourable bank balance
Dr
2 214
Cr
2 214
Assets
=
Liabilities
+
Equity
Classification
+2 214
=
0
+
+2 214
Retained earnings – Income
(Interest income)
Remark
1
The subsequent measurement of the asset-item bank occurs at the favourable bank
balance plus the accrued interest of R2 214.
Example 5.15 Rent income and interest income
AC Entity’s current reporting period ends on 31 December 20.7.
On 31 December 20.7 the following balances, amongst others, appeared in the records of the
entity:
Nr
A24
A30
I4.1
I4.3
U15
Fixed term deposit
Bank
Rent income
Interest income on favourable bank balance
Bank charges
224
Dr
800 000
1 476 000
Cr
60 000
32 080
56 020
Additional information
1
On 30 September 20.7 the entity invested R800 000 in a term deposit for 12 months at 8%
per year. The interest is added at the end of each term and is calculated on a simple basis.
The appropriate interest income for 20.7 still has to be recognised.
2
The bank statement/cheque account statement for December 20.7 inter alia indicates that
bank charges amount to R6 030 for the month and that interest that accrued on the
favourable bank balance amounts to R3 020 for the month. These two items still have to be
recognised in the records of AC Entity.
3
In accordance with a lease agreement (AC Entity is the lessor), which was signed on
1 November 20.7, the lease instalment of R20 000 in total is payable by the lessee at the
beginning of each month for various low value assets. Furthermore, in accordance with the
lease agreement, the lessee paid a refundable deposit of R20 000 on 1 November 20.7. The
lease term is from 1 November 20.7 to 31 October 20.8. All the amounts were received in
accordance with the lease agreement and credited to the rent income account. The
necessary adjustment in respect of the rent income account still has to be made. (As set out
in Annexure 3, the rent deposit received satisfies the definition and recognition criteria of a
liability in the lessor’s records.)
Required:
a)
Recognise the interest income on the favourable bank balance, the bank charges and the
interest income on the term deposit as at 31 December 20.7 in the records (general journal)
of AC Entity for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transaction/event on the accounting
equation are required.
b)
Provide the journal entry to rectify the rent income account in AC Entity’s records on
31 December 20.7 and therefore recognise the rent deposit received in AC Entity’s records
(general journal) for the reporting period ended 31 December 20.7.
Note:Journal narrations as well as the effect of the transaction/event on the accounting
equation are required.
c)
After accounting for the journal entries in (a) and (b) above, present the relevant balances in
the appropriate financial statements of AC Entity for the reporting period ended
31 December 20.7.
d)
Recognise the rent transactions that occurred on 1 November 20.7 in the records (general
journal) of the lessee.
Note:Journal narrations as well as the effect of the transaction/event on the accounting
equation are required.
e)
Provide the journal entry(entries) that must be recognised on the expiry date of the term
deposit in the records (general journal) of AC Entity.
Note:Journal narrations as well as the effect of the transaction/event on the accounting
equation are required.
Remark in respect of the term deposit
1
If interest is added once at the end of the term, it does not mean that the interest
accrues only at the end of the term. The interest accrues evenly, but is calculated on a
simple basis.
225
Example 5.15 Solution
a) Journal entries
J1
20.7
31 Dec
Bank
Interest income on favourable bank balance
Recognise interest income for December 20.7 on
favourable bank balance
Assets
+3 020
J2
20.7
31 Dec
Liabilities
0
+
+
Equity
+3 020
Bank charges
Bank
Recognise bank charges for December 20.7
Assets
- 6 030
J3
20.7
31 Dec
=
=
=
=
Liabilities
0
+
+
Equity
- 6 030
Term deposit
Interest income on term deposit
Recognise interest income for October – December
20.7 on term deposit
R800 000 x 8% x 3/12
Assets
+16 000
=
=
Liabilities
0
+
+
Equity
+16 000
Nr
A30
I4.3
Dr
3 020
Cr
3 020
Classification
Retained earnings – Income
(Interest income)
Nr
U15
A30
Dr
6 030
Cr
6 030
Classification
Retained earnings – Expense
(Bank charges)
Nr
A24
I4.2
Dr
16 000
Cr
16 000
Classification
Retained earnings – Income
(Interest income)
b) Journal entry to recognise rent deposit
J4
20.7
31 Dec Rent income
Rent deposit (received)
Adjustment: Recognise rent deposit received on 1 Nov
20.7
Assets
Nr
I4.1
L11.3
Dr
20 000
Cr
20 000
=
Liabilities
+
Equity
Classification
=
+20 000
+
- 20 000
Retained earnings – Income
Rent income (decrease)
226
Remarks in respect of the abovementioned journal
1
The journal could also have been dated 1 November 20.7.
2
The rent income account decreases as a result of an adjustment. An adjustment of an
error is always journalised as follows: The account that was erroneously credited is
debited and the correct account is credited and vice versa.
c) Presentation of the account balances
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
R
Sales
Cost of sales
Gross profit
Interest income (cr 32 080 cr 3 020) cr 16 000
Rent income (cr 60 000 dr 20 000)
////
Bank charges (dr 56 020 dr 6 030)
////
Profit for the year
xxx
(xxx)
xxx
51 100
40 000
(62 050)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
ASSETS
Current assets
Term deposit (dr 800 000 dr 16 000)
Cash and cash equivalents (dr 1 476 000 dr 3 020 cr 6 030)
816 000
1 472 990
EQUITY AND LIABILITIES
Current liabilities
Trade and other payables
20 000
Calculations:
Dr
Bank
Cr
1 476 000
6 030
3 020
1 472 990
1 479 020
1 479 020
1 472 990
Dr
Rent income
20 000
40 000
60 000
Cr
Dr
Dr
Term deposit
800 000
16 000
816 000
Interest income
(favourable bank
balance)
60 000
Cr
Dr
Cr
32 080
3 020
35 100
60 000
40 000
227
Dr
Bank charges
56 020
6 030
62 050
Cr
Interest income
(term deposit)
Cr
16 000
Remark in respect of the abovementioned calculations
1
The abovementioned calculations (informal T-accounts) can also merely be done
between brackets next to the line item in the relevant financial statement – refer to the
financial statements.
d) Journal entries – Lessee’s records
J1
20.7
1 Nov
Nr
Dr
20 000
20 000
Rent expense
Rent deposit (paid)
Bank
Recognise rent expense and rent deposit paid in
accordance with the lease agreement
Cr
40 000
Assets
=
Liabilities
+
Equity
Classification
- 40 000
=
0
+
-20 000
Retained earnings – Expense
(Rent expense)
+20 000
e) Journal entries in AC Entity’s records on maturity date of term deposit
J5
20.8
30 Sep
Term deposit
Interest income on term deposit
Recognise interest income for Jan – Sep 20.8 on term
deposit
R800 000 x 8% x 9/12
Nr
A24
I4.2
Dr
48 000
Cr
48 000
Assets
=
Liabilities
+
Equity
Classification
+48 000
=
0
+
+48 000
Retained earnings – Income
(Interest income)
J6
20.8
30 Sep
Bank
Term deposit
Derecognise term deposit on maturity date
Assets
=
Liabilities
+
Equity
+864 000
- 864 000
=
0
+
0
228
Nr
A30
A24
Dr
864 000
Cr
864 000
Classification
Annexure 1
Rent expense incurred in cash
Consider the following rent expense account with a lease payment payable at the beginning of
each month in respect of the short term lease of buildings for the relevant month.
Dr
U12 Rent expense
Date
20.7
1 Jan
1 Feb
1 Mar
1 Apr
1 May
1 Jun
1 Jul
1 Aug
1 Sep
1 Oct
1 Nov
1 Dec
Contra account
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Nr
Amount
Date
20.7
15 000 31 Dec
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
180 000
Cr
Contra account
Retained earnings
Nr
Amount
180 000
180 000
Remarks in respect of the rent expense account
1
The rent incurred represents an expense. (Refer to Annexure 3 for a comprehensive
discussion as to why the rent expense satisfies the definition of an expense.)
2
The recognition of the transactions occurs in the same way every month. The lease
payments are accumulated in the rent expense account and at the end of the reporting
period the account is closed off against retained earnings which results in a decrease in
retained earnings. The closing-off process is dealt with in Chapter 7.
3
Detail of all expenses as dealt with above and closed off against retained earnings are
reflected in the statement of profit or loss to indicate the entity’s performance (profit/loss for
the year).
229
Water and electricity expense incurred on credit
Consider the following water and electricity account. At the end of each month, a statement is
received for the water and electricity used/consumed during the month. The statement for
month N is payable before the 25th of month N+1.
Dr
U4 Water and electricity
Date
20.7
30 Jan
28 Feb
30 Mar
30 Apr
30 May
30 Jun
30 Jul
30 Aug
30 Sep
30 Oct
30 Nov
30 Dec
Contra account
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Payable Jozi
Nr
Amount
Date
20.7
12 500 31 Dec
11 700
12 200
13 200
13 800
15 200
15 700
14 200
13 100
12 700
12 300
12 200
158 800
Cr
Contra account
Retained earnings
Nr
Amount
158 800
158 800
Remarks in respect of the expense account
1
The water and electricity used/consumed represents an expense. (Refer to Chapter 2
Example 2.2 (c)(iii) for a comprehensive discussion as to why the water and electricity
expense satisfies the definition of an expense.)
2
The recognition of the transactions occurs in the same way every month. The water and
electricity utilised are accumulated in the water and electricity account and at the end of the
reporting period the account is closed off against retained earnings which results in a
decrease in retained earnings. The closing-off process is dealt with in Chapter 7.
3
Detail of all expenses as dealt with above and closed off against retained earnings are
reflected in the statement of profit or loss to indicate the entity’s performance (profit/loss for
the year).
230
Annexure 2
Rent income received in cash
Consider the following rent income account with a rent receipt at the beginning of each month in
respect of the renting out of the buildings for the relevant month.
Dr
I4.1 Rent income
Date
Contra account
20.7
31 Dec
Retained earnings
Nr
Amount
Date
20.7
180 000 1 Jan
1 Feb
1 Mar
1 Apr
1 May
1 Jun
1 Jul
1 Aug
1 Sep
1 Oct
1 Nov
1 Dec
180 000
Cr
Contra account
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Bank
Nr
Amount
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
15 000
180 000
Remarks in respect of the rent income account
1
The rent received represents an income. (Refer to Chapter 2 paragraph 255 for a
comprehensive discussion as to why rent income satisfies the definition of income.)
2
The recognition of the transactions occurs in the same way every month. The rent receipts
are accumulated in the rent income account and at the end of the reporting period the
account is closed off against retained earnings which results in an increase in retained
earnings. The closing-off process is dealt with in Chapter 7.
3
Detail of all income as dealt with above and closed off against retained earnings are
reflected in the statement of profit or loss to indicate the entity’s performance (profit/loss for
the year).
231
Annexure 3
Application of definitions and recognition criteria
Contents
Bad debts
Bank charges
Bank loan (accumulated interest component)
Depreciation
Employee benefits expense
Interest expense on bank loan
Interest income on term deposit
Machinery
Payroll creditors
Rent deposit paid
Rent deposit received
Rent expense
Rent income
Supplier’s loan
Term deposit
Term deposit (accumulated interest component)
232
Page
233
234
235
236
237
238
239
240
241
242
243
244
245
246
247
248
Bad debts
It can be indicated as follows that bad debts satisfies the definition of an expense:
Definition of an expense
Application – bad debts
Expenses are decreases in
economic benefits during the
accounting period in the form of
outflows or depletions of assets
or incurrences of liabilities
Bad debts are a decrease in economic benefits during the
accounting period in the form of a decrease in assets (trade
receivable).
that result in decreases in
equity, other than those relating
to distributions to equity
participants.
The decrease in economic benefits arising from the
recognition of bad debts results in a decrease in the assetitem trade receivable and an increase in the expense-item
bad debts.
The expense-item bad debts that increases, decreases the
profit for the accounting period.
If the profit decreases, there is a decrease in equity (retained
earnings).
233
Bank charges
It can be indicated as follows that bank charges satisfies the definition of an expense:
Definition of an expense
Application – bank charges
Expenses are decreases in
economic benefits during the
accounting period in the form of
outflows or depletions of assets
or incurrences of liabilities
Bank charges incurred are a decrease in economic benefits
for a specific month/period during the accounting period in the
form of an outflow of cash.
that result in decreases in
equity, other than those relating
to distributions to equity
participants.
The decrease in economic benefits arising from the payment
of bank charges results in a decrease in the asset-item cash
and an increase in the expense-item bank charges.
The expense-item bank charges that increases, decreases
the profit for the accounting period.
If the profit decreases, there is a decrease in equity (retained
earnings).
234
Bank loan (accrued interest component)
It can be indicated as follows that the increase in the loan as a result of the interest that accrues
satisfies the definition and recognition criteria of a liability:
Definition of a liability
Application – accrued interest component of loan
A liability is a present obligation
of the entity
As a result of the interest that accrues (on the original amount
borrowed) in accordance with the loan agreement, the bank
has a legally enforceable right to claim from the entity and the
entity has a legally enforceable obligation towards the bank.
arising from past events
The accrual of interest during the period 1 July 20.7 to
31 December 20.7, in accordance with the loan agreement, is
the past event that gave rise to the present, legal obligation of
the entity.
the settlement of which is
expected to result in an outflow
from the entity of resources
embodying economic benefits.
The settlement of the loan is expected to result in the outflow
of cash in the future (31 December 20.9).
Recognition criteria of a
liability
Application – accrued interest component of loan
An item that meets the definition
of a liability is recognised only if
it satisfies both the following
recognition criteria:
As indicated above, the increase in the loan as a result of the
accumulated interest satisfies the definition of a liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The incurrence of the legal obligation on 31 December 20.7
(as a result of the incurrence of the loan agreement, the
receipt of the borrowed funds that already occurred as well as
the accrual of the interest) leaves the entity no other choice
but to settle the obligation on the future date stipulated in the
loan agreement.
the item has a cost or a value
that can be measured reliably.
The cost of the increase in the loan can be measured reliably
as the accumulated interest as indicated on the loan
statement received. (R30 000 = R500 000 x 12% x 6/12 in
this case.)
235
Depreciation
It can be indicated as follows that depreciation satisfies the definition of an expense:
Definition of an expense
Application – depreciation
Expenses are decreases in
economic benefits during the
accounting period in the form of
outflows or depletions of assets
or incurrences of liabilities
Depreciation is a decrease in economic benefits during the
accounting period in the form of a decrease in depreciable
non-current assets, e.g. equipment.
that result in decreases in
equity, other than those relating
to distributions to equity
participants.
The decrease in economic benefits arising from the
recognition of depreciation results in a decrease in the assetitem depreciable non-current assets, e.g. equipment, and an
increase in the expense-item depreciation.
The expense-item depreciation that increases, decreases the
profit for the accounting period.
If the profit decreases, there is a decrease in equity (retained
earnings).
236
Employee benefits-expense
It can be indicated as follows that the employee benefits expense satisfies the definition of an
expense:
Definition of an expense
Application – employee benefits expense
Expenses are decreases in
economic benefits during the
accounting period in the form of
outflows or depletions of assets
or incurrences of liabilities
Employee benefits incurred is a decrease in economic
benefits for a specific month during the accounting period in
the form of an outflow of cash (net remuneration) as well as in
the form of the incurrence of liabilities (deductions withheld for
payment to institutions on behalf of employees).
that result in decreases in
equity, other than those relating
to distributions to equity
participants.
The decrease in economic benefits arising from the
incurrence of the employee benefits expense results in a
decrease in the asset-item cash as well as the increase in the
liabilities-items payroll creditors and an increase in the
expense-item employee benefits.
The expense-item employee benefits that increases,
decreases the profit for the accounting period.
If the profit decreases, there is a decrease in equity (retained
earnings).
237
Interest expense on bank loan
It can be indicated as follows that the interest expense on a bank loan satisfies the definition of an
expense:
Definition of an expense
Application – interest expense on bank loan
Expenses are decreases in
economic benefits during the
accounting period in the form of
outflows or depletions of assets
or incurrences of liabilities
Interest accrued on a bank loan is a decrease in economic
benefits during the accounting period in the form of the
incurrence of a liability (the accrued interest component of the
bank loan).
that result in decreases in
equity, other than those relating
to distributions to equity
participants.
The decrease in economic benefits arising from the accrual of
interest results in the increase in the liabilities-item bank loan
and an increase in the expense-item interest on bank loan.
The expense-item interest on bank loan that increases,
decreases the profit for the accounting period.
If the profit decreases, there is a decrease in equity (retained
earnings).
238
Interest income on term deposit
It can be indicated as follows that the interest income on a term deposit satisfies the definition of
income:
Definition of income
Application – interest income on a term deposit
Income is increases in economic
benefits during the accounting
period in the form of inflows or
enhancements of assets or
decreases of liabilities
Interest income on a term deposit is an increase in economic
benefits during the accounting period in the form of an
increase in assets (the term deposit).
that result in increases in equity,
other than those relating to
contributions from equity
participants.
The increase in economic benefits arising from the interest
that accrues on the term deposit results in an increase in the
asset-item term deposit and an increase in the income-item
interest income on term deposit.
The income-item interest income on term deposit that
increases, increases the profit for the accounting period.
If the profit increases there is an increase in equity (retained
earnings).
239
Machinery
It can be indicated as follows that machinery satisfies the definition and recognition criteria of an
asset:
Definition of an asset
Application – machinery
An asset is a resource
A machine is a resource for an entity since it can be used in
the execution of operating activities which are performed to
generate income.
controlled by the entity as a
result of past events
Machinery is controlled by the entity as physical possession
of the machinery has transferred to the entity. The risks and
rewards associated with ownership of the machinery have
passed to the entity. As a result the entity will have the ability
to direct the use of the machinery and will obtain substantially
all the remaining benefits from the machinery.
The past event is as a result of the purchase transaction
(purchase contract) for the machinery between the entity and
the supplier, and the delivery of the machinery to the entity on
31 December 20.7.
and from which future economic
benefits are expected to flow to
the entity.
Future economic benefits are expected to flow to the entity
when the machine is used during the execution of operating
activities.
Recognition criteria of an asset Application – machinery
An item that meets the definition
of an asset is recognised only if
it satisfies both the following
recognition criteria:
As set out above, a machine satisfies the definition of an
asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
The machinery will probably be utilised in the executing of
activities of the entity. In this context, future economic benefits
will more likely than not flow to the entity.
the item has a cost or a value
that can be measured reliably.
The cost of the machine can be measured reliably at the
historical cost price thereof, namely the invoice price of
R400 000.
240
Payroll creditors
It can be indicated as follows that the payroll creditors (medical aid fund, pension fund and SARS)
satisfy the definition and the recognition criteria of a liability:
Definition of a liability
Application – payroll creditors
A liability is a present obligation
of the entity
As a result of the employment contracts between the
employees and the entity (the employer) as well as the
Income tax act, the entity has a legal obligation to retain
determinable amounts from the employees’ gross
remuneration and to pay it over to the institutions on behalf of
the employees before the seventh day of the coming month.
arising from past events
The satisfactory service delivery by the employees in
accordance with the employment contracts as well as the
arrival of the pay day are the past events that gave rise to the
present, legal obligation of the entity towards the respective
payroll creditors.
the settlement of which is
expected to result in an outflow
from the entity of resources
embodying economic benefits.
The settlement of the obligations towards the payroll creditors
is expected to result in the outflow of cash in the future (before
the seventh day of the coming month).
Recognition criteria of a
liability
Application – payroll creditors
An item that meets the definition
of a liability is recognised only if
it satisfies both the following
recognition criteria:
As indicated above, the payroll creditors satisfy the definition
of a liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The incurrence of the legal obligation on 30 January 20.7 (as
a result of the satisfactory service delivery by the employees
in accordance with the employment contracts as well as the
Income tax act) leaves the entity no other choice but to settle
the obligations on the specific future dates.
the item has a cost or a value
that can be measured reliably.
The cost of the payroll creditors can be measured reliably at
the historical cost price thereof, namely the amounts as
reflected in the relevant payroll/salaries schedule.
241
Rent deposit paid
It can be indicated as follows that a rent deposit paid satisfies the definition and recognition criteria
of an asset:
Definition of an asset
Application – rent deposit paid
An asset is a resource
The enforceable right to claim the rent deposit from the
lessor at the end of the lease term is a resource to the entity
since economic benefits will flow to the entity in the form of
cash when the lessor repays the deposit.
controlled by the entity as a result
of past events
The deposit paid has been accepted by the lessor. The
entity also has the legal right to the refundable deposit. As a
result the entity will have the ability to direct the right of use
of the rent deposit paid and will obtain substantially all the
remaining benefits from rent deposit paid.
The past events are the entering into and signing of the
lease agreement as well as the payment of the rent deposit
by the entity.
and from which future economic
benefits are expected to flow to
the entity.
Future economic benefits are expected to flow to the entity
as the deposit is expected to be repaid to the entity at the
end of the lease term.
Recognition criteria of an asset
Application – rent deposit paid
An item that meets the definition
of an asset is recognised only if it
satisfies both the following
recognition criteria:
As set out above, the rent deposit paid satisfies the definition
of an asset.
it is probable that future economic
benefits associated with the item
will flow to the entity; and
An acquired asset-item such as a refundable deposit, which
satisfies the definition of an asset, will probably cause the
inflow of future economic benefits when the entity gives
notice for the termination of the services.
The date on which the inflow of future economic benefits
became probable is the date on which control was obtained
over the right to claim, and that is the date on which the
refundable deposit was paid, namely 2 January 20.6.
the item has a cost or a value that
can be measured reliably.
The cost of the rent deposit can be measured reliably at the
historical cost price thereof, namely the deposit amount of
R20 000 that was paid in accordance with the lease
agreement.
242
Rent deposit received
It can be indicated as follows that a rent deposit received satisfies the definition and recognition
criteria of a liability:
Definition of a liability
Application – rent deposit received
A liability is a present obligation
of the entity
As a result of the payment of the rent deposit by the lessee to
the entity (the lessor) in accordance with the lease agreement,
the lessee has a legally enforceable right to claim from the
entity and the entity has a legally enforceable obligation
towards the lessee.
arising from past events
The receipt of the rent deposit by the entity on 1 November
20.7 in accordance with the lease agreement is the past event
that gave rise to the present, legal obligation of the entity.
the settlement of which is
expected to result in an outflow
from the entity of resources
embodying economic benefits.
The repayment of the rent deposit to the lessee is expected to
result in the outflow of cash in the future (31 October 20.8).
Recognition criteria of a
liability
Application – rent deposit received
An item that meets the definition
of a liability is recognised only if
it satisfies both the following
recognition criteria:
As indicated above, the rent deposit received satisfies the
definition of a liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The incurrence of the legal obligation on 1 November 20.7
(the day on which the rent deposit was received in
accordance with the lease agreement) leaves the entity no
other choice but to repay the deposit on the future date as
determined by the lease agreement.
(The entity can withhold the rent deposit only if the lessee
damaged the property and this would probably only be
confirmed at the end of the lease term.)
(The lessee would probably not forfeit the deposit through its
own actions.)
the item has a cost or a value
that can be measured reliably.
The cost of the rent deposit received can be measured
reliably at the historical cost price thereof, namely the amount
of R20 000 received in accordance with the lease agreement.
243
Rent expense
It can be indicated as follows that rent expense (as per IFRS 16) (which is paid in cash) on a short
term lease satisfies the definition of an expense:
Definition of an expense
Application – rent expense
Expenses are decreases in
economic benefits during the
accounting period in the form of
outflows or depletions of assets
or incurrences of liabilities
A rent expense that is incurred in cash, is a decrease in
economic benefits for a specific month/period during the
accounting reporting period in the form of an outflow of cash.
that result in decreases in
equity, other than those relating
to the distributions to equity
participants.
The decrease in economic benefits arising from the payment
of the lease instalment results in a decrease in the asset-item
cash and an increase in the expense-item rent.
The expense-item rent that increases, decreases the profit for
the accounting period.
If the profit decreases, there is a decrease in equity (retained
earnings).
244
Rent income
It can be indicated as follows that the rent income satisfies the definition of income:
Definition of income
Application – rent income
Income is increases in economic
benefits during the accounting
period in the form of inflows or
enhancements of assets or
decreases of liabilities
Rent income that is received in cash, is an increase in
economic benefits for a specific month/period during the
accounting period in the form of an inflow of cash.
that result in increases in equity,
other than those relating to
contributions from equity
participants.
The increase in economic benefits arising from the renting out
of for example buildings for cash, results in an increase in the
asset-item cash and an increase in the income-item rent
income.
The income-item rent income that increases, increases the
profit for the accounting period.
If the profit increases there is an increase in equity (retained
earnings).
245
Supplier’s loan
The supplier’s loan satisfies the definition and recognition criteria of a liability as follows:
Definition of a liability
Application – supplier’s loan
A liability is a present obligation
of the entity
As a result of the delivery of the machine by the supplier to
the entity (the purchaser) in accordance with the loan
agreement/purchase contract, the supplier has a legally
enforceable right to claim from the entity and the entity has a
legally enforceable obligation towards the supplier.
arising from past events
The delivery of the machine on 31 December 20.7 in
accordance with the loan agreement/purchase contract is the
past event that gave rise to the present, legal obligation of the
entity.
the settlement of which is
expected to result in an outflow
from the entity of resources
embodying economic benefits.
The settlement of the loan from the supplier is expected to
result in the outflow of cash in the future (30 December 20.8).
Recognition criteria of a
liability
Application – supplier’s loan
An item that meets the definition
of a liability is recognised only if
it satisfies both the following
recognition criteria:
As indicated above, the supplier’s loan satisfies the definition
of a liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The incurrence of the legal obligation on 31 December 20.7
(the day on which the supplier delivered the machine in
accordance with the contract) leaves the entity no other
choice but to settle the obligation on the future date as agreed
upon in the loan agreement/purchase contract.
the item has a cost or a value
that can be measured reliably.
The cost of the supplier’s loan can be measured reliably at
the historical cost price thereof, namely the invoice price of
the machine of R400 000, as stipulated in the purchase
contract.
246
Term deposit
The acquired term deposit satisfies the definition and recognition criteria of an asset as follows:
Definition of an asset
Application – term deposit
An asset is a resource
The enforceable right to claim in respect of the amount
deposited with the bank is a resource for the entity since
economic benefits in the form of cash will flow to the entity
when the term of the deposit expires.
controlled by the entity as a
result of past events
The entity has the legal right to the term deposit. As a result
the entity will have the ability to direct the right of use of the
term deposit and will obtain substantially all the remaining
benefits from the term deposit.
The past events are the entering into and signing of the
deposit agreement between the bank and the entity as well as
the transferring of the deposit amount to the bank.
and from which future economic
benefits are expected to flow to
the entity.
Future economic benefits are expected to flow to the entity as
it is expected that the bank will, in accordance with the
agreement, repay the initial deposit to the entity on
30 December 20.8.
Recognition criteria of an
asset
Application – term deposit
An item that meets the definition
of an asset is recognised only if
it satisfies both the following
recognition criteria:
As set out above, the term deposit satisfies the definition of an
asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
The term deposit will more likely than not be refunded to the
entity by the bank in accordance with the deposit agreement.
In this context future economic benefits will probably flow to
the entity. The date on which the inflow of future economic
benefits became probable is the date on which the entity
obtained control over the right to claim from the bank, and that
is the date on which the transfer was made to the bank in
accordance with the agreement, namely 31 December 20.7.
the item has a cost or a value
that can be measured reliably.
The cost of the term deposit can be measured reliably at the
historical cost price thereof, namely the cost of the investment
(R100 000) which was transferred to the bank per EFT.
247
Term deposit (accrued interest component)
It can be indicated as follows that the increase in the term deposit as a result of interest that
accrues satisfies the definition and recognition criteria of an asset:
Definition of an asset
Application – accrued interest component of term deposit
An asset is a resource
The enforceable right to claim in respect of the interest that
accrues on the initial amount deposited with the bank, is a
resource for the entity since economic benefits in the form of
cash will flow to the entity when the term of the deposit
expires.
controlled by the entity as a
result of past events
The entity has the legal right to the accrued interest on the
term deposit. As a result the entity will have the ability to
direct the right of use of the interest on the term deposit and
will obtain substantially all the remaining benefits from the
interest on the term deposit.
The past events are the entering into and signing of the
deposit agreement between the bank and the entity with the
interest accruing in accordance with the stipulation of the
agreement.
and from which future economic
benefits are expected to flow to
the entity.
Future economic benefits are expected to flow to the entity as
it is expected that the bank will, in accordance with the
agreement, repay the initial deposit as well as the accrued
interest to the entity on 30 June 20.8 (the end of the term of
the deposit).
Recognition criteria of an
asset
Application – accrued interest component of term deposit
An item that meets the definition
of an asset is recognised only if
it satisfies both the following
recognition criteria:
As set out above, the increase in the term deposit as a result
of accrued interest satisfies the definition of an asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
The interest will more likely than not accrue and subsequently
be paid to the entity in accordance with the deposit
agreement. In this context future economic benefits will
probably flow to the entity.
The date on which the inflow of future economic benefits
became probable is the date on which the entity obtained
control over the right to claim from the bank, and that is the
date on which the interest accrued in accordance with the
agreement, namely 31 December 20.7.
the item has a cost or a value
that can be measured reliably.
The cost of the increase in the term deposit can be measured
reliably as the accumulated interest as indicated on the term
deposit statement received. (R32 000 = R800 000 x 8% x 6/12
in this case.).
248
Chapter 6 Review and adjustments
Contents
Introductory comments
Reporting date versus approval date
Review process
Assets
Depreciable non-current assets
Trade inventories
Trade receivables
Other current assets – office supplies on hand
Term deposit
Cash and cash equivalents
Equity
Capital
Drawings
Liabilities
Loans
Trade and other payables
Expenses
Office supplies
Rent expense
Insurance
Water and electricity
Interest expense
Income
Rent income
Interest income
Recognition of adjustments
Reclassification of a portion of an expense as an asset
Office supplies on hand on the reporting date
Prepaid rent expense
Prepaid insurance
Accrued cash expenses
Rent expense payable
Expenses incurred on credit
Water and electricity expense and telephone expense
Interest expense accrued on loan but not yet recognised
Income receivable
Rent income receivable
Interest income accrued on a term deposit but not yet recognised
Income received in advance
Rent income received in advance
Trade inventories
The perpetual inventory system – a brief overview
Withdrawal of trade inventories by the owner for personal use
Recognition of inventory shortages
Recognition of the write-down of certain inventory items’ cost to the net
realisable value thereof
The periodic inventory system – a brief overview
249
Paragraph
1
7
9
10
10
11
13
15
16
17
19
19
20
23
23
24
25
25
26
27
28
29
30
30
31
32
53
56
62
69
75
75
80
80
82
84
84
89
91
91
95
97
99
102
104
108
Examples
Example
6.1
6.2
6.3
6.4
6.5
6.6
6.7
6.8
6.9
Office supplies on hand
Prepaid rent expense
Prepaid expenses – insurance premium and rent
Rent expense payable
Interest expense accrued on a loan
Interest income accrued on a term deposit
Withdrawal of trade inventories by the owner and write-downs of trade inventories
Periodic inventory system
Correction of errors
250
Chapter 6 Review and adjustments
Introductory comments
1
A thorough review in respect of each category (assets, liabilities, equity, income and
expenses) general ledger accounts takes place as part of the financial procedures with
regards to the end of the reporting period. Resulting from this review process, certain
transactions and events still have to be recognised in respect of the current reporting period.
2
Financial statements have to provide a fair presentation of the financial position (statement of
financial position) and financial performance (statement of profit or loss) of an entity. Fair
presentation is obtained by providing a faithful representation of transactions and events, in
accordance with the definitions and recognition criteria of assets, liabilities, income and
expenses, as set out in the Conceptual Framework 2010.
3
Even if transactions and events are recognised with due care, errors and omissions will still
occur. For example, a rent deposit (paid) could erroneously be debited to the rent expense
account or depreciation for a specific reporting period still has to be written off on for example
furniture. The fact that the financial statements are prepared in respect of a specific reporting
period (usually 12 months), brings about that transactions that take place close to the end of
the reporting period can possibly be recognised in the wrong reporting period.
4
It is consequently necessary for an expert to often (but especially during the end of the
reporting period) review the accounts with insight in order to identify errors and omissions.
This review of the accounts will also include a review of the documentation that is received
after the reporting date.
5
Resulting from this review process, certain transactions and events still have to be
recognised in respect of the current reporting period. In Accounting these transactions and
events in respect of errors and omissions, are referred to as adjustments. Consequently,
distinction is sometimes made in this context, between a pre-adjustment trial balance and a
post-adjustment trial balance.
6
The correction of errors and omissions (adjustments) are journalised/recognised in the same
way as other transactions and events. In the preceding chapters, the effect of the journal
entry on the elements of the accounting equation was reflected below each journal entry. As
from this chapter, this practice is replaced by indicating in brackets next to each account
mentioned in a journal entry one of the following abbreviations:
•
P/L (Statement of profit or loss) for income and expense accounts;
•
SCE (Statement of changes in equity) for the capital and drawings account; and
•
SFP (Statement of financial position) for asset and liability accounts.
251
Reporting date versus approval date
7
The financial statements of an entity with a reporting period that ends on 31 December 20.7,
will only be finalised during January 20.8. The date on which the completed financial
statements are approved by the owner for distribution, is known as the approval date. The
financial statements are therefore completed in the period between the reporting date and the
approval date. During the period between the reporting date and the approval date,
transactions and events can still be recognised, with 31 December 20.7 as effective date. For
example, if the bank statement/cheque account statement for December 20.7 was only
received on 6 January 20.8, the bank charges and the interest income on the favourable
bank balance (or the interest expense on the overdraft bank balance), as indicated on the
bank statement, still have to be recognised (during January 20.8), with 31 December 20.7 as
the effective date. The journals for these transactions are generated during the period
31 December 20.7 to the date on which the financial statements are completed for approval.
(The date of these journals is 31 December 20.7 and are posted as at 31 December 20.7.)
These transactions that are recognised between the reporting date and the approval date,
affect assets, liabilities, income and expenses. Recognition of these transactions may
however only occur in respect of those assets, liabilities, income and expenses that satisfied
the definition and recognition criteria of the specific element(s) on or before 31 December
20.7.
8
In Accounting, income accounts, expense accounts and the drawings account are known as
temporary accounts. These accounts are only used to accumulate the effect of relevant
transactions for a specific reporting period (e.g. 20.7). As soon as the financial statements
are approved for distribution on for example 4 February 20.8, the temporary accounts for 20.7
are closed off against retained earnings with effective date 31 December 20.7. From 1
January 20.8 a new set of accounts for income, expenses and drawings for the 20.8 reporting
period is used. It is merely continued in 20.8 to use the existing accounts for assets, liabilities
and capital. During the period 31 December 20.7 to 4 February 20.8 journals that relate to the
20.7 reporting period are generated. During this period, 20.8 operating activities however also
take place for which journals with a 20.8 date are generated. The journals for the 20.8
reporting period can however only be posted to the general ledger after the temporary
accounts for 20.7 are closed off against the appropriate accounts. Also refer to Chapter 7
paragraphs 6 to 10.
Review process
9
As part of the financial procedures in respect of the end of the reporting period, a thorough
review of each category (assets, liabilities, equity, income and expenses) general ledger
accounts has to take place. This process can cause adjustments to be recognised. The
review process is summarised in the following paragraphs by means of questions that could
possibly be asked.
Assets
Depreciable non-current assets
10
Has depreciation for the current reporting period been appropriately written off on each
depreciable non-current asset?
252
Trade inventories
11
Have all inventory shortages (with regards to the perpetual inventory system) been
recognised?
12
Have write-downs to net realisable value been recognised, where necessary?
Trade receivables
13
Have all irrecoverable amounts already been recognised as irrecoverable/an expense?
14
Have all credit sales before and after the reporting date, been recognised in the correct
reporting period?
Other current assets – office supplies on hand
15
Have office supplies on hand been recognised as an asset at the end of the reporting period?
Term deposit
16
Is the term deposit carried at the correct amortised cost by recognising all accrued interest?
Cash and cash equivalents
17
Have the bank charges and the interest income on the favourable bank balance (or interest
expense on the overdraft bank balance), as it appears on the bank statement of the last
month of the reporting period, been recognised?
18
Have all direct deposits, as it appears on the bank statement of the last month of the
reporting period, been recognised?
Equity
Capital
19
Have all contributions (cash and otherwise) by the owner been recognised as capital
contributions?
Drawings
20
Have all cash withdrawn by the owner for personal use been recognised as drawings?
21
Have trade inventories withdrawn by the owner for personal use been recognised as
drawings?
22
Have all expenses incurred by the owner for personal use, but paid by the entity, been
recognised as drawings?
Liabilities
Loans
23
Is the loan carried at the correct amortised cost by recognising all accrued interest?
Trade and other payables
24
Have all credit purchases of goods and services before and after the reporting date, been
recognised in the correct reporting period?
253
Expenses
Office supplies
25
Has the office supplies that were unutilised on a reporting date been transferred to the
reporting period where it will be used?
Rent expense
26
Does the rent expense account have expense debits for a maximum of 12 months
(depending on the lease term)?
(Rent is usually paid in cash at the beginning of each month, but could be payable due to an
oversight. It could also occur that the following month’s rent, e.g. January 20.8, which falls in
the following reporting period, is paid during the current reporting period, e.g. December
20.7.)
Insurance
27
Has an appropriate portion of the insurance expense been transferred to the reporting period
to which it relates?
(Insurance premiums that are paid annually, but of which the insurance period does not
coincide with the reporting period, give rise to prepaid insurance premiums.)
Water and electricity
28
Does the water and electricity account have expense debits for only 12 months? (The
expense for the last month of the reporting period most probably still has to be recognised.)
Interest expense
29
Has the interest that accrued on the loan during the current reporting period been
recognised?
Income
Rent income
30
Does the rent income account have income credits for a maximum of 12 months (depending
on the lease term)?
(Rent is usually received in cash at the beginning of each month, but could be receivable for
the entity (lessor) due to an oversight by the lessee. It could also occur that the following
month’s rent, e.g. January 20.8, which falls in the following reporting period, is received by
the entity (lessor) during the current reporting period, e.g. December 20.7.)
Interest income
31
Has the interest that accrued on the term deposit during the current reporting period been
recognised?
Recognition of adjustments
32
The year-end review process brings about that, before financial statements can be prepared,
a few adjustments (corrections of errors and omissions) have to be recognised.
Subsequently, a summary of journals in respect of a series of adjustments that could possibly
be made, are provided:
254
33
Recognise depreciation on depreciable non-current assets:
Dr
Depreciation (P/L)
Cr
34
Recognise inventory shortages (in respect of the perpetual inventory system):
Dr
Loss due to inventory shortages (P/L)
Cr
35
Loss with write down of inventories to net realisable value (P/L)
Cr
Trade inventories (SFP)
Recognise irrecoverable debts in respect of a trade receivable:
Dr
Bad debts (P/L)
Cr
37
Trade inventories (SFP)
Recognise write-down of trade inventories to net realisable value:
Dr
36
Accumulated depreciation (SFP)
Trade receivable (SFP)
Recognise credit sales of trade inventories on or close to (but before) the reporting date that
were not recognised:
Dr
Trade receivable (SFP)
Cr
Sales (P/L)
and (in respect of the perpetual inventory system)
Dr
Cost of sales (P/L)
Cr
38
Recognised current assets such as office supplies on hand as an asset:
Dr
Office supplies on hand (SFP)
Cr
39
Term deposit (SFP)
Cr
Bank charges (P/L)
Cr
Bank (SFP)
Recognise a capital contribution by the owner in the form of a delivery vehicle, but not yet
recognised:
Dr
Delivery vehicle (SFP)
Cr
42
Interest income – term deposit (P/L)
Recognise bank charges that were not recognised:
Dr
41
Office supplies (P/L)
Recognise interest that accrued on a term deposit during the reporting period:
Dr
40
Trade inventories (SFP)
Capital (SCE)
Recognise trade inventories withdrawn by the owner, but not yet recognised:
Dr
Drawings (SCE)
Cr
Trade inventories (SFP)
255
43
Recognise interest that accrued on a loan during the reporting period:
Dr
Interest expense (P/L)
Cr
44
Loan (SFP)
Recognise credit purchases of trade inventories on or close to (but before) the reporting date
that were not recognised:
Dr
Trade inventories (SFP) (in respect of the perpetual inventory system) or
Purchases (P/L) (in respect of the periodic inventory system)
Cr
45
Recognise accrued rent expense as a liability:
Dr
Rent expense (P/L)
Cr
46
Prepaid rent expense (SFP)
Cr
Prepaid insurance (SFP)
Cr
Telephone or Water and electricity or Repairs (P/L)
Cr
Rent income receivable (SFP)
Cr
Rent income (P/L)
Recognise rent income received in advance:
Dr
Rent income (P/L)
Cr
51
Payable (SFP)
Recognise rent income receivable:
Dr
50
Insurance (P/L)
Recognise expenses in respect of services that have already been utilised (e.g. telephone,
water and electricity or repairs), but where payment will only occur after the reporting date:
Dr
49
Rent expense (P/L)
Recognise insurance premium prepaid as an asset:
Dr
48
Rent expense payable / Accrued rent expense (SFP)
Recognise prepaid rent as an asset:
Dr
47
Trade payable (SFP)
Rent income received in advance (SFP)
Correction of errors:
In practice, the occurrence of errors is limited through the use of computer systems and
competent employees. However, errors still occur, for example if a rent deposit paid is
debited against the rent expense account instead of against the asset account “Rent deposit
(paid)”. The approach that should be followed in this example is to debit the correct account
and to credit the account erroneously debited.
The correction of errors in the entity’s accounting records is explained at the end of this
chapter by means of Example 6.9.
52
Subsequently, some of the abovementioned adjustments will be dealt with more
comprehensively.
256
Reclassification of a portion of an expense as an asset
53
It is known that an expense usually holds economic benefits for an entity during a specific
reporting period. Consider the following two expenses: rent expense and salaries expense.
The lease payment is usually paid monthly at the beginning of each month and the future
economic benefits associated with this payment is the utilisation of the leased item for the
specific month in order to execute operating activities and generate sales. Salaries are
usually paid at the end of each month for the utilisation of the employees’ services in respect
of the execution of operating activities.
54
There are, per definition, future economic benefits associated with an asset. In the context of
the reporting date, future means a period that extends beyond the reporting date (Conceptual
Framework 2010.4.45). The future economic benefits associated with the asset-item is
expected to flow to the entity in the next financial period. The future economic benefits
associated with a trade receivable that is recognised two weeks before the end of the
reporting period, will probably be received in cash within three weeks after the current
reporting date.
55
In Accounting, when incurring certain expenses (e.g. rent expense, insurance and office
supplies), the expense is debited against the expense account. In respect of these expenses,
it often holds good that a portion of the amount that was recognised as an expense, should
be reclassified as an asset on the reporting date. In this regard, the following asset-items are
subsequently dealt with: office supplies on hand, prepaid rent expense and prepaid insurance
expense.
Office supplies on hand on the reporting date
56
Office supplies are purchased in accordance with cash or credit transactions and are
recognised by debiting the office supplies expense account and crediting bank or the relevant
payable. At the end of the reporting period there are usually still office supplies that are
unused/on hand.
57
An example of office supplies on hand is as follows:
On 1 January 20.7, AC Entity commenced with operating activities. The entity’s reporting
period ends every year on 31 December. On 31 December 20.7, the office supplies expense
account reflects a debit balance of R658 000. A physical count of the office supplies together
with the application of the average cost price for the items, indicate that on 31 December
20.7, office supplies to the amount of R55 000 are on hand. It is expected that the financial
statements for the reporting period ended 31 December 20.7 will be approved on 31 January
20.8.
58
The economic benefits associated with the office supplies on hand on 31 December 20.7, will
only be utilised during the first month or two of 20.8. Consequently, the office supplies on
hand on 31 December 20.7 should be recognised as an asset (read paragraph 55 again) by
debiting the asset-item office supplies on hand with R55 000 and crediting the office supplies
expense account with R55 000. The relevant journal is generated with a 31 December 20.7
date and is also posted as at 31 December 20.7. The office supplies expense is therefore
presented in the statement of profit or loss for the year ended 31 December 20.7 at R603 000
(R658 000 – R55 000). The office supplies on hand of R55 000 is presented as other current
assets under the heading “Current assets” in the statement of financial position as at
31 December 20.7.
257
59
On 1 January 20.8, the asset-item office supplies on hand has a debit balance of R55 000
that has to be derecognised by crediting the asset account and debiting the office supplies
expense account for 20.8 with R55 000. The journal for this transaction is usually created
after the financial statements for 20.7 are finalised. The reason is that the relevant office
supplies are going to be utilised during the first month or two of 20.8. The journal for this
transaction is usually generated after the journal in paragraph 58. This journal has a 20.8
date and is posted just after the temporary accounts for 20.7 are closed off against the
appropriate accounts. Refer back to paragraph 8.
60
This manner of accounting for office supplies entails using principles of the periodic inventory
system. This matter is discussed in more detail in paragraph 110 and in Chapter 13.
61
It can be indicated as follows that office supplies on hand on 31 December 20.7 satisfies the
definition and recognition criteria of an asset:
Definition of an asset
Application – office supplies on hand
An asset is a resource
Office supplies on hand are a resource that is utilised in an
entity during the execution of its operating activities.
controlled by the entity as a
result of past events
The office supplies on hand is controlled by the entity as
physical possession of the office supplies is with the entity.
As a result, the entity will have the ability to direct the right of
use of the office supplies on hand and will obtain
substantially all the remaining benefits from the office
supplies.
The past event is as a result of the purchase transaction
(purchase contract) of the office supplies as well as the
delivery of the office supplies which have already taken
place.
and from which future
economic benefits are
expected to flow to the entity.
Future economic benefits are expected to flow to AC Entity
(the purchasing entity) as a result of the utilisation of the
office supplies.
Recognition criteria of an Application – office supplies on hand
asset
An item that meets the
definition of an asset is
recognised only if it satisfies
both the following recognition
criteria:
As set out above, office supplies on hand satisfies the
definition of an asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
The office supplies will probably be utilised during the first
and second month of the 20.8 reporting period in the
execution of the entity’s operating activities. In this context,
future economic benefits will probably flow to the entity.
the item has a cost or a value
that can be measured
reliably.
The cost of the office supplies on hand can be measured
reliably at the historical cost thereof, namely R55 000.
258
Example 6.1 Office supplies on hand
On 2 January 20.7, AS Entity commenced with operating activities. On 31 December 20.7, the end
of the first reporting period of AS Entity, the office supplies expense account reflected a debit
balance of R425 000. A physical count of the office supplies together with the application of the
average cost price of these items indicated that office supplies of R45 000 were on hand on
31 December 20.7.
On 31 December 20.8 the following balances, amongst others, appeared in the records of
AS Entity:
Dr
R
455 000
45 000
Office supplies expense account
Office supplies on hand (31 Dec 20.7)
Cr
R
A physical count of the office supplies together with the application of the average cost price of
these items indicated that office supplies of R40 000 were on hand on 31 December 20.8.
The financial statements for 20.7 was approved for distribution on 23 February 20.8. It is expected
that the financial statements for 20.8 will be approved for distribution on 31 January 20.9.
Required:
a)
Explain the meaning of the item “Office supplies on hand – 31 Dec 20.7” as indicated above.
b)
Journalise, as at 31 December 20.8, the transfer of office supplies on hand on 31 December
20.7 to the office supplies expense account for 20.8 in the records (general journal) of
AS Entity for the reporting period ended 31 December 20.8.
c)
Recognise the office supplies on hand on 31 December 20.8 in the records (general journal)
of AS Entity for the reporting period ended 31 December 20.8.
d)
After accounting for the abovementioned journal entries, present the relevant balances in the
financial statements of AS Entity for the reporting period ended 31 December 20.8.
Note: Comparative figures must be provided.
e)
Journalise, as at 1 January 20.9, the transfer of office supplies on hand on 31 December 20.8
to the office supplies expense account for 20.9 in the records (general journal) of AS Entity
for the reporting period ended 31 December 20.9.
Example 6.1 Solution
a) Meaning of the item “Office supplies on hand – 31 Dec 20.7”
On 31 December 20.7 office supplies that were on hand on this date, was recognised as an asset
by means of a journal, as set out below:
J1
20.7
31 Dec
Office supplies on hand (SFP)
Office supplies (P/L)
Recognise office supplies on hand on 31 Dec 20.7 as an
asset by reclassifying a part of the expense as an asset
259
Dr
45 000
Cr
45 000
The office supplies on hand that were recognised as an asset on 31 December 20.7, were utilised
completely within the first month or two of the 20.8 reporting period. Consequently, the asset-item
office supplies on hand (31 Dec 20.7) has to be derecognised during the 20.8 reporting period by
crediting the asset-item with R45 000 and debiting the office supplies expense (for 20.8) with
R45 000. This journal is usually generated early in January 20.8 and is posted as soon as the
temporary accounts for 20.8 are active. Refer back to paragraphs 58 and 59. In this example the
entity neglected to derecognise the office supplies on hand (31 Dec 20.7) during January 20.8.
(Such a case is often included in questions to test whether the understanding exists that the assetitem should be derecognised in the following reporting period. Refer to journal J1 below (part (b) of
this example).)
b) Journal entry – closing off of office supplies on hand on 31 December 20.7 against the
office supplies expense account for 20.8
J1
20.8
31 Dec
Office supplies (P/L)
Office supplies on hand (SFP)
Derecognise office supplies on hand on 31 Dec 20.7 by
reclassifying it as an expense in 20.8
Dr
45 000
Cr
45 000
c) Recognise office supplies on hand on 31 December 20.8 as asset
J2
20.8
31 Dec
Office supplies on hand (SFP)
Office supplies (P/L)
Recognise office supplies on hand on 31 Dec 20.8 by
reclassifying a part of the expense as an asset
Dr
40 000
Cr
40 000
d) Presentation of balances in the 20.8 financial statements
AS ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.8
20.8
20.7
R
R
Sales
xxx
xxx
Cost of sales
(xxx)
(xxx)
Gross profit
///
xxx
xxx
Office supplies (dr 45 000 dr 455 000 cr 40 000) / (dr 425 000 cr 45 000)
///
Profit for the year
260
(460 000)
XXX
(380 000)
XXX
AS ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
20.8
R
ASSETS
Current assets
Trade inventories
Other current assets
xx
40 000
20.7
R
xx
45 000
e) Journal entry – closing off of the office supplies on hand on 31 December 20.8 against the
office supplies expense account for 20.9
J1
20.9
1 Jan
Office supplies (P/L)
Office supplies on hand (SFP)
Derecognise office supplies on hand on 31 Dec 20.8 by
reclassifying it as an expense in 20.9
Dr
40 000
Cr
40 000
The following informal T-accounts are provided to confirm the principles and entries under
discussion:
Dr
20.7
31 Dec
20.8
1 Jan
31 Dec
20.9
1 Jan
Office supplies on hand (asset)
20.7
Office supplies expense
45 000 31 Dec Balance cf
45 000
20.8
Balance bd
45 000 31 Dec Office supplies expense
Office supplies expense
40 000
Balance cf
85 000
20.9
Balance bd
40 000 1 Jan
Office supplies expense
Dr
20.7
Office supplies (expense) (20.7)
20.7
Jan-Dec Bank/Payable
425 000 31 Dec
Cr
45 000
45 000
45 000
40 000
85 000
40 000
Cr
Office supplies on hand
Profit or loss
45 000
380 000
425 000
Dr
Office supplies (expense) (20.8)
20.8
20.8
Jan-Dec Bank/Payable
455 000 31 Dec Office supplies on hand
31 Dec Office supplies on hand
45 000
Profit or loss
500 000
Cr
425 000
Dr
20.9
1 Jan
Office supplies (expense) (20.9)
Office supplies on hand
40 000
261
40 000
460 000
500 000
Cr
Remarks
1
Asset and liability accounts reflect the effect of transactions that affected these
accounts since the inception of the entity and are accumulated in the balances of the
accounts. Asset and liability accounts are therefore continuously used over the
reporting periods. Each new reporting period begins with the balances of the accounts
for assets, liabilities, capital and retained earnings as brought forward from the previous
reporting period.
2
Expense accounts, such as the office supplies expense account, are part of retained
earnings and are, at the end of each reporting period, closed off against the profit or
loss account which is in turn closed off against retained earnings. The closing off of
income and expense accounts against profit or loss is discussed in Chapter 7. At the
beginning of each reporting period, a new set of income and expense accounts are
opened.
Prepaid rent expense
62
An expense such as rent is usually paid in cash and is recognised on the date of the payment
by debiting the rent expense account and crediting the bank account. The lease payment is
usually payable in advance every month on a date and at an amount as specified in the lease
agreement, e.g. on the first day of the month or the 27th of the immediate preceding month.
63
In the case where the lease payment has to be paid at the end of the immediate preceding
month, it brings about that the payment, which is made in the last month of the current
reporting period, holds economic benefits for the entity that extends until after the current
reporting date (that is the first month of the following reporting period). Consider the following
example in this regard:
On 20 October 20.7, AC Entity entered into a lease agreement to rent four low value items at
R20 000 per month in total from 1 November 20.7. The first lease payment is payable on
1 November 20.7, where after the lease payments are payable in advance every month on
the 27th of the preceding month. AC Entity’s current reporting period ends on 31 December
20.7.
64
The rent expense account will contain the following entries on 31 December 20.7:
Dr
Date
20.7
1 Nov
27 Nov
27 Dec
65
U12 Rent expense
Contra account
Bank
Bank
Bank
Nr
Jx
Jx
Jx
Amount
Date
Cr
Contra account
Nr
Amount
20 000
20 000
20 000
The lease payments on 1 November 20.7 and 27 November 20.7 are recognised on these
dates since a decrease in the associated asset-item cash occurred on these dates. The
economic benefits associated with the expense will be utilised in the following month (which
still falls within the current reporting period).
262
66
In the same way, the lease payment on 27 December 20.7 is recognised on this date since a
decrease in the associated asset-item cash occurred on this date. The economic benefits
associated with the expense will be utilised in the following month, but the following month is
part of the 20.8 reporting period. The future economic benefits associated with the rent
expense debited on 27 December 20.7, will therefore only be utilised in the following
reporting period (20.8). The lease payment made on 27 December 20.7, is referred to in
Accounting as prepaid rent expense on 31 December 20.7. The asset-item prepaid
expense occurs only in respect of cash expenses that are prepaid on the reporting date.
67
Since the economic benefits associated with this prepaid expense will only be utilised in the
following reporting period (20.8), it does not satisfy the definition of an expense. Prepaid rent
expense does however satisfy the definition and recognition criteria of an asset and has to be
recognised as an asset on 31 December 20.7 by debiting prepaid rent expense and crediting
the rent expense (20.7). Prepaid rent expense is presented in the statement of financial
position as other current assets under the heading “Current assets”. During the 20.8 reporting
period, the asset-item prepaid rent expense is derecognised by crediting the asset and
debiting the rent expense account for 20.8.
68
It can be indicated as follows that prepaid rent expense satisfies the definition and recognition
criteria of an asset:
Definition of an asset
Application – prepaid rent expense
An asset is a resource
The rent that was prepaid in December 20.7, is a
resource that provides AC Entity with the exclusive right
of use of the items in January 20.8.
controlled by the entity as a result
of past events
The lessee controls the use of the item for which it has
prepaid rent. As a result the entity will have the ability to
direct the right of use of the items rented and will obtain
substantially all the remaining benefits from prepaid rent
expense.
The past events are the entering into and signing of the
lease agreement as well as the fact that the January
20.8 lease payment has already been paid in December
20.7.
and from which future economic
benefits are expected to flow to
the entity.
The future economic benefits relate to the utilisation of
the items during January 20.8. If the entity can utilise the
items, it can execute its operating activities. Future
economic benefits are expected to flow to the entity from
these operating activities.
Recognition criteria of an asset Application – prepaid rent expense
An item that meets the definition
of an asset is recognised only if it
satisfies both the following
recognition criteria:
As set out above, the prepaid rent expense satisfies the
definition of an asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
The entity will probably utilise the items in January 20.8
to execute its operating activities. In this context, future
economic benefits will probably flow to the entity.
the item has a cost or a value
that can be measured reliably.
The cost of the prepaid rent expense can be measured
reliably as the amount that was paid in accordance with
the lease agreement, namely R20 000.
263
Example 6.2 Prepaid rent expense
During December 20.6, AC Entity entered into a lease agreement to rent six low value items for 60
months at R30 000 per month for all six items. The lease payment is payable on the first day of
every month. The lease term commenced on 1 January 20.7. AC Entity’s reporting period ends on
31 December.
On 31 December 20.8, the following balances, amongst others, appeared in the records of
AC Entity:
Dr
R
330 000
30 000
Rent expense
Prepaid rent expense (31 Dec 20.7)
Dr
R
Additional information
The lease payment for January 20.8 has already been paid on 28 December 20.7.
Required:
a)
Explain the meaning of the item “Prepaid rent expense (31 Dec 20.7)” as indicated above.
b)
As at 1 January 20.8, journalise the transfer of the prepaid rent expense on 31 December
20.7 to the rent expense account for 20.8 in the records (general journal) of AC Entity.
c)
Present the relevant balances in the financial statements of AC Entity for the reporting period
ended 31 December 20.8.
Note: Comparative figures must be provided.
Example 6.2 Solution
a) Meaning of the item “Prepaid rent expense (31 Dec 20.7)”
This item relates to the January 20.8 lease payment that was paid in December 20.7. On
31 December 20.7, the prepaid rent expense satisfies the definition and recognition criteria of an
asset and consequently has to be recognised as an asset on this date by means of a journal, as set
out below:
J1
20.7
31 Dec
Prepaid rent expense (SFP)
Rent expense (P/L)
Recognise prepaid rent on 31 Dec 20.7 as an asset by
reclassifying a portion of the expense as an asset
Dr
30 000
Cr
30 000
The economic benefits associated with this prepaid rent expense will be utilised in the first month of
the 20.8 reporting period. Consequently, the asset-item prepaid rent has to be derecognised at the
beginning of the 20.8 reporting period by crediting the asset-item with R30 000 and debiting the
rent expense (for 20.8) with R30 000. In this example the entity neglected to derecognise the
prepaid rent expense (31 Dec 20.7) during January 20.8. (Such a case is often included in
questions to test whether the understanding exists that the asset-item should be derecognised in
the following reporting period. Refer to journal J2 below (part (b) of this example).)
264
The question can be asked why the payment of the lease instalment on 28 December 20.7 is not
journalised as follows: debit the prepaid rent expense and credit bank with R30 000. The answer is
that the rent payment can be recognised as such. However, the practice is to debit the cash
payment of an expense during 20.7 against the relevant expense account for 20.7 and that the
adjustment, whereby the rent expense account is credited and the prepaid rent expense account is
credited, occurs thereafter.
b) Journal entry – closing off of prepaid rent on 31 Dec 20.7 against the rent expense
account for 20.8
J2
20.8
1 Jan
Rent expense (P/L)
Prepaid rent expense (SFP)
Derecognise the rent prepaid on 31 Dec 20.7 by reclassifying
it as an expense in 20.8
Dr
30 000
Cr
30 000
c) Presentation of balances in the 20.8 financial statements
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.8
20.8
R
xxx
Sales
(xxx)
Cost of sales
xxx
Gross profit
///
Rent expense (dr 330 000 dr 30 000) / (dr 390 000 cr 30 000)
(360 000)
///
Profit for the year
XXX
20.7
R
xxx
(xxx)
xxx
(360 000)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
20.8
R
ASSETS
Current assets
Trade inventories
Other current assets
20.7
R
xx
xx
30 000
The following informal T-accounts are provided to confirm the principles and entries under
discussion:
Dr
20.7
31 Dec
Rent expense
20.8
1 Jan
Balance bd
Prepaid rent expense (asset)
20.7
30 000 31 Dec Balance cf
30 000
20.8
30 000 1 Jan
Rent expense
265
Cr
30 000
30 000
30 000
Dr
20.7
Jan-Dec Bank (30 000 x 13)
Rent expense (20.7)
20.7
390 000 31 Dec Prepaid rent expense
Profit or loss
390 000
Dr
20.8
1 Jan
Prepaid rent expense
Feb-Dec Bank (30 000 x 11)
Rent expense (20.8)
20.8
30 000 31 Dec Profit or loss
330 000
360 000
Cr
30 000
360 000
390 000
Cr
360 000
360 000
Prepaid insurance
69
It is normal commercial practice to take out an insurance policy (in other words, to enter into
an insurance contract with an insurer) and the purpose is to transfer losses resulting from
events such as fires, floods and theft to the insurer by paying a premium. Items such as
buildings, plant, equipment and trade inventories are usually insured. It is also possible to
insure the loss of profit for a period after the incident. Insurance premiums are usually paid
cash and the expense is recognised by debiting the insurance expense account and crediting
the bank account.
70
Insurance premiums are usually paid at the beginning of each month. However, in respect of
the insurance of property, it occurs that the insurance premiums are annually prepaid.
71
An example in this regard is as follows:
On 1 July 20.7, AC Entity obtained control of the land and buildings when the owner, as part
of his capital contribution, made the property available for the exclusive use of the entity.
(Refer to Chapter 2 paragraphs 137 and 138) Insurance was taken out in respect of the
buildings and on 1 July 20.7 the insurance premium for the year ended 30 June 20.8, to the
amount of R96 000, was paid. AC Entity’s current reporting period ends on 31 December
20.7. On 1 July 20.7, this transaction was recognised by debiting the insurance expense
account with R96 000 and crediting the bank account with the same amount.
72
The payment of the premium on 1 July 20.7 is recognised on this date since a decrease in
the associated asset-item cash occurred on this date. On 1 July 20.7 the insurance expense
account was debited with the full premium paid and the bank account was credited. The
economic benefits associated with the expense will be utilised in the following 12 months
(which partially falls within the current reporting period and partially in the following reporting
period). The future economic benefits associated with a portion (50% or otherwise the last 6
of the 12 months) of the insurance expense will therefore only be utilised in the 20.8 reporting
period.
266
73
A portion (50%) of the insurance premium that was paid on 1 July 20.7, is referred to in
Accounting as prepaid insurance premium on 31 December 20.7. As already mentioned,
the asset-item prepaid expense arises only when cash expenses are prepaid on the reporting
date. Since the economic benefits associated with a portion (50%) of this expense will only
be utilised in the following reporting period (20.8), it does not satisfy the definition of an
expense. Prepaid insurance expense does however satisfy the definition and recognition
criteria of an asset and has to be recognised as an asset on 31 December 20.7. Prepaid
insurance is presented in the statement of financial position as other current assets under the
heading “Current assets”. During the 20.8 reporting period the asset-item prepaid insurance
is derecognised by crediting the asset and debiting the insurance expense account for 20.8.
74
It can be indicated as follows that prepaid insurance expense satisfies the definition and
recognition criteria of an asset:
Definition of an asset
Application – prepaid insurance
An asset is a resource
The portion of the insurance premium that is prepaid on
31 December 20.7, is a resource which gives the entity
insurance coverage of assets for the period 1 January 20.8
to 30 June 20.8.
controlled by the entity as a
result of past events
The entity has a legally enforceable right to the insurance
for the next 6 months due to prepayment. As a result the
entity will have the ability to direct the right of use of the
prepaid insurance expense and will obtain substantially all
the remaining benefits from prepaid insurance expense.
The past events are the entering into and signing of the
insurance contract (policy) as well as the payment of the
insurance premium on 1 July 20.7.
and from which future
The future economic benefits relates to the utilisation of the
economic benefits are
insurance coverage during the period 1 January 20.8 to
expected to flow to the entity. 30 June 20.8.
Recognition criteria of an
asset
Application – prepaid insurance
An item that meets the
definition of an asset is
recognised only if it satisfies
both the following
recognition criteria:
As set out above, the prepaid insurance expense satisfies
the definition of an asset.
it is probable that future
economic benefits
associated with the item will
flow to the entity; and
It is probable that the entity will utilise the insurance
coverage during the period 1 January 20.8 to 30 June 20.8.
In this context, future economic benefits will probably flow to
the entity.
the item has a cost or a
value that can be measured
reliably.
The cost of the prepaid insurance expense can be
measured reliably as 50% (or otherwise 6 of the 12 months)
of the premium, which was paid in accordance with the
policy, namely R48 000.
267
Example 6.3 Prepaid expenses – insurance premium and rent
On 31 December 20.8, AH Entity’s current reporting date, the following balances, amongst others,
appeared in the records of the entity:
Rent expense – low value items
Insurance – factory buildings
20.8
R
660 000
288 000
Assets
Land (at cost price)
Factory building (at cost price)
Rent deposit
Prepaid rent (31 Dec 20.7)
Prepaid insurance (31 Dec 20.7)
500 000
1 600 000
60 000
60 000
132 000
Remark in respect of the prepaid rent – 31 Dec 20.7
1
On 31 December 20.7 the prepaid rent was recognised as an asset since the
January 20.8 rent was paid during December 20.7. Consequently the asset prepaid rent
(31 Dec 20.7) had to be derecognised during January 20.8 by debiting the rent expense
account (for 20.8) and crediting the prepaid rent (31 Dec 20.7) with R60 000. (Such
asset-items (prepaid rent (31 Dec 20.7) and prepaid insurance (31 Dec 20.7) are often
included in questions to test whether the understanding exists that the asset-items
should be derecognised in the following reporting period. Refer to journals J1 and J2
below.)
On 1 January 20.7, AH Entity entered into a lease agreement whereby AH Entity is the lessee.
Twelve (12) low value items are leased until 31 December 20.9 at R60 000 per month in total,
payable before the 7th of each month. In accordance with the lease agreement, AH Entity also paid
a deposit of R60 000 with occupation on 1 January 20.7. The rent for January 20.8 was paid on
28 December 20.7. The rent for January 20.9 was paid on 3 January 20.9.
On 1 July 20.7, as part of his capital contribution, the owner made a new factory building available
for the exclusive use of AH Entity and the entity occupied the building on this date. The cost/value
placed on the property is as follows: land R500 000 and buildings R1 600 000. Depreciation on the
factory building for 20.8 still has to be recognised over the estimated useful life of 20 years, in
accordance with the straight line method. The building is insured for 12 months at an annual
premium of R264 000, which was paid on 1 July 20.7. On 1 July 20.8, the insurance was renewed
at an annual premium of R288 000. This amount was paid on the renewal date.
Required:
a)
Recognise the omitted transactions in the records (general journal) of AH Entity for the
reporting period ended 31 December 20.8.
b)
After accounting for the abovementioned journal entries, present the balances in the financial
statements of AH Entity for the reporting period ended 31 December 20.8.
Note: Comparative figures must be provided.
268
Example 6.3 Solution
a) Omitted journal entries
J1
20.8
1 Jan
J2
20.8
1 Jan
J3
20.8
31 Dec
J4
20.8
31 Dec
Rent expense (P/L)
Prepaid rent expense (SFP)
Derecognise the rent prepaid in December 20.7 by
reclassifying it as an expense in 20.8
Insurance (P/L)
Prepaid insurance (SFP)
Derecognise the insurance prepaid in 20.7 by reclassifying it
as an expense in 20.8
Depreciation – buildings (P/L)
Accumulated depreciation – buildings (SFP)
Recognise depreciation on factory buildings for 20.8
R1 600 000 ÷ 20 = R80 000
Prepaid insurance (SFP)
Insurance (P/L)
Recognise (6 months’) insurance expense prepaid on 31 Dec
20.8 as an asset by reclassifying a portion of the expense as
an asset
R288 000 x 6/12 = R144 000
269
Dr
60 000
Cr
60 000
Dr
132 000
Cr
132 000
Dr
80 000
Cr
80 000
Dr
144 000
Cr
144 000
b) Presentation of balances
AH ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.8
20.8
20.7
R
R
Sales
xxx
Xxx
Cost of sales
(xxx)
(xxx)
Gross profit
///
xxx
Xxx
Rent expense (dr 60 000 dr 660 000) / (dr 780 000 cr 60 000)
(720 000)
(720 000)
Insurance (dr 132 000 dr 288 000 cr 144 000) / (dr 264 000 cr 132 000)
(276 000)
(132 000)
(80 000)
(40 000)
Depreciation (1 600 000 ÷ 20) / (1 600 000 ÷ 20 x 6/12)
///
Profit for the year
XXX
XXX
AH ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
ASSETS
Non-current assets
Land
Buildings (dr 1 600 000 cr 40 000 cr 80 000) / (dr 1 600 000 cr 40 000)
20.8
20.7
R
R
500 000
1 480 000
500 000
1 560 000
60 000
144 000
60 000
192 000
Rent deposit
Current assets
Other current assets (144 000 / dr 60 000 dr 132 000)
Rent deposit
Remark in respect of rent deposit
1
The rent deposit becomes current at the end of 20.8 as the lease comes to an end in 20.9.
In 20.8 the rent deposit under non-current asset is therefore R0 as it is moved to current
assets.
270
The following informal T-accounts are provided to confirm the principles and entries under
discussion:
Dr
20.7
1 Jan
Rent deposit (asset)
20.7
60 000 31 Dec Balance cf
60 000
Bank
20.8
1 Jan
Balance bd
20.8
60 000 31 Dec
60 000
20.9
1 Jan
Balance bd
60 000
Balance cf
Cr
60 000
60 000
60 000
60 000
Remark in respect of rent deposit (asset)
1
The rent deposit becomes current at the end of 20.8 as the lease comes to an end in 20.9.
In 20.8 the rent deposit under non-current asset is therefore R0 as it is moved to current
assets.
Dr
20.7
31 Dec
Rent expense
20.8
1 Jan
Balance bd
Prepaid rent expense (asset)
20.7
60 000 31 Dec Balance cf
60 000
20.8
60 000 1 Jan
Rent expense
Cr
60 000
60 000
60 000
Remark in respect of prepaid rent expense (asset)
1
This account has a zero balance at the end of 20.8 as there is no prepayment at the end
of 20.8.
Dr
20.7
31 Dec
Insurance
20.8
1 Jan
31 Dec
Balance bd
Insurance
20.9
1 Jan
Balance bd
Dr
20.7
Jan-Dec Bank
Prepaid insurance (asset)
20.7
132 000 31 Dec Balance cf
132 000
20.8
132 000 1 Jan
Insurance
144 000 31 Dec Balance cf
276 000
Cr
132 000
132 000
132 000
144 000
276 000
144 000
Rent expense (20.7)
20.7
780 000 31 Dec Prepaid rent expense
Profit or loss
780 000
271
Cr
60 000
720 000
780 000
Dr
20.7
1 Jul
Bank
Insurance (20.7)
20.7
264 000 31 Dec
Cr
Prepaid insurance
Profit or loss
264 000
Dr
20.8
1 Jan
Prepaid rent expense
Feb-Dec Bank
Dr
20.8
1 Jan
1 Jul
Prepaid insurance
Bank
Rent expense (20.8)
20.8
60 000 31 Dec Profit or loss
660 000
720 000
Insurance (20.8)
20.8
132 000 31 Dec
288 000
420 000
132 000
132 000
264 000
Cr
720 000
720 000
Cr
Prepaid insurance
Profit or loss
144 000
276 000
420 000
Accrued cash expenses
Rent expense payable
75
As already mentioned, an expense such as rent is usually paid monthly in cash, at the
beginning of the month or at the end of the immediate preceding month. The payments occur
in accordance with a legally enforceable lease agreement. The cash expense is recognised
on the day of payment by debiting the rent expense account and crediting the bank account.
It can however happen that the rent is outstanding (not paid) for a specific month or months.
This would usually happen due to an oversight.
76
Consider the following example in this regard:
AC Entity’s reporting period end every year on 31 December. AC Entity rents eight low value
items at R40 000 per month in total which, in accordance with the lease agreement, is
payable on the first day of every month. On 31 December 20.7, the rent expense account
reflects a debit balance of R440 000. Due to an oversight, the lease payment that was
payable on 1 December 20.7, was paid only on 8 January 20.8. (Note: It is practice to debit
the cash payment of an expense during a reporting period (20.8 in this case) against the
relevant expense account for that specific reporting period (20.8 in this case). The journal
was generated on 8 January 20.8 and was posted as at this date.)
77
On 31 December 20.7, the lease payment in arrears represents an item that satisfies the
definition and recognition criteria of a liability. In Accounting, this liability is referred to as
accrued rent expense or rent expense payable on 31 December 20.7. The rent expense
payable has to be recognised as a liability on 31 December 20.7 by debiting the rent expense
account and crediting the liability-item rent expense payable. This will result in the rent
expense being presented in the statement of profit or loss for the reporting period ended
31 December 20.7 at R480 000. The liability-item rent expense payable is presented in the
statement of financial position on 31 December 20.7 as part of the line item trade and other
payables under the heading “Current liabilities”. During 20.8, the liability-item rent expense
payable is derecognised by debiting the rent expense payable account and crediting the rent
272
expense account for 20.8. The liability-item expense payable occurs only in respect of cash
expenses that are payable/in arrears on the reporting date.
78
79
It can be indicated as follows that rent expense payable satisfies the definition and
recognition criteria of a liability:
Definition of a liability
Application – rent expense payable
A liability is a present obligation
of the entity
As a result of the utilisation of the items in
December 20.7 in accordance with the lease agreement
and the fact that no payment was made in
December 20.7, AC Entity has a legally enforceable
obligation towards the lessor.
arising from past events
The past events that gave rise to the present, legal
obligation are the entering into and signing of the lease
agreement as well as the utilisation of the items by AC
Entity during December 20.7.
the settlement of which is
expected to result in an outflow
from the entity of resources
embodying economic benefits.
The settlement of the December 20.7 lease payment will
result in an outflow of cash in the future (January 20.8).
Recognition criteria of a
liability
Application – rent expense payable
An item that meets the definition
of a liability is recognised only if it
satisfies both the following
recognition criteria:
As set out above, the lease payment in arrears satisfies
the definition of a liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The existence of a legal obligation on 31 December 20.7,
as a result of the lease agreement as well as the
utilisation of the property during December 20.7, leaves
AC Entity no other choice but to settle the lease
instalment in arrears.
the item has a cost or a value
that can be measured reliably.
The cost of the lease payment in arrears can be
measured reliably as the amount that is payable in
accordance with the lease agreement, namely R40 000.
Take note that even though the lease payment was indeed paid during January 20.8, it does
not mean that a liability did not exist on 31 December 20.7.
Example 6.4 Rent expense payable
On 31 December 20.8, the following balances, amongst others, appeared in the records of
AC Entity:
Dr
R
520 000
Rent expense
Rent expense payable (31 Dec 20.7)
Trade payables (R650 000 on 31 Dec 20.7)
Cr
R
40 000
812 000
273
Additional information
1
In accordance with the lease agreement, the lease payment is R40 000 per month for the
period of the lease.
2
The lease payment for December 20.7 was paid on 8 January 20.8 and was recognised on
this day by debiting the rent expense account and crediting the bank account.
Required:
a)
Explain the meaning of the item “Rent expense payable (31 Dec 20.7)” as indicated above.
b)
Journalise, as at 31 December 20.8, the transfer of the rent expense payable on
31 December 20.7 to the rent expense account for 20.8 in the records (general journal) of
AC Entity for the reporting period ended 31 December 20.8.
c)
After accounting for the additional information, present the relevant balances in the financial
statements of AC Entity for the reporting period ended 31 December 20.8.
Note: Comparative figures must be provided.
Example 6.4 Solution
a) Meaning of the item “Rent expense payable (31 Dec 20.7)”
This item relates to the December 20.7 lease payment which was paid only in January 20.8. On
31 December 20.7, the accrued rent expense satisfies the definition and recognition criteria of a
liability and consequently has to be recognised as a liability on this date by means of a journal, as
set out below:
J1
20.7
31 Dec
Rent expense (P/L)
Rent expense payable (SFP)
Recognise rent payable on 31 Dec 20.7 as a liability
Dr
40 000
Cr
40 000
The entity neglected to derecognise the rent expense payable (31 Dec 20.7) during January 20.8
by debiting the rent expense payable and crediting the rent expense (20.8). Such a liability-item is
often included in questions to test whether the understanding exists that the liability-item has not
yet been derecognised due to an oversight. Refer to journal J2 below (part (b) of this example).)
b) Journal entry – closing off of the rent payable on 31 December 20.7 against the rent
expense account for 20.8
J2
20.8
31 Dec
Rent expense payable (SFP)
Rent expense (P/L)
Derecognise rent expense payable on 31 Dec 20.7 against
the rent expense account (20.8)
Dr
40 000
Cr
40 000
Remark
1
The 20.8 expense includes the one payment that relates to the 20.7 rent expense payable.
274
c) Presentation of balances in the 20.8 financial statements
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.8
20.8
20.7
R
R
Sales
xxx
xxx
Cost of sales
(xxx)
(xxx)
Gross profit
///
xxx
xxx
Rent expense (dr 520 000 cr 40 000) / (dr 440 000 dr 40 000)
///
Profit for the year
(480 000)
(480 000)
XXX
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
EQUITY AND LIABILITIES
Current liabilities
Trade and other payables (20.7: cr 650 000 cr 40 000)
20.8
20.7
R
R
812 000
690 000
The following informal T-accounts are provided to confirm the principles and entries under
discussion:
Dr
20.7
31 Dec
Balance cf
20.8
31 Dec
Rent expense
Rent expense payable (liability)
20.7
40 000 31 Dec Rent expense
40 000
20.8
40 000 1 Jan
Balance bd
Dr
20.7
Jan-Nov Bank
31 Dec Rent expense payable
Dr
20.8
Jan-Dec Bank
Rent expense (20.7)
20.7
440 000 31 Dec Profit or loss
40 000
480 000
Rent expense (20.8)
20.8
520 000 31 Dec Rent expense payable
Profit or loss
520 000
275
Cr
40 000
40 000
40 000
Cr
480 000
480 000
Cr
40 000
480 000
520 000
Remark in respect of the rent expense payable account
1
On 31 December 20.7 the rent expense payable satisfies the definition and
recognition criteria of a liability and is consequently recognised as a liability as at
31 December 20.7. During 20.8 the rent expense payable account is derecognised
by closing off the liability against the rent expense account against which the
payment was debited. As already mentioned with regards to the payment of
expenses, it is practice to credit the bank account on the date of the payment and to
debit the relevant expense account on the same day. The 20.8 expense includes the
one payment that relates to the 20.7 rent expense payable.
Expenses incurred on credit
Water and electricity expense and telephone expense
80
Expenses incurred on credit are accounted for in accordance with the accrual basis of
accounting by debiting the expense account and crediting the account of the payable as soon
as the invoice/statement for a specific month is received. When payment occurs, the payable
is debited and the bank account is credited. The year-end review could also indicate that
expenses which have been accounted for in accordance with the accrual basis of accounting
need to be adjusted.
81
Consider the following example in this regard:
AC Entity’s current reporting period ends on 31 December 20.7. The owner will probably
approve the financial statements for 20.7 for distribution on 4 February 20.8. During the yearend review process in respect of the 20.7 reporting period, AC Entity identified the following
errors and omissions which consequently require adjustments:
•
The water and electricity statement for November 20.7, which was received from
Payable Jozi in December 20.7, was recognised twice during the first week of
December 20.7 due to an oversight.
The error must be corrected as follows:
Dr
Payable Jozi (SFP)
Cr
•
Water and electricity (P/L)
The water and electricity statement for December 20.7 was received from Payable Jozi
only on 18 January 20.8 and has not yet been recognised.
This transaction/omission still has to be recognised as follows, with 31 December 20.7
as effective date:
Dr
Water and electricity (P/L)
Cr
Payable Jozi (SFP)
276
•
The payment to Payable Telkom on 18 December 20.7 was duplicated on
21 December 20.7 due to an oversight. The general ledger account for Payable Telkom
is consequently as follows:
Dr
20.7
18 Jan Bank
// Feb-Sep are left out
18 Nov Bank
18 Dec Bank
21 Dec Bank
Payable Telkom
20.7
38 000 1 Jan
Balance bd
// Feb-Sep are left out
36 750 31 Oct Telephone
38 500 30 Nov Telephone
38 500 31 Dec Telephone
Cr
38 000
36 750
38 500
39 250
No adjustment is required in respect of this error. The telephone expense account is
correct since 12 months’ expenses have been accounted for. The liability is presented
at R750 (R39 250 – R38 500) in the statement of financial position on 31 December
20.7 as part of the line item trade and other payables under the heading “Current
liabilities”. The payment during January 20.8 will also only be R750, that is the
December 20.7 statement to the amount of R39 250 less the amount of R38 500 that
was paid too much (the duplication) on 21 December 20.7.
Interest expense accrued on loan but not yet recognised
82
Interest on borrowed funds is usually calculated monthly and consequently added to the
primary debt at the end of each month. Interest is therefore calculated on interest, which is
formally referred to as a monthly compounded interest calculation. From a practical
educational viewpoint, the interest in this work will mostly be bi-annually or annually
compounded interest calculations.
83
It is possible that the year-end review process could reveal that interest accrued has not yet
been recognised. Interest accrued means that the interest expense accumulated during a
reporting period and that the cost of the loan has to be increased with this amount. The loan
account therefore has to be credited with the accrued interest amount and the interest
expense account has to be debited with the same amount. The interest expense is a result of
the requirement that the subsequent measurement of a loan has to occur at the amortised
cost thereof.
Example 6.5 Interest expense accrued on a loan
AC Entity’s reporting date is 31 December. On 1 July 20.7, the entity received R1 500 000 on loan.
The written loan agreement was signed on 24 June 20.7 and inter alia stipulates that the interest
rate is 12% per year and that the interest and the primary debt is repayable in one amount on
30 June 20.9. The interest is added to the primary debt at the end of every six months and the
interest schedule is as follows:
Date
1 Jul 20.7
31 Dec 20.7
30 Jun 20.8
31 Dec 20.8
30 Jun 20.9
Detail
Primary debt
Interest
Interest
Interest
Interest
Interest at
12% per year
90 000
95 400
101 124
107 191
393 715
277
Amortised cost of the
loan
1 500 000
1 590 000
1 685 400
1 786 524
1 893 715
On 31 December 20.8 the following balances, amongst others, appeared in the records of
AC Entity:
Dr
R
Loan
Interest expense on overdraft bank account
Cr
R
1 590 000
24 876
Required:
a)
b)
Recognise the relevant outstanding transactions in the records (general journal) of AC Entity
for the reporting period ended 31 December 20.8.
Present the balances of the relevant accounts in the financial statements of AC Entity for the
reporting period ended 31 December 20.8.
Note: Comparative figures must be provided.
c)
Derecognise the loan on 30 June 20.9 in the records (general journal) of AC Entity for the
reporting period ended 31 December 20.9.
Note:Accept that the interest expense for the period 1 January 20.9 to 30 June 20.9 has
already been correctly recognised.
Remark in respect of Example 6.5’s set of facts
1
By reviewing the set of facts, one must realise that the accrued interest in respect of the
loan for 20.8 has not yet been recognised.
Example 6.5 Solution
a) Journal entries – outstanding transactions
J1
20.8
31 Dec
Interest expense on loan (P/L)
Loan (SFP)
Recognise the interest expense for the period 1 Jan 20.8 to
30 Jun 20.8
R1 590 000 x 12% x 6/12 = 95 400
Dr
95 400
Cr
95 400
Remark in respect of the date used in J1
1
Subsequent to the review process this journal will be generated and posted between
the reporting date and the approval date. Consequently, the effective date of the
transaction should be 31 December 20.8. If the entity did not neglect to record this
transaction, the date of the journal would have been 30 June 20.8.
278
J2
20.8
31 Dec
Dr
101 124
Interest expense on loan (P/L)
Loan (SFP)
Recognise the interest expense for the period 1 Jul 20.8 to
31 Dec 20.8
R1 685 400 x 12% x 6/12 = 101 124
Cr
101 124
b) Presentation of balances
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.8
Sales
Cost of sales
Gross profit
///
Interest expense (dr 95 400 dr 101 124 dr 24 876)
///
Profit for the year
20.8
20.7
R
R
xxx
(xxx)
xxx
xxx
(xxx)
xxx
(221 400)
(90 000)
XXX
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
EQUITY AND LIABILITIES
Non-current liabilities
Long term loan
Current liabilities
Current portion of long term loan
20.8
20.7
R
R
0
1 590 000
1 786 524
c) Journal entry – derecognition of loan on 30 June 20.9
J1
20.9
30 Jun Loan (SFP)
Bank (SFP)
Derecognise loan due to payment
279
Dr
1 893 715
0
Cr
1 893 715
The following informal T-accounts are provided to confirm the principles and entries under
discussion:
Dr
Loan
Cr
20.7
20.7
31 Dec Balance cf
1 590 000 1 Jul
Bank
1 500 000
31 Dec Interest expense
90 000
1 590 000
1 590 000
20.8
20.8
31 Dec Balance cf
1 786 524 1 Jan
Balance bd
1 590 000
31 Dec Interest expense
95 400
Interest expense
101 124
1 786 524
1 786 524
20.9
20.9
30 Jun Bank
1 893 715 1 Jan
Balance bd
1 786 524
30 Jun Interest expense
107 191
1 893 715
1 893 715
Dr
20.7
31 Dec
Dr
20.8
31 Dec
Dr
20.9
30 Jun
Loan
Loan
Loan
Loan
Interest expense (20.7)
20.7
90 000 31 Dec Profit or loss
Interest expense (20.8)
20.8
95 400 31 Dec Profit or loss
101 124
196 524
Interest expense (20.9)
20.9
107 191 31 Dec Profit or loss
Cr
90 000
Cr
196 524
196 524
Cr
107 191
Income receivable
Rent income receivable
84
Income such as rent is usually received monthly, at the beginning of the month or at the end
of the immediate preceding month. The payments by the lessee, and therefore the receipts
by the lessor, occur in accordance with a legally enforceable lease agreement. The income is
recognised on the day of the receipt by debiting the bank account and crediting the rent
income account. It can however occur that the lessee does not pay the rent for a specific
month or months.
85
Consider the following example in this regard:
AC Entity’s reporting period ends every year on 31 December. AC Entity hires out land and
buildings at R50 000 per month, which is, in accordance with the lease agreement, payable
on the first day of every month. On 31 December 20.7, the rent income account reflected a
credit balance of R550 000. Due to an oversight by the lessee, the lease instalment that was
receivable on 1 December 20.7, was paid to AC Entity only on 8 January 20.8.
280
86
On 31 December 20.7, the lease instalment receivable represents an item that satisfies the
definition and recognition criteria of an asset. In Accounting, this asset is referred to as rent
income receivable on 31 December 20.7. The rent income receivable has to be recognised
as an asset on 31 December 20.7 by debiting the asset-item rent income receivable and
crediting the rent income account. This will result in the rent income being presented at
R600 000 in the statement of profit or loss for the reporting period ended 31 December 20.7.
The asset-item rent income receivable is presented in the statement of financial position on
31 December 20.7 as part of the line item other current assets under the heading “Current
assets”. During 20.8 the asset-item rent income receivable is derecognised by crediting the
rent income receivable account and debiting the rent income account for 20.8. The asset-item
income receivable occurs only in respect of cash income that is receivable on the reporting
date.
87
It can be indicated as follows that rent income receivable satisfies the definition and
recognition criteria of an asset:
Definition of an asset
Application – rent income receivable
An asset is a resource
Rent income receivable is a resource for the entity since
economic benefits in the form of cash will flow to the entity as
soon as the lessee settles its debt.
controlled by the entity as a
result of past events
AC Entity has an enforceable right to rent income receivable.
As a result AC Entity will have the ability to direct the right of
use of rent income receivable and will obtain substantially all
the remaining benefits from the rent income receivable.
The past events are the entering into and signing of the
lease agreement as well as the fact that the December 20.7
rent income is still outstanding as a result of the utilisation of
the land and buildings from AC Entity at a fixed amount
during December 20.7.
Future economic benefits are expected to flow to the entity
and from which future
when the lessee pays the outstanding amount.
economic benefits are
expected to flow to the entity.
281
Recognition criteria of an Application – rent income receivable
asset
88
An item that meets the
definition of an asset is
recognised only if it satisfies
both the following
recognition criteria:
As set out above, rent income receivable satisfies the
definition of an asset.
it is probable that future
economic benefits
associated with the item will
flow to the entity; and
The lease agreement and the fact that the land and buildings
have already been utilised by the lessee during December
20.7, leaves the lessee no other choice but to pay the lease
instalment and therefore the inflow of future economic
benefits is probable for the lessor.
the item has a cost or a
value that can be measured
reliably.
The cost of the rent income receivable can be measured
reliably at the historical cost price thereof, namely the amount
of R50 000 receivable in accordance with the lease
agreement.
Take note that even though the lease instalment was indeed received during January 20.8, it
does not mean that an asset did not exist on 31 December 20.7.
Interest income accrued on a term deposit but not yet recognised
89
Interest income on a term deposit is usually calculated simply/uncompounded, in other words
interest is not calculated on interest. Consider a term deposit of R200 000 which was made
on 1 January 20.7 for one year at a rate of 7.5% per year, calculated simply. The interest is
therefore calculated as: R200 000 (initial investment) x 7.5% x 12/12 (the full year) =
R15 000. The interest income gradually accumulates over the term of the deposit. Therefore,
at the end of each month interest income to the amount of R1 250 (R15 000 ÷ 12)
accumulates or, stated differently, at the end of each month an amount of R1 250’s interest
accrued.
90
It is possible that the year-end review process could reveal that interest accrued has not yet
been recognised. Interest accrued means that the interest income accumulated during a
reporting period and that the cost of the term deposit has to be increased with this amount.
The deposit therefore has to be debited with the accrued interest amount and the interest
income account has to be credited with the same amount. The interest income is a result of
the requirement that the subsequent measurement of a term deposit has to occur at the
amortised cost thereof.
282
Example 6.6 Interest income accrued on a term deposit
On 1 October 20.7, AD Entity invested an amount of R500 000 in a fixed term deposit for 18
months. Interest at 8% per year (calculated simply) is repayable together with the capital amount at
the end of the term. AD Entity’s current reporting date is 31 December 20.8.
On 31 December 20.8 the following balances, amongst others, appeared in AD Entity’s records:
Term deposit
Interest income on favourable bank balance (20.7 R920)
Dr
R
510 000
Cr
R
2 750
Required:
a)
Recognise the relevant omitted transaction in the accounting records (general journal) of
AD Entity for the reporting period ended 31 December 20.8.
b)
Present the relevant balances in the appropriate financial statements of AD Entity for the
reporting period ended 31 December 20.8.
Note: Comparative figures must be provided.
c)
Derecognise the term deposit on 31 March 20.9 in the records (general journal) of AD Entity
for the reporting period ended 31 December 20.9.
Note:Accept that the interest income for the period 1 January 20.9 to 31 March 20.9 has
already been correctly recognised.
Remark in respect of Example 6.5’s set of facts
1
By reviewing the set of facts, one must realise that the accrued interest in respect of the
term deposit for 20.8 has not yet been recognised.
Example 6.6 Solution
a) Journal entry – outstanding transaction
J1
20.8
31 Dec
Term deposit (SFP)
Interest income on term deposit (P/L)
Recognise interest income for 20.8
R500 000 x 8% x 12/12 = 40 000
283
Dr
40 000
Cr
40 000
b) Presentation of balances in the 20.8 financial statements
AD ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.8
20.8
20.7
R
R
///
Gross profit
Other income (cr 40 000 cr 2 750) / (cr 920 cr (10 000 = 500 000 x 8% x 3/12))
///
Profit for the year
xxx
xxx
42 750
10 920
XXX
XXX
AD ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
20.8
R
ASSETS
Non-current assets
Term deposit (dr 500 000 dr 10 000)
Current assets
Term deposit (dr 510 000 dr 40 000)
20.7
R
0
510 000
550 000
0
c) Journal entry – derecognition of term deposit
J1
20.9
31 Mar
Bank (SFP)
Term deposit (SFP)
Derecognise term deposit due to term that elapsed
R550 000 + (R500 000 x 8% x 3/12 = 10 000) = 560 000
284
Dr
560 000
Cr
560 000
Income received in advance
Rent income received in advance
91
As already mentioned, an income such as rent is usually received monthly in cash, either at
the beginning of the month or at the end of the immediate preceding month. The payments by
the lessee, and therefore the receipts by the lessor, occur in accordance with a legally
enforceable lease agreement. The income is recognised on the day of the receipt by debiting
the bank account and crediting the rent income account. It can however occur that the lessee
pays the lease instalment for a specific month in advance.
92
Consider the following example in this regard:
AC Entity’s reporting period ends every year on 31 December. AC Entity hires out land and
buildings at R50 000 per month, which is, in accordance with the lease agreement, payable
on the first day of each month. On 31 December 20.7, the rent income account reflected a
credit balance of R650 000. The lease instalment that was payable by the lessee on
1 January 20.8, was already paid to AC Entity on 20 December 20.7.
93
On 31 December 20.7, the lease instalment received in advance represents an item that
satisfies the definition and recognition criteria of a liability. In Accounting, this liability is
referred to as rent income received in advance on 31 December 20.7. The rent income
received in advance has to be recognised as a liability on 31 December 20.7 by debiting the
rent income account and crediting the account rent income received in advance. This will
result in the rent income being presented at R600 000 in the statement of profit or loss for the
reporting period ended 31 December 20.7. The liability-item rent income received in advance
is presented in the statement of financial position on 31 December 20.7 as part of the line
item trade and other payables under the heading “Current liabilities”. During 20.8 the liabilityitem rent income received in advance is derecognised by debiting the rent income received in
advance account and crediting the rent income account for 20.8. The liability-item income
received in advance occurs only in respect of cash income that was received in advance on
the reporting date.
94
It can be indicated as follows that the rent income received in advance satisfies the definition
and recognition criteria of a liability:
Definition of a liability
Application – rent income received in advance
A liability is a present obligation
of the entity
The entity has a present, legal obligation towards the
lessee on 31 December 20.7, since the January 20.8
lease instalment, which was only receivable on
1 January 20.8 in accordance with the lease agreement,
has already been received and the lessee therefore has
a right to utilise the property in accordance with the
lease agreement during January 20.8.
arising from past events
The past events that gave rise to the present, legal
obligation are the entering into and signing of the lease
agreement as well as the receipt of the January 20.8
lease instalment.
the settlement of which is
expected to result in an outflow
from the entity of resources
embodying economic benefits.
The “settlement” will occur in that the lessee will utilise
the property during January 20.8 for which payment has
already occurred in the 20.7 reporting period.
285
Recognition criteria of a
liability
Application – rent income received in advance
An item that meets the definition
of a liability is recognised only if it
satisfies both the following
recognition criteria:
As set out above, the rent income received in advance
satisfies the definition of a liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
It is probable that the lessee will utilise the property
during January 20.8 as a result of which economic
benefits will flow from AC Entity (the lessor).
the item has a cost or a value
that can be measured reliably.
The cost of the rent income received in advance can be
measured reliably as the amount that was received,
namely R50 000.
Trade inventories
95
96
As part of the year-end review process, the following has to be ensured in respect of trade
inventories:
•
that trade inventories which were taken by the owner for personal use, have every time
been recognised as drawings;
•
that write-downs to net realisable value have been recognised, where necessary; and
•
that all inventory shortages (in respect of the perpetual inventory system) have been
recognised.
Up to now, trade inventories were accounted for by making use of the perpetual inventory
system. In the last section of this chapter, the periodic inventory system is briefly dealt with.
The recording of/accounting for trade inventories is a very important section in Accounting
and is dealt with in more detail in Chapter 13.
The perpetual inventory system – a brief overview
97
In accordance with the perpetual inventory system:
•
Trade inventories purchased are recognised as an asset by debiting the trade
inventories account and crediting either trade payables or bank.
•
Trade inventories sold are recognised as an expense by debiting the cost of sales
account and crediting the trade inventories account. Once the sale takes place, the cost
of sales in respect of each sales transaction is immediately determined by the system.
•
The number of items that should be on hand in respect of each inventory item as well
as the cost of the specific item is indicated.
•
Physical inventory counts are frequently performed and compared to the number of
inventory items that, according to the system, should be on hand. In this way, inventory
shortages and the cost thereof are isolated.
•
Inventory items are identified in respect of which the cost is more than the amount that
is expected to be realised from the sale of these items.
286
98
Subsequently, the recognition of the following events will be dealt with in the context of the
year-end review process:
•
Withdrawal of trade inventories by the owner for personal use;
•
The recognition of inventory shortages that arose; and
•
The recognition of the write-down of certain inventory items’ cost to the net realisable
value thereof.
Withdrawal of trade inventories by the owner for personal use
99
Drawings by the owner for personal use mostly consist of cash withdrawn as well as the
withdrawal of trade inventories. The recognition of drawings and the presentation thereof in
the statement of changes in equity have already been dealt with. Within the context of the
year-end review process, it could be revealed that the withdrawal of trade inventories during
the last month of the reporting period still has to be recognised.
100 An example of such a case is as follows:
On 31 December 20.7, the current reporting date of AC Entity, the entity’s records reflected
the following two debit balances, amongst others: Trade inventories R412 000 and Drawings
R588 000. The withdrawal of trade inventories with a cost of R12 000 by the owner still has to
be recognised.
101 The withdrawal of the trade inventories will be recognised by debiting the drawings account
with R12 000 and crediting the trade inventories account with the same amount. Drawings
will therefore be presented at R600 000 in the statement of changes in equity and trade
inventories will be presented at R400 000 in the statement of financial position on
31 December 20.7 in the line item inventories under the heading “Current assets”.
Recognition of inventory shortages
102 The perpetual inventory system indicates, in respect of each inventory item, the quantity of
items that should be on hand as well as the cost of each item. During the year, the physical
units on hand are, on a sample basis, compared to the number of units as indicated by the
system. The comparison will identify any shortages that arose. The shortages can be as a
result of theft or because of items that are damaged. The perpetual inventory system will
indicate the cost of the inventory shortages. Inventory shortages must be recognised as an
expense in the reporting period in which it occurs.
103 The source document in respect of the recognition of inventory shortages is the print-out by
the inventory system, which provides detail of the inventory shortages, and has to be
authorised by the owner. It is convention to include the inventory shortage in the cost of sales
expense. Inventory shortages are however initially recognised by debiting the account “Loss
due to inventory shortages” (with the cost of the inventory shortage) and crediting the trade
inventories account. At the end of the reporting period, the loss due to inventory shortages
account is closed off against the cost of sales account. In this way important information in
respect of trade inventories, which could be useful with for instance choosing a supplier, is
maintained.
287
Recognition of the write-down of certain inventory items’ cost to the net realisable
value thereof
104 At initial recognition, trade inventories purchased are measured at the historical cost price
thereof. Subsequent measurement of trade inventories occurs at the lower of cost and net
realisable value. For purposes of this work, the net realisable value is the estimated sales
price that would be obtained.
105 The purchase department of an entity plays an important role in the success of a trading
entity. An effective purchase department ensures that there are always sufficient quality trade
inventories on hand, which were purchased at a competitive price. However, it still occurs
that the demand for certain purchased trade inventory items decline and that the sales prices
have to be reduced. The reduction in the sales price can be of such a nature that the sales
price is lower than the initial cost price of the relevant trade inventory items.
106 The perpetual inventory system identifies inventory items of which the cost is more than the
estimated sales price (net realisable value) thereof. These inventory items’ cost has to be
written down to the estimated sales price thereof. The write-downs are recognised in the
reporting period in which the impairment of the trade inventories occurred. The write-down is
a result of the requirement that the subsequent measurement of trade inventories on the
reporting date has to occur at the lower of cost price and net realisable value of the trade
inventories.
107 The source document in respect of the recognition of such a write-down is the print-out by the
inventory system, which provides detail of the amounts that have to be write-down. The
owner has to authorise this write-down. It is convention to include this write-down in the
expense cost of sales. Write-downs of trade inventory items’ cost price to the net realisable
value thereof are however initially recognised by debiting the account “Loss with write down
of inventories to net realisable value” (with the difference between the cost price and the net
realisable value thereof) and crediting the trade inventories account. At the end of the
reporting period, the account Loss with write down of inventories to net realisable value is
closed off against the cost of sales account. In this way important information in respect of
trade inventories is maintained.
Example 6.7 Withdrawal of trade inventories by the owner and write-downs of trade
inventories
AC Entity’s reporting date is 31 December. On 31 December 20.7 the following balances, amongst
others, appeared in the entity’s records:
Dr
Sales
Cost of sales
Trade inventories
Drawings
Cr
8 050 000
3 225 000
480 000
580 000
AC Entity uses the perpetual inventory system.
The year-end review process in respect of the accounts and records of the entity indicated that the
following events still have to be recognised:
1
On 31 December 20.7, the owner withdrew trade inventories with a cost of R20 000 for
personal use. The trade inventories were delivered to the owner on the same day. This
transaction still has to be recognised.
288
2
On 31 December 20.7, the inventory system indicated that obsolete and damaged trade
inventory items with a cost of R35 000 should be written off. The owner authorised the writeoff.
3
On 31 December 20.7, the inventory system indicated that certain inventory items’ cost is
R33 000 more than the estimated sales price thereof. The owner authorised the write-down.
Required:
a)
b)
Recognise the abovementioned transaction and events in the records (general journal) of
AC Entity for the reporting period ended 31 December 20.7.
After accounting for the abovementioned journal entries, present the balances in the
appropriate financial statements of AC Entity for the reporting period ended 31 December
20.7.
Example 6.7 Solution
a) Journal entries
J1
20.7
31 Dec
J2
20.7
31 Dec
J3
20.7
31 Dec
Drawings (SCE)
Trade inventories (SFP)
Recognise the withdrawal of trade inventories (at cost price)
by the owner
Loss due to inventory shortages (P/L)
Trade inventories (SFP)
Recognise the write-off of obsolete and damaged inventories
as an expense
Loss with write down of inventories to NRV (P/L)
Trade inventories (SFP)
Recognise the write-down of the cost of certain inventory
items to the net realisable value thereof
Dr
20 000
Cr
20 000
Dr
35 000
Cr
35 000
Dr
33 000
Cr
33 000
Remark in respect of Journals J2 and J3
1
At the end of the reporting period, both expense accounts are, as part of the closing off
process, closed off against the cost of sales account.
289
b) Presentation of balances in the financial statements
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
20.7
R
Sales
8 050 000
Cost of sales (dr 3 225 000 dr 35 000 dr 33 000)
(3 293 000)
Gross profit
///
Profit for the year
4 757 000
XXX
AC ENTITY
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.7
Retained
earnings
R
Changes in equity for 20.7
Additional capital contributions by the owner
Profit for the year
Distributions to the owner (drawings) (dr 580 000 dr 20 000)
Balance at 31 December 20.7
(600 000)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
ASSETS
Current assets
Inventories (dr 480 000 cr 20 000 cr 35 000 cr 33 000)
392 000
The following informal T-accounts are provided to confirm the principles and entries under
discussion:
Dr
20.7
31 Dec
Balance
Trade inventories
20.7
480 000 31 Dec
480 000
20.8
1 Jan
Balance
392 000
290
Cr
Drawings
Loss due to inventory
shortages
Loss with write down of
inventories to NRV
Balance cf
20 000
35 000
33 000
392 000
480 000
Dr
20.7
31 Dec
Dr
20.7
31 Dec
Drawings
20.7
580 000 31 Dec
20 000
600 000
Balance
Trade inventories
Balance
Loss due to inventory
shortages
Loss with write down of
inventories to NRV
Cost of sales
20.7
3 225 000 31 Dec
Cr
Retained earnings
600 000
600 000
Cr
Profit or loss
3 293 000
35 000
33 000
3 293 000
Dr
20.7
31 Dec
Loss due to inventory shortages
20.7
35 000 31 Dec Cost of sales
Trade inventories
Dr
20.7
31 Dec
Loss with write down of inventories to NRV
20.7
Trade inventories
33 000 31 Dec Cost of sales
3 293 000
Cr
35 000
Cr
33 000
The periodic inventory system – a brief overview
108 The periodic inventory system is less sophisticated than the perpetual inventory system. Prior
to 1975, the periodic inventory system was basically the only system that was used to
account for trade inventories. With the development in computer technology and software,
the perpetual inventory system originated as a system that, apart from the periodic inventory
system, is used to account for trade inventories. Most small and medium entities however still
use the periodic inventory system. In this section, attention is paid to the periodic inventory
system.
109 Office supplies and office supplies on hand are accounted for by using the principles of a
periodic inventory system. In this regard, review paragraphs 57 to 59 as well as Example 6.1.
110 In accordance with the periodic inventory system:
•
Trade inventories purchased are recognised as an expense by debiting the purchase
account and crediting either trade payables or bank.
•
Trade inventories sold are recognised by debiting the bank account or the specific trade
receivable’s account and crediting the sales account. The cost of sales is not
recognised simultaneously with the individual sales transaction.
•
Cost of sales is “calculated” as follows at the end of the reporting period:
-
Open an expense account named cost of sales;
-
Derecognise trade inventories which were recognised as an asset on the
previous reporting date (thus the opening balance of trade inventories for the
current reporting date), by crediting the trade inventories account and debiting the
cost of sales account;
291
-
Close off the purchases account against the cost of sales account by crediting the
purchases account and debiting the cost of sales account; and
-
Recognise trade inventories on hand on the current reporting date (thus the
closing opening balance of trade inventories for the current reporting date), by
debiting the trade inventories account and crediting the cost of sales account.
•
The extent of recordkeeping of inventories is limited.
•
Trade inventories on hand on the current reporting date (thus the closing balance) are
identified by performing a physical inventory count. The cost of the trade inventory
items on hand is determined with reference to the purchase price of the items. Trade
inventories on hand are therefore only periodically determined and mostly only on the
reporting date.
•
Inventory shortages are not identified/isolated, but reflected in a lower trade inventories,
as physically counted.
•
The inventory items of which the cost is more than the estimated sales price thereof is
identified and appropriately written down to the amount of the estimated sales price
after the trade inventories were recognised as an asset.
Example 6.8 Periodic inventory system
AC Entity’s current reporting date is 31 December 20.7. AC Entity uses the periodic inventory
system. On 31 December 20.7 the following balances, amongst others, appeared in the records of
the entity:
Dr
Sales
Purchases
Trade inventories (1 Jan 20.7)
Drawings
Trade payables
Cr
8 050 000
3 225 000
480 000
580 000
455 225
Additional information
1
On 31 December 20.7, trade inventories to the amount of R35 000 was purchased and
received from Payable K, but not yet recognised. The invoice from Payable K indicates that
the amount is payable on or before 29 January 20.8.
2
A withdrawal by the owner of trade inventories with a cost price of R20 000 on 18 December
20.7, still has to be recognised.
3
Trade inventories on hand on 31 December 20.7 were physically counted and the cost
thereof was calculated in accordance with the average cost method as R520 000. The trade
inventories on hand on 31 December 20.7 still has to be recognised.
4
On 31 December 20.7, certain inventory items’ cost is in total R30 000 more than the
estimated sales price thereof. The necessary write-down still has to be recognised.
292
Required:
a)
With reference to the definition and recognition criteria of an asset indicate whether the trade
inventories on hand on 31 December 20.7 can be recognised as an asset.
b)
Explain the meaning of the debit balances of purchases and trade inventories (1 Jan 20.7) as
indicated in the abbreviated trial balance.
c)
Recognise the abovementioned transaction and events in the records (general journal) of
AC Entity for the reporting period ended 31 December 20.7.
d)
Show the following accounts, as it would appear in the records of AC Entity for the reporting
period ended 31 December 20.7:
e)
i)
Trade inventories;
ii)
Cost of sales; and
iii)
Purchases.
Present the following items in the financial statements of AC Entity for the reporting period
ended 31 December 20.7:
i)
Sales;
ii)
Cost of sales;
iii)
Trade inventories; and
iv)
Trade payables.
Example 6.8 Solution
a) Trade inventories – an asset
It can be indicated as follows that trade inventories on hand on 31 December 20.7 satisfies the
definition and recognition criteria of an asset
Definition of an asset
Application – trade inventories on hand
An asset is a resource
Trade inventories are a resource for a trading entity such as
AC Entity since it is purchased to be sold at a profit to
customers in order to generate cash flow.
controlled by the entity as a result
of past events
Inventory is controlled by the entity, as physical possession
of the inventories has transferred to the entity. The risks and
rewards associated with ownership of the inventories have
passed to the entity. As a result, the entity will have the
ability to direct the use of the inventory and will obtain
substantially all the remaining benefits from the inventories.
The past events in this transaction are the ordering of
inventories by AC Entity and delivery by Payable K.
and from which future economic
benefits are expected to flow to
the entity.
Future economic benefits are expected to flow to AC Entity
when the trade inventories are sold.
293
Recognition criteria of an asset
Application – trade inventories on hand
An item that meets the definition
of an asset is recognised only if it
satisfies both the following
recognition criteria:
As set out above, trade inventories satisfy the definition of an
asset.
it is probable that future economic
benefits associated with the item
will flow to the entity; and
An acquired asset-item, such as trade inventories, which
satisfies the definition of an asset, will probably cause the
inflow of future economic benefits when the trade inventories
are sold.
The date on which the inflow of future economic benefits
became probable is the date on which control was obtained
over the trade inventories, and that is the date on which the
trade inventories were delivered by the supplier (Payable K)
in accordance with the purchase contract, namely
31 December 20.7.
the item has a cost or a value that
can be measured reliably.
The cost of the trade inventories can be measured reliably at
the historical cost price thereof, namely the invoice price of
R35 000.
b) Meaning of the debit balances of purchases and trade inventories (1 Jan 20.7)
Purchases R3 225 000
This amount represents the sum of all the individual purchase transactions of trade inventories
(cash or credit) that were recognised by AC Entity during 20.7 by debiting the purchase account
and crediting bank or the specific trade payable.
Trade inventories (1 Jan 20.7)
This amount represents the trade inventories on hand that were recognised as an asset on
31 December 20.6 and which will probably be sold during the first or second month of the 20.7
reporting period. Consequently, trade inventories (1 Jan 20.7) has to be derecognised by crediting
the trade inventories account and debiting the cost of sales account. The derecognition mostly
occurs only at the end of the current reporting period, namely 31 December 20.7 in this case.
c) Journal entries
J1
20.7
31 Dec
Purchases (P/L)
Payable K (SFP)
Recognise trade inventories purchased
J2
20.7
31 Dec/ Drawings (SCE)
20 Dec
Purchases (P/L)
Recognise withdrawal of trade inventories by owner
294
Dr
35 000
Cr
35 000
Dr
20 000
Cr
20 000
J3
20.7
31 Dec
J4
20.7
31 Dec
Trade inventories (SFP)
Cost of sales (P/L)
Recognise trade inventories on hand on 31 December 20.7
as an asset by reclassifying a portion of the cost of sales as
an asset
Loss with write down of inventories to NRV (P/L)
Trade inventories (SFP)
Recognise write-down of the cost of certain inventory items to
the net realisable value thereof
Dr
520 000
Cr
520 000
Dr
30 000
Cr
30 000
d) General ledger accounts
Dr
20.7
1 Jan
31 Dec
Balance bd
Cost of sales
Trade inventories
20.7
480 000 31 Dec
520 000
Cr
Cost of sales
Loss with write down of
inventories to NRV
Balance cf
1 000 000
20.8
1 Jan
Dr
20.7
31 Dec
Balance bd
Trade inventories (opening)
Purchases
Loss with write down of
inventories to NRV
Dr
20.7
31 Dec
490 000
1 000 000
490 000
Cost of sales
20.7
480 000 31 Dec
3 240 000
30 000
Cr
Trade inventories (closing)
Profit or loss
3 750 000
Dr
20.7
Jan-Dec Bank/Payable
Payable K
480 000
30 000
Purchases
20.7
3 225 000 31 Dec
35 000
3 260 000
520 000
3 230 000
3 750 000
Cr
Drawings
Cost of sales
20 000
3 240 000
3 260 000
Loss with write down of inventories to NRV
20.7
Trade inventories
30 000 31 Dec Cost of sales
Cr
295
30 000
e) Presentation of balances in the 20.7 financial statements
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
20.7
R
Sales
8 050 000
Cost of sales
(3 230 000)
Gross profit
///
Profit for the year
4 820 000
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
ASSETS
Current assets
Inventories (dr 520 000 cr 30 000)
490 000
EQUITY AND LIABILITIES
Current liabilities
Trade and other payables (cr 455 225 cr 35 000)
490 225
Example 6.9 Correction of errors
AC Entity’s current reporting date is 31 December 20.7. AC Entity uses the periodic inventory
system. On 31 December 20.7 the following balances, amongst others, appeared in the records of
the entity:
Dr
780 000
2 880 000
252 000
714 000
355 000
Rent expense
Purchases
Depreciation – equipment
Office supplies
Maintenance
Equipment (cost price)
Accumulated depreciation – equipment
Cr
2 540 000
752 000
Additional information
1
The lease agreement was signed on 18 December 20.6 for various small low value assets. In
accordance with the lease agreement:
•
The rent expense is R60 000 per month, payable on the 2nd day of each month for three
years from 2 January 20.7. (Note: The rent for 20.7 was paid promptly.)
296
•
A refundable deposit of R60 000 is payable on 2 January 20.7. (Note: The rent deposit
was paid and debited against the rent expense account.)
2
On 18 December 20.7, office supplies were ordered from Payable K. The office supplies were
received on 28 December 20.7 and recognised by debiting the purchases account with
R34 000 and crediting Payable K with the same amount. (The invoice indicates that the
amount is payable on or before 27 January 20.8.)
3
No equipment items were purchased during 20.7. On 30 June 20.7 maintenance of the
equipment was satisfactorily completed by a service provider at a cost of R40 000 and paid
on this date. This maintenance costs were debited against the equipment account. The
depreciation expense for 20.7 has already been calculated and recognised. The depreciation
expense was calculated by allocating the cost of the equipment over the useful life thereof,
namely 10 years, to the depreciation expense by using the straight line method.
((R2 500 000 ÷ 10) + (R40 000 ÷ 10 x 6/12)).
Required:
Recognise the corrections resulting from the abovementioned additional information in the records
(general journal) of AC Entity for the reporting period ended 31 December 20.7.
Example 6.9 Solution
Journal entries
J1
20.7
31 Dec
J2
20.7
31 Dec
J3
20.7
31 Dec
Rent deposit (SFP)
Rent expense (P/L)
Correction: rent deposit erroneously debited against rent
expense
Office supplies (P/L)
Purchases (P/L)
Correction: purchase of office supplies erroneously debited
against purchases
Maintenance (P/L)
Equipment (SFP)
Correction: maintenance erroneously debited against
equipment
297
Dr
60 000
Cr
60 000
Dr
34 000
Cr
34 000
Dr
40 000
Cr
40 000
J4
20.7
31 Dec
Accumulated depreciation – equipment (SFP)
Depreciation – equipment (P/L)
Correction: reversal of depreciation (on R40 000) recognised
in error
Dr
2 000
Cr
2 000
Remark in respect of journal J4
1
The correction in respect of the depreciation could also have been recognised by
reversing/writing back the initial depreciation of R252 000 and recognising the correct
amount in respect of depreciation. In this case the journal entries would have been as
follows:
J4.1
20.7
31 Dec
J4.2
20.7
31 Dec
Accumulated depreciation – equipment (SFP)
Depreciation – equipment (P/L)
Correction: reversal of depreciation erroneously
calculated and recognised
Depreciation – equipment (P/L)
Accumulated depreciation – equipment (SFP)
Recognise depreciation for 20.7
298
Dr
252 000
Cr
252 000
Dr
250 000
Cr
250 000
Chapter 7 The closing off process
Contents
Paragraph
1
3
6
11
15
Introductory comments
The closing off process
The closing journals
The result of the closing off process
Closing remarks
299
Examples
Example
7.1
The closing off process
300
Chapter 7 The closing off process
Introductory comments
1
2
Subsequent to the completion of the review and adjustment process, the financial statements
of an entity are prepared for a relevant reporting period (e.g. the year ended 31 December
20.7) for approval by the owner. (The format of the statements is set out in Chapter 3). The
approval date is a month or two after the reporting date, e.g. 4 February 20.8. The financial
statements for a reporting period (e.g. the year ended 31 December 20.7) comprise:
•
A statement of profit or loss for the year ended 31 December 20.7. This statement is
prepared from the balances on the individual income and expense accounts as at
31 December 20.7;
•
A statement of changes in equity for the year ended 31 December 20.7. The statement
of changes in equity reflects the extent of and changes in capital contributions by the
owner(s) as well as earnings that were retained in the entity, after distributions to the
owner(s) (drawings) during the 20.7 reporting period; and
•
A statement of financial position as at 31 December 20.7. This statement is prepared
from the capital account balance, the retained earnings account balance as well as the
balances on the individual asset and liability accounts as at 31 December 20.7.
Subsequently, attention is paid to the closing off process whereby the accounts for income,
expenses and drawings are closed off against retained earnings as at the reporting date.
The closing off process
3
The nature of the closing off process is discussed with reference to the retained earnings
column of the following statement of changes in equity.
AC ENTITY
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.7
Capital
R
6 000 000
Balance at 31 December 20.6
Changes in equity for 20.7
Additional capital contribution by owner
Profit for the year
Distributions to owner (drawings)
Balance at 31 December 20.7
Retained
earnings
R
2 147 055
500 000
6 500 000
1 824 465
(960 000)
3 011 520
Remark
1
The financial statements were approved for distribution on 4 February 20.8.
301
Total
R
8 147 055
500 000
1 824 465
(960 000)
9 511 520
4
Retained earnings at the beginning of the current reporting period (R2 147 055) are the
accumulated profits, after drawings, for the period since inception of the entity until
31 December 20.6.
5
The profit for the year ended 31 December 20.7 (R1 824 465) is added to the retained
earnings at the beginning of the year. However, income, expenses and drawings are not
accumulated directly against retained earnings during the reporting period, but are
accumulated in appropriate accounts for individual income-items, individual expense-items
and drawings. Such treatment ensures that useful information in respect of income, expenses
and drawings during the reporting period can be obtained by the owner and his employees
directly from the accounts. Income accounts, expense accounts and the drawings account
are temporary accounts and are valid only for a specific reporting period (20.7 in this case).
Subsequent to the completion of the financial statements for approval by the owner (on
4 February 20.8 in this case) the temporary accounts are closed off against the retained
earnings account as at the relevant reporting date (31 December 20.7 in this case). The
balance of the retained earnings as at 31 December 20.7, will therefore be R3 011 520 after
the closing entries. The statement of changes in equity therefore provides detail of the
increase that occurred in the balance of retained earnings during 20.7. The statement of
changes in equity also provides detail of the increase that occurred in the capital balance
during 20.7. It is necessary to refer back to Chapter 3 paragraphs 34 to 42.
The closing journals
6
The closing journals are generated when the financial statements are approved for
distribution (4 February 20.8 in this case). The date reflected on the closing journal is the
reporting date (31 December 20.7 in this case) which also represents the date on which the
journals are posted. The closing entries (closing journals) are as follows:
7
Expenses:
Dr
Retained earnings (SCE)
Cr
Individual expenses (P/L)
with the account balances as at 31 December 20.7, which naturally also reflect the effect of
the journals resulting from the adjustment process.
8
Income:
Dr
Individual income (P/L)
Cr
Retained earnings (SCE)
with the account balances as at 31 December 20.7, which naturally also reflect the effect of
the journals resulting from the adjustment process.
The closing off of income- and expense accounts against retained earnings are combined
into one journal. Refer to Example 7.1.
9
Drawings:
Dr
Retained earnings (SCE)
Cr
Drawings (SCE)
with the account balance as at 31 December 20.7, which naturally also reflect the effect of
the journals resulting from the adjustment process.
302
10
The practice also exists to close off the income account sales and the expense account cost
of sales to a memorandum account/intermediate account, namely the gross profit account/
trading account. This gross profit account as well as all the other income and expense
accounts are then closed off to a memorandum account/intermediate account, namely the
profit or loss account, where after the profit or loss account is closed off against the retained
earnings account. Drawings are still closed off against the retained earnings account.
The result of the closing off process
11
Each income account, expense account and the drawings account has no balance at the
beginning of each reporting period. The effect of transactions on income, expenses and
drawings for a reporting period is accumulated in the appropriate income accounts, expense
accounts and the drawings account for the specific reporting period. The balances on these
temporary accounts (also called nominal accounts) are closed off against retained earnings
at the end of the reporting period. This process is repeated each reporting period.
12
Each reporting period starts with a new set of accounts for income, expenses and drawings.
The accounts for assets, liabilities, capital and retained earnings however start with a balance
as brought forward from the previous reporting period. The opening balance on these
accounts represents the net effect of the result that transactions had on these items during all
previous reporting periods.
13
The list of balances obtained from the accounting records at the end of the reporting period,
before the yearend review and adjustment procedures have been performed, is known as the
pre-adjustment list of balances (or the pre-adjustment trial balance). Sometimes the words
“list of balances” are also referred to as the trial balance.
14
The list of balances obtained from the accounting records at the end of reporting period, after
the yearend review and adjustment procedures have been performed, is known as the postadjustment list of balances (or the post-adjustment trial balance). The closing off process
deals with the post-adjustment list of balances/post-adjustment trial balance.
303
Example 7.1 The closing off process
The following information represents the post-adjustment list of balances of AC Entity on
31 December 20.7, the entity’s current reporting date.
Acc
no
A1
Land (cost price)
A2.1
Buildings (cost price)
A2.2
Accumulated depreciation – buildings
A3.1
Machinery (cost price)
A3.2
Accumulated depreciation – machinery
A4.1
Delivery vehicles (cost price)
A4.2
Accumulated depreciation – delivery vehicles
A5.1
Furniture and equipment (cost price)
A5.2
Accumulated depreciation – furniture and equipment
Trade inventories (cost price less write offs to net realisable value)
A20
D1
Receivable A
D2
Receivable B
D3
Receivable C
A23.1
Office supplies on hand
A23.2
Prepaid insurance
A24
Fixed term deposit (amortised cost) (short term)
A30
Bank
E1
Capital
E2.1
Retained earnings (1 Jan 20.7)
E2.2
Drawings
L2
Bank loan (amortised cost) (long term)
K1
Payable K
K2
Payable L
K7
Payable Jozi
K10
Payable Telkom
L11.1
Rent expense payable
L11.8
Deposit: rent (lease term expires 31 Dec 20.8)
L4
Supplier’s loan (amortised cost) (short term)
I1
Sales
I4.1
Rent income
I4.2
Interest income on term deposit
U1
Cost of sales
U3
Salaries and wages
U4
Water and electricity
U6
Telephone and communication
U7
Office supplies
U8
Insurance
U9
Fuel and maintenance
U11
Doubtful debts
U19
Administrative expenses
U20.1
Depreciation – buildings
U20.2
Depreciation – machinery
U20.3
Depreciation – delivery vehicles
U20.4
Depreciation – furniture and equipment
U30.2
Interest expense on bank loan
U30.3
Interest expense on supplier’s loan
304
Dr
R
450 200
1 800 000
Cr
R
270 000
1 500 000
450 000
960 000
384 000
562 000
168 600
1 927 025
1 205 000
1 405 000
1 240 500
125 000
13 000
420 000
1 028 345
6 500 000
1 147 055
960 000
1 100 000
1 050 750
1 204 000
40 050
15 285
40 000
15 000
247 500
12 493 110
45 000
20 000
5 827 005
2 548 750
402 500
204 800
420 000
156 000
242 525
342 000
840 000
90 000
150 000
192 000
56 200
110 000
12 500
25 190 350
25 190 350
Additional information
1
During 20.7, the owner deposited a further R500 000 into the entity’s cheque account. This
transaction has already been appropriately recognised.
Required:
a)
Prepare the statement of profit or loss and the statement of changes in equity of AC Entity for
the reporting period ended 31 December 20.7.
b)
Provide the closing journals as at 31 December 20.7.
c)
After accounting for the closing journals, prepare an updated post-adjustment trial balance as
at 31 December 20.7.
d)
Prepare the statement of financial position of AC Entity as at 31 December 20.7.
Example 7.1 Solution
a) Statement of profit or loss and the statement of changes in equity
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Sales
Cost of sales
Gross profit
Other income
Rent income
Interest income
Salaries and wages
Water and electricity
Telephone and communication
Insurance
Fuel and maintenance
Depreciation (dr 90 000 dr 150 000 dr 192 000 dr 56 200)
Doubtful debts
Office supplies
Administrative expenses
Interest expense (dr 110 000 dr 12 500)
Profit for the year
305
R
12 493 110
(5 827 005)
6 666 105
45 000
20 000
(2 548 750)
(402 500)
(204 800)
(156 000)
(242 525)
(488 200)
(342 000)
(420 000)
(840 000)
(122 500)
963 830
AC ENTITY
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.7
Capital
R
6 000 000
Balance at 31December 20.6
Changes in equity for 20.7
Additional capital contributions by the owner
Profit for the year
Distributions to owner (drawings)
Balance at 31 December 20.7
Retained
earnings
R
1 147 055
500 000
6 500 000
963 830
(960 000)
1 150 885
Total
R
7 147 055
500 000
963 830
(960 000)
7 650 885
b)
Closing journal: Income and expenses
20.7
31 Dec
Sales (P/L)
Rent income (P/L)
Interest income on term deposit (P/L)
Cost of sales (P/L)
Salaries and wages (P/L)
Water and electricity (P/L)
Telephone and communication (P/L)
Office supplies (P/L)
Insurance (P/L)
Fuel and maintenance (P/L)
Doubtful debts (P/L)
Administrative expenses (P/L)
Depreciation – buildings (P/L)
Depreciation – machinery (P/L)
Depreciation – delivery vehicles (P/L)
Depreciation – furniture and equipment (P/L)
Interest expense on bank loan (P/L)
Interest expense on supplier’s loan (P/L)
Retained earnings (SCE)
Recognise the closing off of income and expense
accounts (temporary accounts) against retained earnings
(The amount of R963 830 is total income less total expenses or merely
the balancing amount of the journal.)
306
Dr
12 493 110
45 000
20 000
Cr
5 827 005
2 548 750
402 500
204 800
420 000
156 000
242 525
342 000
840 000
90 000
150 000
192 000
56 200
110 000
12 500
963 830
If the income account sales and the expense account cost of sales were first closed off against the
gross profit account and this account together with the abovementioned other income and expense
accounts were then closed off to the profit or loss account and the profit or loss account were
thereafter closed off against the retained earnings account, the following journals have to be
recognised:
J1
20.7
31 Dec
J2
20.7
31 Dec
J3
20.7
31 Dec
Sales (P/L)
Cost of sales (P/L)
Gross profit (P/L)
Recognise the closing off of the sales and cost sales
accounts (temporary accounts) against gross profit
Gross profit (P/L)
Profit or loss (P/L)
Recognise the closing off of the gross profit account
(temporary account) against the profit or loss account
Rent income (P/L)
Interest income on term deposit (P/L)
Salaries and wages (P/L)
Water and electricity (P/L)
Telephone and communication (P/L)
Office supplies (P/L)
Insurance (P/L)
Fuel and maintenance (P/L)
Doubtful debts (P/L)
Administrative expenses (P/L)
Depreciation – buildings (P/L)
Depreciation – machinery (P/L)
Depreciation – delivery vehicles (P/L)
Depreciation – furniture and equipment (P/L)
Interest expense on bank loan (P/L)
Interest expense on supplier’s loan (P/L)
Profit or loss (P/L)
Recognise the closing off of income and expense
accounts (temporary accounts) against profit or loss
307
Dr
12 493 110
Cr
5 827 005
6 666 105
Dr
6 666 105
Cr
6 666 105
Dr
45 000
20 000
Cr
2 548 750
402 500
204 800
420 000
156 000
242 525
342 000
840 000
90 000
150 000
192 000
56 200
110 000
12 500
5 702 275
J4
20.7
31 Dec
Profit or loss (P/L)
Retained earnings (SCE)
Recognise the closing off of the profit or loss account
(temporary account) against retained earnings
Dr
963 830
Cr
963 830
Closing journal: Drawings
20.7
31 Dec
Dr
960 000
Retained earnings (SCE)
Drawings (SCE)
Recognise the closing off of the drawings account
(temporary account) against retained earnings
Cr
960 000
General ledger accounts
The general ledger account for retained earnings will be as follows after accounting for the closing
journals:
Dr
20.7
31 Dec
Drawings
Balance cf
Retained earnings
20.7
960 000 1 Jan
1 150 885 31 Dec
2 110 885
20.8
1 Jan
Cr
Balance bd
Income and expenses
1 147 055
963 830
2 110 885
Balance bd
1 150 885
If the gross profit account and the profit- or loss account were used as intermediate accounts, then
the relevant general ledger accounts would have been as follows after accounting for the closing
journals:
Dr
20.7
31 Dec
Dr
20.7
31 Dec
Dr
20.7
31 Dec
Profit or loss
Income and Expenses
Profit or loss
Drawings
Balance cf
Gross profit
20.7
6 666 105 31 Dec
Profit or loss
20.7
5 702 275 31 Dec
963 830
6 666 105
Retained earnings
20.7
960 000 1 Jan
1 150 885 31 Dec
2 110 885
20.8
1 Jan
308
Cr
Sales and Cost of sales
6 666 105
Cr
Gross profit
6 666 105
6 666 105
Cr
Balance bd
Profit or loss
1 147 055
963 830
2 110 885
Balance bd
1 150 885
c) Updated post-adjustment trial balance of AC Entity as at 31 December 20.7
Acc
no
A1
Land (cost price)
A2.1
Buildings (cost price)
A2.2
Accumulated depreciation – buildings
A3.1
Machinery (cost price)
A3.2
Accumulated depreciation – machinery
A4.1
Delivery vehicles (cost price)
A4.2
Accumulated depreciation – delivery vehicles
A5.1
Furniture and equipment (cost price)
A5.2
Accumulated depreciation – furniture and equipment
Trade inventories (cost price less write offs to net realisable value) A20
D1
Receivable A
D2
Receivable B
D3
Receivable C
A23.1
Office supplies on hand
A23.2
Prepaid insurance
A24
Fixed term deposit (amortised cost)
A30
Bank
E1
Capital
E2.1
Retained earnings (31 Dec 20.7)
L2
Bank loan (amortised cost)
K1
Payable K
K2
Payable L
K7
Payable Jozi
K10
Payable Telkom
L11.1
Rent expense payable
L11.8
Deposit: rent
L4
Supplier’s loan (amortised cost)
309
Dr
R
450 200
1 800 000
Cr
R
270 000
1 500 000
450 000
960 000
384 000
562 000
168 600
1 927 025
1 205 000
1 405 000
1 240 500
125 000
13 000
420 000
1 028 345
6 500 000
1 150 885
1 100 000
1 050 750
1 204 000
40 050
15 285
40 000
15 000
247 500
12 636 070 12 636 070
d)
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
20.7
R
ASSETS
Non-current assets
Land
Buildings (dr 1 800 000 cr 270 000)
Machinery (dr 1 500 000 cr 450 000)
Delivery vehicles (dr 960 000 cr 384 000)
Furniture and equipment (dr 562 000 cr 168 600)
Total non-current assets
Current assets
Inventories
Trade receivables (dr 1 205 000 dr 1 405 000 dr 1 240 500)
Other current assets (dr 125 000 dr 13 000)
Term deposit
Cash and cash equivalents
Total current assets
Total assets
450 200
1 530 000
1 050 000
576 000
393 400
3 999 600
1 927 025
3 850 500
138 000
420 000
1 028 345
7 363 870
11 363 470
EQUITY AND LIABILITIES
Equity
Capital
Retained earnings
Total equity
6 500 000
1 150 885
7 650 885
Non-current liabilities
Bank loan
Total non-current liabilities
1 100 000
1 100 000
Current liabilities
Trade and other payables
(cr 1 050 750 cr 1 204 000 cr 40 050 cr 15 285 cr 40 000 cr 15 000)
Short term loans
Current portion of long term loans
Total current liabilities
Total liabilities
Total equity and liabilities
310
2 365 085
247 500
0
2 612 585
3 712 585
11 363 470
Closing remarks
15
A thorough review in respect of each category (assets, liabilities, equity, income and
expenses) general ledger accounts takes place as part of the financial procedures with
regards to the end of the reporting period. Resulting from this review process, certain
transactions and events still have to be recognised in respect of the current reporting period.
The journals for these transactions are generated during the period 31 December 20.7 (the
current reporting date) to the date on which the financial statements are approved for
distribution (4 February 20.8 in this case). The date assigned to these journals is
31 December 20.7 and the journals are posted as at 31 December 20.7. These journals
therefore affect assets, liabilities, income, expenses and drawings as at 31 December 20.7.
Recognition of these transactions and events may however occur only in respect of
those assets, liabilities, income and expenses that satisfied the definition and
recognition criteria of the relevant element on or before 31 December 20.7 (the current
reporting date). (Refer Chapter 6.)
16
Subsequent to posting the journals resulting from the adjustment process as at 31 December
20.7, the general purpose financial statements are prepared from the account balances as at
31 December 20.7.
17
The closing journals are generated after the financial statements are approved for distribution
(4 February 20.8 in this case). The date assigned to these journals is 31 December 20.7 and
these journals are posted as at 31 December 20.7.
311
Chapter 8 Value added tax
Contents
Introduction
VAT input and VAT output
Purchases of goods and services that represent taxable supplies
Recognition of VAT input as an asset within cash transactions
Recognition of VAT input as an asset within credit transactions
Sale of goods and services that represent taxable supplies
Recognition of VAT output as a liability within cash transactions
Recognition of VAT output as a liability within credit transactions
Miscellaneous transactions
Taxable supplies of which the VAT input may not be claimed
Zero-rated supplies
Exempt supplies
Transactions and events that do not have a VAT effect
VAT return
VAT input as asset and VAT output as liability
313
Paragraph
1
15
22
24
29
36
38
43
46
47
49
50
52
55
57
Examples
Example
8.1
8.2
8.3
8.4
8.5
8.6
8.7
8.8
8.9
8.10
8.11
VAT input
VAT output
Write-off of bad debts
Recoupment of debt previously written off as irrecoverable
Withdrawal of trade inventories by the owner
Donation of trade inventories
Purchase of a passenger vehicle as well as goods and services for the
entertainment of staff
Purchase of fuel
Payment in respect of exempt supplies
Receipt of exempt supplies
Payment of VAT due and the presentation of the VAT balances
314
Chapter 8 Value added tax
Introduction
1
Value added tax, which is usually referred to as VAT, is a transaction tax or a consumer tax
that was introduced in South Africa in 1991. VAT is a form of income for the government and
arises in that specific entities have to register as vendors in accordance with the VAT Act and
have to charge VAT on the taxable supply of goods or services. A taxable supply is a
transaction that the entity incurs whereby goods are sold or services are delivered and on
which VAT has to be charged. The rate at which VAT is charged can change from time to
time. The standard rate was 14% until 1 April 2018. On 1 April 2018, after 25 years, the
standard VAT rate was increased to 15%.
2
When an entity that is a registered VAT vendor makes a taxable supply, the sales price (or
listed price) must include VAT. If a registered VAT vendor sells goods at a listed price of for
example R5 750, the VAT amount and the sales price excluding VAT will be calculated as
follows by using a VAT rate of 15%:
Consideration (listed price)
VAT (15/115 x R5 750)
Sales price excluding VAT (100/115 x R5 750)
R
5 750
750
5 000
In the abovementioned example the sales price excluding VAT is therefore R5 000, the VAT
component R750 and the listed price or sales price R5 750.
3
In this work it is mostly only the listed price that is known and it is often indicated as the sales
price (including VAT). VAT is therefore either 15/100 of the sales price excluding VAT
(15/100 X R5 000 = R750) or 15/115 of the sales price including VAT (15/115 X R5 750 =
R750).
4
In the abovementioned example, the selling entity (registered VAT vendor) therefore received
R5 750 from the sale of the goods, of which R750 must be paid to the South African Revenue
Services (SARS). The registered VAT vendor therefore acts as agent for SARS by collecting
VAT on taxable supplies on behalf of SARS.
5
Registration as a vendor for VAT purposes is compulsory if the total value of the taxable
supplies made by an entity exceeds R1 000 000 in a twelve-month period. If the total value of
taxable supplies made by an entity is less than R1 000 000, but more than R50 000,
registration is voluntary. The VAT which a registered VAT vendor collects in respect of the
transactions (taxable supplies) that the entity entered into with customers must be paid over
to SARS. At the end of a VAT period, the registered VAT vendor will submit a VAT return that
inter alia reflects the amount payable to SARS. The amount due to SARS in respect of VAT
collected on taxable supplies (VAT output) is reduced by the amount of the VAT which has
been paid to suppliers (VAT input), except for the VAT paid on certain items that may not be
claimed. To enable the registered VAT vendor to complete the VAT return, the VAT collected
from customers and the VAT paid to suppliers must be correctly accounted for.
315
6
VAT is administered by entities who act as agents for SARS. In most cases, VAT does not
involve any additional costs to an entity that is registered as a vendor in accordance with the
VAT Act, except for the cost to administer the VAT on behalf of SARS. It is usually the end
user that pays the full amount of VAT.
7
The following diagram is an example of how the VAT system works:
Wholesaler
Manufacturer
Sole proprietor
ĺ
Manufacturer
manufactures the product
and then sells it to the
wholesaler
Wholesaler purchases
goods from the
manufacturer and sells it
to the sole proprietor
Sales price
R1 150
Sales price
R1 725
Sales price
R4 312.50
VAT output
R150
VAT output
R225
VAT output
R562.50
VAT input
R150
VAT input
VAT input
Pays to SARS
Rnil
R150
Pays to SARS
R75
ĺ
Sole proprietor purchases
goods from the wholesaler
and sells it to the public
Pays to SARS
R225
R337.50
Remark
1
The VAT input with regards to the manufacturer is accepted as Rnil to keep the
example simple and to simplify the understanding of the example.
8
SARS therefore received a total amount of R562.50 (R150 + R75 + R337.50) from all the
registered VAT vendors. This amount also represents the tax (VAT at 15%) on the total value
added (R4 312.50 – Rnil) to this transaction, namely R4 312.50 x 15/115. As mentioned
above, it is usually the end user, who is not registered for VAT purposes, who pays the total
VAT amount, namely R562.50 in this case.
9
One of the fundamental principles of the VAT system of South Africa is that the system is
invoice-based. In accordance with the invoice basis, a taxable supply occurs at the earliest of
the following two events:
•
the date on which the invoice is issued for delivery that has already taken place
(purchases and sales); or
•
the date on which the payment is made or received.
10
The requirement of the invoice basis in respect of the recognition of purchases and sales
(taxable supplies) in the records of the registered VAT vendor is therefore in accordance with
accrual accounting.
11
Smaller entities can apply with SARS to use the payment basis instead of the invoice basis to
account for VAT. In accordance with the payment basis, VAT is accounted for on the date on
which the cash flow occurred in respect of taxable supplies that took place. The payment
basis is not used in this work.
316
12
13
In this chapter the recognition of VAT in the accounting records is dealt with on an
introductory basis. Attention is paid to the following:
•
VAT input and VAT output;
•
The recognition of sales and purchases of goods and services that represent taxable
supplies in the records of a registered VAT vendor;
•
The recognition of miscellaneous transactions (taxable supplies) in the records of a
registered VAT vendor
•
Supplies in respect of which the VAT input may not be accounted for against the VAT
output;
•
Zero-rated supplies;
•
Exempt supplies;
•
Events and VAT;
•
The VAT return; and
•
VAT input as an asset and VAT output as a liability.
In the subject Taxation, detailed attention is paid to the stipulations of the VAT Act.
VAT input and VAT output
14
When a registered VAT vendor purchases goods from another registered VAT vendor and
the transaction represents a taxable supply in accordance with the VAT Act, the purchase
price includes VAT. The VAT which is paid to the supplier is VAT input or input tax in the
hands of the purchasing entity. The VAT which is received from the purchasing entity is
VAT output or output tax in the hands of the selling entity.
15
Taxable supplies are defined in the VAT Act. In this work only a number of taxable supplies
are dealt with.
16
At the initial recognition of assets, expenses and income, VAT is isolated and recognised.
17
VAT input arises from the purchase (in cash and on credit) of goods (e.g. trade inventories,
office supplies and certain non-current assets) and services that are taxable supplies and is,
at the initial recognition of the relevant asset-item or expense-item, isolated and recognised
as an asset. VAT input therefore does not form part of the cost of the relevant asset-item or
expense-item. VAT input represents the tax (VAT) that is paid on taxable supplies and can be
claimed from SARS in respect of most transactions.
18
VAT output arises from the sale (in cash and on credit) of goods (e.g. trade inventories and
non-current assets) and the delivery of services that are taxable supplies and is, at the initial
recognition of the relevant income-item, isolated and recognised as a liability. VAT output
therefore does not form part of the relevant income-item. VAT output represents the tax
(VAT) that is charged on taxable supplies and must be paid over to SARS.
19
To determine the amount due to SARS, the VAT input is deducted from/accounted for against
the VAT output.
20
The item VAT input belongs to the element assets and the item VAT output belongs to the
element liabilities. In paragraphs 57 and 58 it is formally indicated that the item VAT input and
the item VAT output satisfy the definition and recognition criteria of respectively an asset and
a liability.
317
Example 8.1 VAT input
On 15 January 20.7, AC Entity, a registered VAT vendor, received trade inventories that were
purchased from a registered VAT vendor on this day for cash. The invoice indicates the purchase
price as R9 430 (including VAT).
Required:
Recognise the abovementioned transaction in the records (general journal) of AC Entity for the
month ended 31 January 20.7 if it is accepted that:
a)
AC Entity uses the perpetual inventory system; and
b)
AC Entity uses the periodic inventory system.
Example 8.1 Solution
a) Journal entry – perpetual inventory system
J1
20.7
15 Jan
Trade inventories (SFP) (9 430 x 100/115)
VAT input (SFP) (9 430 x 15/115)
Bank (SFP)
Recognise trade inventories purchased for cash
Dr
8 200
1 230
Cr
9 430
b) Journal entry – periodic inventory system
J1
20.7
15 Jan
Purchases (P/L) (9 430 x 100/115)
VAT input (SFP) (9 430 x 15/115)
Bank (SFP)
Recognise trade inventories purchased for cash
Dr
8 200
1 230
Cr
9 430
Remark in respect of the above
1
If the entity is registered as a VAT vendor, the VAT input does not form part of the cost
of trade inventories, or the cost of non-current assets, or the cost of expenses.
Example 8.2 VAT output
On 20 January 20.7, AC Entity, a registered VAT vendor, delivered trade inventories that were sold
on this day for cash. The invoice indicates the sales price as R23 575 (including VAT). The cost of
the trade inventories sold was R8 200.
Required:
Recognise the abovementioned transaction in the records (general journal) of AC Entity for the
month ended 31 January 20.7 if it is accepted that:
a)
AC Entity uses the perpetual inventory system; and
b)
AC Entity uses the periodic inventory system.
318
Example 8.2 Solution
a) Journal entry – perpetual inventory system
J1
20.7
20 Jan
Bank (SFP)
VAT output (SFP) (23 575 x 15/115)
Sales (P/L) (23 575 x 100/115)
Recognise trade inventories sold for cash
Dr
23 575
Cr
3 075
20 500
Remark in respect of the above
1
J2
20.7
20 Jan
If the entity is registered as a VAT vendor, the VAT output does not form part of the
income-item sales.
Cost of sales (P/L)
Trade inventories (SFP)
Recognise the cost of the trade inventories sold
Dr
8 200
Cr
8 200
b) Journal entry – periodic inventory system
The journal entry to recognise the sales transaction in the records of AC Entity is the same as for
the perpetual inventory system. (Refer to (a) above.)
The periodic inventory system does not isolate the cost of sales in respect of individual sales
transactions and consequently there is no journal entry to recognise cost of sales. Cost of sales is
recognised in accordance with the periodic inventory system only as part of the year-end review
process.
Remark in respect of Examples 8.1 and 8.2
1
If AC Entity (only with reference to Examples 8.1 and 8.2 above) would have completed
a VAT return at the end of the VAT period, the return would have reflected that
AC Entity would have to pay an amount of R1 845 to SARS. The amount of R1 845 is
calculated by reducing the VAT output (R3 075) with the VAT input (R1 230).
Purchases of goods and services that represent taxable
supplies
21
For a purchasing entity, who is a registered VAT vendor, the purchase price of the following
goods and services that are purchased from a selling entity, who is a registered VAT vendor,
includes VAT-input:
•
Non-current assets such as machinery, furniture, equipment and delivery vehicles;
•
Current assets such as trade inventories; and
•
Expenses such as office supplies, water and electricity, telephone, insurance, rent of
commercial property and bank charges.
319
22
Subsequently, attention is paid to a number of transactions that cause VAT input to be
recognised as an asset.
Recognition of VAT input as an asset within cash transactions
23
In the case of the cash purchase of goods and services which represent taxable supplies, the
VAT input is recognised as an asset with the initial recognition of the transaction.
24
The cash purchase of a delivery vehicle from a registered VAT vendor for R373 750
(including VAT) that was delivered on 15 December 20.7, will be recognised as follows:
20.7
15 Dec
25
Delivery vehicle (SFP) (373 750 x 100/115)
VAT input (SFP) (373 750 x 15/115)
Bank (SFP)
Recognise delivery vehicle purchased for cash
Dr
325 000
48 750
Cr
373 750
The cash purchase of trade inventories from a registered VAT vendor for R51 750 (including
VAT) that were delivered on 10 December 20.7, will be recognised as follows:
Cash purchase of trade inventories – perpetual inventory system
20.7
10 Dec
Trade inventories (SFP) (51 750 x 100/115)
VAT input (SFP) (51 750 x 15/115)
Bank (SFP)
Recognise trade inventories purchased for cash
Dr
45 000
6 750
Cr
51 750
Cash purchase of trade inventories – periodic inventory system
20.7
10 Dec
26
Purchases (P/L) (51 750 x 100/115)
VAT input (SFP) (51 750 x 15/115)
Bank (SFP)
Recognise trade inventories purchased for cash
Dr
45 000
6 750
Cr
51 750
The payment of the December 20.7 lease instalment in respect of commercial property
(accept that the lessee is a registered VAT vendor and the lease term is short term) to the
amount of R23 000 (including VAT) on 2 December 20.7, will be recognised as follows:
20.7
2 Dec
Rent expense (P/L) (23 000 x 100/115)
VAT input (SFP) (23 000 x 15/115)
Bank (SFP)
Recognise rent of property for December 20.7
320
Dr
20 000
3 000
Cr
23 000
27
The payment of the insurance premium in cash to the amount of R13 225 (including VAT) on
3 December 20.7 to a registered VAT vendor, will be recognised as follows:
20.7
3 Dec
Insurance (P/L) (13 225 x 100/115)
VAT input (SFP) (13 225 x 15/115)
Bank (SFP)
Recognise insurance premium for December 20.7
Dr
11 500
1 725
Cr
13 225
Recognition of VAT input as an asset within credit transactions
28
In the case of the credit purchase of goods and services which represent taxable supplies,
the VAT input is recognised as an asset with the initial recognition of the credit purchase.
There is no VAT implication on settlement of the liability.
29
The purchase of a delivery vehicle on credit from Payable L (a registered VAT vendor) to the
amount of R431 250 (including VAT), which was delivered on 15 December 20.7, will be
recognised as follows:
20.7
15 Dec
xxx
xxx
Delivery vehicle (SFP) (431 250 x 100/115)
VAT input (SFP) (431 250 x 15/115)
Payable L (SFP)
Recognise delivery vehicle and the accompanying
liability
Payable L (SFP)
Bank (SFP)
Derecognise payable due to settlement
Dr
375 000
56 250
Cr
431 250
Dr
431 250
Cr
431 250
Remark
1
30
Interest is classified as an exempt supply and therefore has no VAT. The impact of
interest is not shown in this example for simplicity.
The purchase of machinery with a supplier’s loan from Supplier M (a registered VAT vendor)
to the amount of R460 000 (including VAT), which was delivered on 31 December 20.7, will
be recognised as follows:
20.7
31 Dec
Machinery (SFP) (460 000 x 100/115)
VAT input (SFP) (460 000 x 15/115)
Loan from Supplier M (SFP)
Recognise machinery and the accompanying liability
321
Dr
400 000
60 000
Cr
460 000
xxx
xxx
Loan from supplier M (SFP)
Bank (SFP)
Derecognise liability due to settlement
Dr
460 000
Cr
460 000
Remark
1
31
Interest is an exempt supply and therefore has no VAT. The impact of interest is not
shown in this example for simplicity.
The purchase of trade inventories on credit from Payable K (a registered VAT vendor) to the
amount of R86 250 (including VAT), which was delivered on 12 December 20.7, will be
recognised as follows:
Credit purchase of trade inventories – perpetual inventory system
20.7
12 Dec
xxx
xxx
Trade inventories (SFP) (86 250 x 100/115)
VAT input (SFP) (86 250 x 15/115)
Payable K (SFP)
Recognise trade inventories and the accompanying
liability
Payable K (SFP)
Bank (SFP)
Derecognise payable due to settlement
Dr
75 000
11 250
Cr
86 250
Dr
86 250
Cr
86 250
Credit purchase of trade inventories – periodic inventory system
20.7
12 Dec
xxx
xxx
Purchases (P/L) (86 250 x 100/115)
VAT input (SFP) (86 250 x 15/115)
Payable K (SFP)
Recognise purchases and the accompanying liability
Payable K (SFP)
Bank (SFP)
Derecognise payable due to settlement
322
Dr
75 000
11 250
Cr
86 250
Dr
86 250
Cr
86 250
32
The purchase of office supplies on credit from Payable N (a registered VAT vendor) to the
amount of R14 490 (including VAT), which were delivered on 9 December 20.7, will be
recognised as follows:
20.7
9 Dec
xxx
xxx
33
Office supplies (P/L) (14 490 x 100/115)
VAT input (SFP) (14 490 x 15/115)
Payable N (SFP)
Recognise office supplies and the accompanying
liability
Payable N (SFP)
Bank (SFP)
Derecognise payable due to settlement
Dr
12 600
1 890
Cr
14 490
Dr
14 490
Cr
14 490
Receipt of the statement from Payable Telkom (a registered VAT vendor) on 31 December
20.7to the amount of R14 145 (including VAT), in respect of the telephone usage for
December 20.7 that will be settled in 20.8, will be recognised as follows:
20.7
31 Dec
xxx
xxx
Telephone (P/L) (14 145 x 100/115)
VAT input (SFP) (14 145 x 15/115)
Payable Telkom (SFP)
Recognise telephone expense for December 20.7 and
the accompanying liability
Payable Telkom (SFP)
Bank (SFP)
Derecognise payable due to settlement
323
Dr
12 300
1 845
Cr
14 145
Dr
14 145
Cr
14 145
34
The incurrence of repairs on credit from Payable O (a registered VAT vendor) to the amount
of R19 780 (including VAT), which were completed to the owner’s satisfaction on
30 December 20.7, will be recognised as follows:
20.7
30 Dec
xxx
xxx
Repairs (P/L) (19 780 x 100/115)
VAT input (SFP) (19 780 x 15/115)
Payable O (SFP)
Recognise repairs and the accompanying liability
Payable O (SFP)
Bank (SFP)
Derecognise payable due to settlement
Dr
17 200
2 580
Cr
19 780
Dr
19 780
Cr
19 780
Sale of goods and services that represent taxable supplies
35
36
For a selling entity, who is a registered VAT vendor, the sales price of the following goods
includes VAT output:
•
Sale of trade inventories;
•
Rent income in respect of the letting of commercial property; and
•
Sale of certain non-current assets.
Subsequently, attention is paid to a number of transactions that cause VAT output to be
recognised as a liability.
324
Recognition of VAT output as a liability within cash transactions
37
In the case of the cash sale of goods which represent taxable supplies, the VAT output is
recognised as a liability with the initial recognition of the cash transaction. VAT output is not
paid over SARS immediately. This is discussed in detail in paragraphs 55 and 56.
38
In respect of all the transactions below it is accepted that the selling entity is a registered VAT
vendor.
39
The cash sale of trade inventories for R287 500 (including VAT) that were delivered on
30 December 20.7, will be recognised as follows:
20.7
30 Dec
Bank (SFP)
VAT output (SFP) (287 500 x 15/115)
Sales (P/L) (287 500 x 100/115)
Recognise cash sale of trade inventories
Dr
287 500
Cr
37 500
250 000
Remark in respect of the above
1
40
The inventory system (perpetual or periodic) that an entity uses, has no influence on
the initial recognition of the sales transaction and the accompanying VAT output
obligation.
The cost of the trade inventories that were sold and delivered on 30 December 20.7,
amounted to R100 000 and will be recognised as follows:
Recognition of cost of sales – perpetual inventory system
20.7
30 Dec
Cost of sales (P/L)
Trade inventories (SFP)
Recognise cost of trade inventories sold
Dr
100 000
Cr
100 000
Remarks in respect of the above
41
1
The abovementioned journal is only applicable in respect of the perpetual inventory
system since the cost of the sold trade inventories for individual transactions is
available only for the perpetual inventory system.
2
The VAT input has already been isolated and recognised as separate asset with the
purchase and delivery of the trade inventories. Consequently, the cost price of the trade
inventories and therefore also the cost of sales, excludes VAT.
The receipt of the December 20.7 lease payment from the lessee for a short term lease to the
amount of R23 000 (including VAT), on 2 December 20.7, will be recognised as follows:
20.7
2 Dec
Bank (SFP)
VAT output (SFP) (23 000 x 15/115)
Rent income (P/L) (23 000 x 100/115)
Recognise rent income for December 20.7
325
Dr
23 000
Cr
3 000
20 000
Recognition of VAT output as a liability within credit transactions
42
In the case of the credit sale of goods which represent taxable supplies, the VAT output is
recognised as a liability with the initial recognition of the credit transaction.
43
The sale and delivery of trade inventories on credit by a registered VAT vendor to
Receivable A on 30 December 20.7, to the amount of R431 250 (including VAT) will be
recognised as follows:
20.7
30 Dec
44
Receivable A (SFP)
VAT output (SFP) (431 250 x 15/115)
Sales (P/L) (431 250 x 100/115)
Recognise credit sale of trade inventories
Dr
431 250
Cr
56 250
375 000
The cost of the trade inventories that were sold and delivered on 30 December 20.7,
amounted to R150 000 and will be recognised as follows:
Recognition of cost of sales – perpetual inventory system
20.7
30 Dec
Cost of sales (P/L)
Trade inventories (SFP)
Recognise cost of trade inventories sold
Dr
150 000
Cr
150 000
Remarks in respect of the above
1
The abovementioned journal is only applicable in respect of the perpetual inventory
system since the cost of the sold trade inventories for individual transactions is
available only for the perpetual inventory system.
2
The VAT input has already been isolated and recognised as separate asset with the
purchase and delivery of the trade inventories. Consequently, the cost price of the trade
inventories and therefore also the cost of sales, excludes VAT.
Miscellaneous transactions
45
In this section the following transactions, which do not represent taxable supplies, but indeed
have an effect on VAT, will be dealt with by means of the following examples:
•
Write-off of a trade receivable’s debt as irrecoverable;
•
Recoupment of a trade receivable’s debt that has previously been written off as
irrecoverable;
•
Drawings of trade inventories by the owner for personal use; and
•
Donation of trade inventories.
326
Example 8.3 Write-off of bad debts
AC Entity is a registered VAT vendor. After numerous fruitless attempts to collect the outstanding
debt of Receivable J, which occurred over several months, the entity decided to write off the debt to
the amount of R36 800 as irrecoverable (usually the debt includes VAT). On 31 December 20.7,
the owner authorised the write-off.
Required:
Recognise the abovementioned event in the records (general journal) of AC Entity for the reporting
period ended 31 December 20.7.
Example 8.3 Solution
Journal entry
J1
20.7
31 Dec
Bad debts (P/L) (36 800 x 100/115)
VAT input (SFP) (36 800 x 15/115)
Receivable J (SFP)
Derecognise Receivable J as per authorisation by owner
Dr
32 000
4 800
Cr
36 800
Remarks in respect of Example 8.3
1
If it is accepted that the original credit sale occurred on 3 March 20.7, the following
journal would have been recognised in respect of the recognition of the trade receivable
on this date:
20.7
3 Mar
Receivable J (SFP)
VAT output (SFP)
Sales (P/L)
Recognise credit sale of trade inventories
Dr
36 800
Cr
4 800
32 000
2
The VAT output for March 20.7 (which includes the R4 800) would have been reduced
with the VAT input for March 20.7 and the net amount would have been paid over to
SARS.
3
The write-off of the trade receivable’s debt as irrecoverable results in the establishment
of an expense. Although the write-off does not represent a taxable supply, SARS
provided relief in that the VAT input that arises in respect of the expense may be
claimed from SARS. In this manner, the VAT output that was previously “paid too
much” (when the credit sale was recognised) is recouped.
327
Example 8.4 Recoupment of debt previously written off as irrecoverable
AC Entity is a registered VAT vendor. The cheque account statement for December 20.7 indicates
an electronic deposit of R2 875 on 22 December 20.7 from AB Executors, the liquidator of
Receivable E’s insolvent estate. Receivable E’s debt of R11 500 was written off as irrecoverable in
June 20.7. The liquidation distribution is 25c in the Rand.
Required:
Recognise the abovementioned transaction in the records (general journal) of AC Entity for the
reporting period ended 31 December 20.7.
Example 8.4 Solution
Journal entry
J1
20.7
22 Dec
Bank (SFP)
VAT output (SFP) (2 875 x 15/115)
Bad debts (P/L) (2 875 x 100/115)
Recognise liquidation dividend deposited by AB Executors in
respect of Receivable E previously written off
Dr
2 875
Cr
375
2 500
Remark in respect of Example 8.4
1
The recoupment of debt previously written off as irrecoverable, results in the decrease
of an expense. SARS deems this recoupment as a taxable supply and consequently
VAT output has to be recognised.
Example 8.5 Withdrawal of trade inventories by the owner
AC Entity is a registered VAT vendor.
On 31 December 20.7 the owner withdrew trade inventories with a cost price of R20 000 (excluding
VAT) for personal use.
Required:
Recognise the abovementioned transaction in the records (general journal) of AC Entity for the
reporting period ended 31 December 20.7.
Example 8.5 Solution
Journal entry
J1
20.7
31 Dec
Drawings (SCE) (20 000 x 115/100)
VAT output (SFP) (20 000 x 15/100)
Trade inventories (SFP)
Recognise the withdrawal of trade inventories by the owner
328
Dr
23 000
Cr
3 000
20 000
Remark in respect of Example 8.5
1
When the purchase of the trade inventories was recognised, VAT input was recognised
as asset. This VAT input was recouped from SARS in that it was used to reduce the
VAT output on the date of the relevant VAT return. SARS deems the withdrawal of
trade inventories by the owner as a taxable supply and consequently VAT output has to
be recognised.
Example 8.6 Donation of trade inventories
AC Entity is a registered VAT vendor.
On 21 December 20.7 trade inventories with a cost price of R17 500 (excluding VAT) were donated
to a local welfare organisation.
Required:
Recognise the abovementioned transaction in the records (general journal) of AC Entity for the
reporting period ended 31 December 20.7.
Example 8.6 Solution
Journal entry
J1
20.7
21 Dec
Donation (P/L) (17 500 x 115/100)
VAT output (SFP) (17 500 x 15/100)
Trade inventories (SFP)
Recognise the donation of trade inventories
Dr
20 125
Cr
2 625
17 500
Remark in respect of Example 8.6
1
As in the case with the withdrawal of trade inventories by the owner for personal use,
SARS deems the donation of trade inventories as a taxable supply. VAT output
consequently has to be recognised.
Taxable supplies of which the VAT input may not be claimed
46
47
For a registered VAT vendor, the payments in respect of the following taxable supplies
include VAT input, but the VAT input may not be claimed from SARS (input VAT denied):
•
Purchases of vehicles that are not a delivery vehicles (purchases that are a motor car
as defined);
•
Purchases of goods and services for purposes of entertainment; and
•
Membership fees paid to clubs or associations.
The VAT input on these items is not recognised separately, but forms part of the cost price
of the asset or the expense.
329
Example 8.7 Purchase of a passenger vehicle as well as goods and services for the
entertainment of staff
AC Entity is a registered VAT vendor.
On 30 June 20.7, AC Entity made cash payments in respect of the following:
•
A passenger vehicle was purchased for R230 000 (including VAT) cash from a registered
VAT vendor.
•
Entertainment costs in respect of staff to the amount of R69 000 (including VAT) were paid in
cash to a registered VAT vendor.
Required:
Recognise the abovementioned transactions in the records (general journal) of AC Entity for the
month ended 30 June 20.7.
Example 8.7 Solution
Journal entries
J1
20.7
30 Jun
J2
20.7
30 Jun
Vehicle (SFP)
Bank (SFP)
Recognise passenger vehicle purchased for cash
Entertainment (P/L)
Bank (SFP)
Recognise entertainment costs in respect of staff
Dr
230 000
Cr
230 000
Dr
69 000
Cr
69 000
Zero-rated supplies
48
The VAT rate on the following supplies is zero (0%) and consequently includes VAT at 0% or
a Rnil VAT amount for the seller as well as the purchaser:
•
Fuel; and
•
Certain foods e.g. fresh vegetables and fruit, eggs, milk and mealie-meal.
Note: Since the South African government has increased the VAT rate from 14 to 15 percent,
a task team was appointed to investigate items to be added to the list of zero-rated supplies.
This was done in order to soften the blow on poor people. It is submitted that items that could
qualify are white bread, poultry, flour, candles, soap, basic medicines, pay-as-you-go airtime,
education-related goods and sanitary pads.
330
Example 8.8 Purchase of fuel
AC Entity is a registered VAT vendor.
The driver of AC Entity’s delivery vehicle purchased fuel by means of a Garage card/Petrol card.
The bank statement for the week ended 30 June 20.7 indicated petrol card purchases on 28 June
20.7 of R5 000 from a registered VAT vendor.
Remark in respect of a garage card/petrol card
1
A garage card can only be used for the purchase of fuel and oil at a petrol station. Any
such purchases through the presentation of the garage card are recouped electronically
from AC Entity’s cheque account.
Required:
Recognise the abovementioned transaction in the records (general journal) of AC Entity for the
month ended 30 June 20.7.
Example 8.8 Solution
Journal entry
J1
20.7
28 Jun
Fuel (P/L)
Bank (SFP)
Recognise fuel purchases for June 20.7
Dr
5 000
Cr
5 000
Exempt supplies
49
50
Exempt supplies are transactions that entail the delivery of goods and services that includes
no VAT. Examples of exempt supplies include the following:
•
Capital contributions or cash withdrawals by the owner;
•
Financial services such as:
-
The incurrence of a term deposit;
-
Interest income earned on a term deposit or a favourable bank balance;
-
The incurrence of a loan;
-
Interest expense charged on a mortgage bond, a bank loan, a lease liability, a
supplier’s loan as well as on an overdraft bank balance;
•
The letting of residential property; and
•
The transport of passengers in South Africa by means of taxis, busses or trains.
The receipt of or the payment in respect of the abovementioned items by a registered VAT
vendor therefore includes no VAT.
331
Example 8.9 Payment in respect of exempt supplies
AC Entity is a registered VAT vendor.
On 30 June 20.7, AC Entity invested an amount of R600 000 in a term deposit with a term of
12 months at 10% per year.
The bank statement for June 20.7 indicates the interest on the bank overdraft as R11 700.
Required:
Recognise the abovementioned transactions in the records (general journal) of AC Entity for the
month ended 30 June 20.7.
Example 8.9 Solution
Journal entries
J1
20.7
30 Jun
J2
20.7
30 Jun
Dr
600 000
Term deposit (SFP)
Bank (SFP)
Recognise term deposit incurred
Cr
600 000
Interest expense on bank overdraft (P/L)
Bank (SFP)
Recognise interest expense on bank overdraft
Dr
11 700
Cr
11 700
Remark in respect of the term deposit
1
The accrued interest income on the term deposit that must be recognised on
31 December 20.7, to the amount of R30 000 (R600 000 x 10% x 6/12), represents an
exempt supply and will be recognised by debiting the term deposit account with
R30 000 and crediting the interest income account with the same amount.
Example 8.10 Receipt of exempt supplies
AC Entity is a registered VAT vendor.
On 30 June 20.7, AC Entity received an amount of R1 000 000 in respect of a bank loan. The bank
loan, together with the interest, must be repaid in one amount on 30 June 20.8. The interest rate is
12% per year.
The bank statement for June 20.7 indicates the interest income on the favourable bank balance as
R2 700.
Required:
Recognise the abovementioned transactions in the records (general journal) of AC Entity for the
month ended 30 June 20.7.
332
Example 8.10 Solution
Journal entries
J1
20.7
30 Jun
J2
20.7
30 Jun
Bank (SFP)
Bank loan (SFP)
Recognise loan amount received and accompanying liability
Bank (SFP)
Interest income on favourable bank balance (P/L)
Recognise interest income on favourable bank balance
Dr
1 000 000
Cr
1 000 000
Dr
2 700
Cr
2 700
Remark in respect of the loan
1
The accrued interest expense that must be recognised on 31 December 20.7, to the
amount of R60 000 (R1 000 000 x 12% x 6/12), represents an exempt supply and will
be recognised by debiting the interest expense account with R60 000 and crediting the
bank loan account with the same amount.
Transactions and events that do not have a VAT effect
51
Employment is excluded from the definition of an enterprise.
therefore have no VAT effect.
Salaries and wages paid
52
Events that result from the subsequent measurement of assets give rise to expense and
income-items that naturally do not include VAT, since it does not represent taxable supplies.
Examples of such items are depreciation, an impairment loss in respect of property, plant and
equipment items, an increase/a decrease in the allowance for doubtful debts, the write-off of
inventory shortages (perpetual inventory system) and the write-off of certain inventory items
to the net realisable value thereof.
53
When an expense (that represents a taxable supply) is incurred, the VAT involved is isolated
and recognised as an asset. The cost at which these expenses are incurred therefore
excludes VAT. If a portion of the expenses are reclassified as an asset on the reporting date,
the cost of the asset also excludes VAT. Examples of such assets that arise on the reporting
date from the reclassification of an expense are prepaid insurance and office supplies on
hand.
VAT return
54
At the end of the VAT period, each registered VAT vendor has to submit a VAT return to
SARS. Depending on the extent of the annual taxable supplies made by the VAT vendor, the
VAT period can be either a one month period, a two month period, a six month period or an
annual period. In this work, it is accepted that the VAT period is a calendar month.
333
56
On the VAT return, the registered VAT vendor will offset the input tax that was paid to
suppliers against the output tax that was collected from customers. If the output tax exceeds
the input tax, the net amount must be paid to SARS by the 25th day of the month following the
end of the VAT period. If the input tax exceeds the output tax, SARS will pay the amount due
to the registered VAT vendor by making a direct deposit into the vendor’s bank account. In
this work the output tax will always exceed the input tax.
VAT input as asset and VAT output as liability
57
It can be indicated as follows that VAT input satisfies the definition and recognition criteria of
an asset:
Definition of an asset
Application – VAT input
An asset is a resource
VAT input is a resource for the entity since it is an amount
that is, in accordance with the VAT Act, collectable from
SARS and can therefore be utilised (in the future) to reduce
the obligation in respect of VAT output.
controlled by the entity as a
result of past events
VAT input is controlled by the purchasing entity as the
purchasing entity has the right to claim the VAT from SARS.
As a result the entity will have the ability to direct the right of
use of the VAT input and will obtain substantially all the
remaining benefits from the VAT input.
The past event is as a result of purchase transactions that
were incurred by the registered VAT vendor in respect of
goods and services (that are taxable supplies) and that
already occurred.
and from which future
economic benefits are
expected to flow to the entity.
The VAT input is recouped by appropriately reducing the
VAT output which is payable to SARS. Future economic
benefits are consequently expected to flow to the VAT
vendor in that the VAT input reduces the outflow of cash on
VAT output.
Recognition criteria of an
asset
Application – VAT input
An item that meets the
definition of an asset is
recognised only if it satisfies
both the following recognition
criteria:
As set out above, VAT input satisfies the definition of an
asset.
it is probable that future
economic benefits associated
with the item will flow to the
entity; and
VAT input, which satisfies the definition of an asset, will
probably result in the inflow of future economic benefits when
it reduces the outflow of cash on VAT output, as required by
the VAT Act.
The date on which the inflow of future economic benefits
became probable, is the date on which the taxable supply
was recognised.
334
VAT input will more likely than not result in the inflow as it
reduces the outflow of cash on VAT output or results in a
refund from SARS as per the VAT Act. In this context, future
economic benefits are probable.
the item has a cost or a value
that can be measured
reliably.
58
The cost of the VAT input can be measured reliably at the
historical cost price thereof, namely the amounts indicated
on the relevant VAT-invoices and accumulated by the
accounting system.
It can be indicated as follows that VAT output satisfies the definition and recognition criteria of
a liability:
Definition of a liability
Application – VAT output
A liability is a present
obligation of the entity
The VAT vendor (selling entity) has a present, legal
obligation towards SARS as a result of taxable supplies
made by the entity in accordance with the VAT Act. This
requires the VAT vendor to pay VAT output, collected from
customers on behalf of SARS, over to SARS.
arising from past events
The past events are the sales transactions in respect of
goods or services (which are taxable supplies) incurred by
the VAT vendor.
the settlement of which is
expected to result in an
outflow from the entity of
resources embodying
economic benefits.
The settlement of the amount due to SARS is expected to
result in an outflow of cash in the future.
Recognition criteria of a
liability
Application – VAT output
An item that meets the
definition of a liability is
recognised only if it satisfies
both the following recognition
criteria:
As set out above, VAT output satisfies the definition of a
liability.
it is probable that future
economic benefits associated
with the item will flow from the
entity; and
The VAT vendor is in accordance with the VAT Act obliged
to pay the VAT output, as appropriately reduced with VAT
input, over to SARS.
the item has a cost or a value
that can be measured
reliably.
The cost of the VAT output (obligation) can be measured
reliably at the historical cost price thereof, namely the VAT
output (per sales invoices) as appropriately reduced with
VAT input (per purchase invoices).
335
Example 8.11 Payment of VAT due and the presentation of the VAT balances
AC Entity’s VAT period is a calendar month and the current reporting date is 31 December 20.7.
On 24 December 20.7, AC Entity’s records contained inter alia the following balances:
Dr
224 000
VAT input
VAT output
Bank
Trade payables
Cr
314 000
449 500
763 200
Additional information
1
On 24 December 20.7 the following appeared on the VAT return for November 20.7:
VAT output
VAT input
Amount due to SARS
R172 700
R123 200
R49 500
2
The amount due in respect of the November 20.7 VAT return was paid to the SARS on
24 December 20.7 by means of an EFT.
3
Every year, AC Entity closes for business from 25 December to 1 January of the new
calendar year.
Required:
a)
Journalise the entries in respect of the payment of the VAT to SARS in the records (general
journal) of AC Entity.
b)
Present the balances in the VAT input and VAT output accounts in the statement of financial
position of AC Entity as at 31 December 20.7.
Example 8.11 Solution
a) Journal entries
J1
20.7
24 Dec
J2
20.7
24 Dec
VAT output (SFP)
VAT input (SFP)
VAT payment control (SFP)
Recognise the closing-off of VAT output and VAT input, as it
appears on the November 20.7 VAT return, against the VAT
payment control account
VAT payment control (SFP)
Bank (SFP)
Recognise the settlement of the VAT owing according to the
November VAT return
336
Dr
172 700
Cr
123 200
49 500
Dr
49 500
Cr
49 500
Remark in respect of the above
1
The VAT payment control account is known in Accounting as a memorandum
account. A memorandum account is used to make the recognition of a transaction
easier and more understandable. The asset disposal account that is used at school is
also an example of a memorandum account.
The following informal T-accounts are provided to confirm the principles and entries under
discussion:
Dr
20.7
24 Dec
Balance bd
VAT input
20.7
224 000 24 Dec
31 Dec
224 000
20.8
1 Jan
Balance bd
100 800
Dr
20.7
24 Dec
31 Dec
Dr
20.7
24 Dec
VAT payment control
Balance cf
VAT input
Bank
VAT output
20.7
172 700 24 Dec
141 300
314 000
20.8
1 Jan
Cr
VAT payment control
Balance cf
123 200
100 800
224 000
Cr
Balance bd
314 000
314 000
Balance bd
141 300
VAT payment control
20.7
123 200 24 Dec VAT output
49 500
172 700
Cr
172 700
172 700
b) Presentation of VAT balances
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
EQUITY AND LIABILITIES
Current liabilities
Trade and other payables
(cr 763 200 (cr 314 000 dr 172 700) (dr 224 000 cr 123 200))
20.7
R
803 700
Remark in respect of the above
1
As indicated above, the amount due to SARS of R40 500 (R141 300 – R100 800) (in
other words VAT output less VAT input) is presented as a current liability as part of the
line item “Trade and other payables”.
337
Chapter 9 Trade payables and trade receivables
Contents
Introduction
Recognition, measurement and derecognition of trade payables and trade
receivables
The purchase contract as financial instrument
Recognition of the purchase and sale of trade inventories
Partial derecognition of a trade payable or trade receivable due to returns
Discounts and the measurement of a transaction at initial recognition
Trade discount and the trading (purchase/sale) of trade inventories
Cash discount and the trading (purchase/sale) of trade inventories
Settlement discount
Recognition of interest charged by the selling entity
Payables reconciliation
Payables reconciliation – a summary of the procedure
Identify differences
Complete and adjust the payable’s account, where necessary
Complete and adjust the statement, where necessary
Trade payables – summary
Impairment of trade receivables and bad debts
Impairment of trade receivables
Bad debts – the derecognition of a trade receivable
Trade receivables – summary
339
Paragraph
1
6
6
10
18
21
23
25
28
31
38
43
45
46
49
55
61
62
74
78
Examples
Example
9.1
9.2
9.3
9.4
9.5
9.6
9.7
9.8
Recognition and derecognition of a trade payable and a trade receivable
Derecognition of a trade payable or trade receivable due to returns
Trade discount on the purchase/sale of trade inventories
Cash discount on trade inventories purchased/sold
Settlement discount
Recognition of interest on an outstanding amount
Payables reconciliation
Bad debts and the allowance for doubtful debts
340
Chapter 9 Trade payables and trade receivables
Introduction
1
This chapter will mainly deal with a transaction that results from the exchange of trade
inventories between a wholesaler and a retailer, under two headings, namely trade payables
and trade receivables.
2
In the text and examples of this chapter it is accepted that the relevant entities use the
perpetual inventory system. However, it will be indicated in an appropriate manner how the
text and the solutions of examples would change if the entities used the periodic inventory
system.
3
In this chapter the following is dealt with in respect of trade payables:
4
5
•
initial recognition and measurement of trade payables, including accounting for various
discounts with initial measurement;
•
derecognition of a trade payable because a payment was made;
•
a trade payable as a financial liability;
•
partial derecognition of a trade payable as a result of returns (out);
•
subsequent measurement of trade payables on the reporting date and the recognition
of interest charged by the selling entity; and
•
presentation of trade payables.
The following is dealt with in respect of trade receivables:
•
initial recognition and measurement of receivables, including accounting for various
discounts with initial measurement;
•
derecognition of a trade receivable because payment was received;
•
a trade receivable as financial asset;
•
partial derecognition of a trade receivable as a result of returns (in);
•
derecognition or partial derecognition of a trade receivable due to bad debts;
•
subsequent measurement of trade receivables on the reporting date and the
recognition of interest charged by the entity (the seller);
•
the recognition of an impairment in respect of trade receivables on the reporting date
(allowance for doubtful debts); and
•
presentation of trade receivables.
Various aspects in paragraphs 3 and 4 above are dealt with collectively.
341
Recognition, measurement and derecognition of trade
payables and trade receivables
The purchase contract as financial instrument
6
A trade receivable is a financial asset since a cash amount will contractually be received with
the settlement thereof. A trade payable is a financial liability since a cash amount will, in
accordance with a contract, be paid with the settlement thereof.
7
A purchase contract is a financial instrument since it gives rise to a financial asset for one
entity and a financial liability for another entity. (IAS 32.11) Refer to Example 9.1 below. The
purchase contract between R Entity and W Entity gives rise to a financial liability (Payable W)
in R Entity’s records and a financial asset (Receivable R) in W Entity’s records.
R Entity’s records (purchasing entity)
Dr
K17 Payable W
Date
Contra account
Fol
Amount
Cr
Date
20.7
16 Jan
Contra account
Fol
Trade inventories and
VAT input
(Purchases and
VAT input)
J1
Amount
86 250
W Entity’s records (selling entity)
Dr
D11 Receivable R
Date
20.7
16 Jan
Contra account
Sales and
VAT output
Fol
J1
Amount
Date
Cr
Contra account
Fol
Amount
86 250
Remark in respect of the account K17 Payable W
1
The entry between brackets and in italics represents the accounts that would have
been affected if R Entity used the periodic inventory system.
8
The initial measurement and the subsequent measurement of trade receivables and trade
payables are regulated by the standard IFRS 9 Financial Instruments.
9
Trade payables and trade receivables are measured as follows:
•
Initial measurement occurs at historical cost price, which is the invoice price including
VAT.
•
Subsequent measurement occurs at amortised cost. During the period of the credit term
(30 days or 60 days or 90 days), no interest is accounted for and therefore amortised
cost means the outstanding invoice amount, which includes VAT. If the debt is not
settled within the credit term granted, then interest is charged on the outstanding
amount and therefore amortised cost means the outstanding invoice amount (which
includes VAT) plus accrued interest. An allowance for doubtful debts could be
recognised in terms of the impairment model for trade receivables. The allowance for
doubtful debts is dealt with in paragraphs 61 to 73.
342
Recognition of the purchase and sale of trade inventories
10
A purchasing entity will recognise trade inventories purchased on credit as an asset and the
accompanying trade payable as a liability, only if the definition and recognition criteria of an
asset and liability respectively were satisfied. Refer to Chapter 2 paragraphs 167 to 170.
11
A selling entity will, in the case of a credit sale of trade inventories, recognise the trade
receivable and the accompanying sale only if the trade receivable and the sale satisfy the
definition and recognition criteria of an asset and income respectively. The past/critical event
that determines whether the definitions and recognition criteria were satisfied is the delivery
of the trade inventories.
12
However, it is not only about the physical delivery. The delivered goods must be in
accordance with the order as well as the accompanying invoice and must furthermore not
have any visible defect as a result of damage. If the aforementioned requirements are met,
the appropriate employee of the purchasing entity will accept receipt of and sign for the
goods.
13
The asset trade inventories and the accompanying liability trade payable can then be
recognised by the payables division in the records of the purchasing entity. At the same time
the asset trade receivable and the accompanying income sales can be recognised in the
records of the selling entity.
14
If the trade inventories were damaged with delivery or if it is not in accordance with the order,
the goods together with the invoice will simply be returned and consequently no transaction is
recognised.
15
If both the purchasing and selling entities are registered VAT vendors, trade receivables and
trade payables are measured with initial recognition at the invoice amount, which includes
VAT. The cost price of the trade inventories and the sales (income) however exclude VAT.
16
If the purchasing entity uses the periodic inventory system, the items brought about by the
transaction are the expense-item purchases and the liabilities-item trade payable. If the
selling entity uses the periodic inventory system, the cost price of the sold items for individual
transactions is not known. Consequently, in these circumstances, the selling entity will not
recognise the expense-item cost of sales and the associated decrease in the asset-item trade
inventories.
17
In accordance with accrual accounting, the purchase/sale of trade inventories on credit and
the resulting settlement are treated as separate transactions.
Example 9.1 Recognition and derecognition of a trade payable and a trade receivable
R Entity and W Entity are both registered as vendors in terms of the VAT Act.
W Entity is as wholesaler one of the suppliers of products to R Entity.
On 16 January 20.7, R Entity received trade inventories, which were ordered from W Entity on
12 January 20.7. The invoice amount is R86 250 (including VAT) and is payable on or before
14 February 20.7. The cost price of these inventories is R30 000 according to W Entity’s records.
Both entities use the perpetual inventory system.
343
Required:
a)
Provide journal entries to recognise the transactions in the records (general journal) of
R Entity.
b)
Provide journal entries to recognise the transactions in the records (general journal) of
W Entity.
c)
Show Payable W’s account in the records of R Entity.
d)
Show Receivable R’s account in the records of W Entity.
Remark in respect of Example 9.1
1
Where applicable, the solution will time and again, between brackets and in italics,
indicate the change in the account if both entities use the periodic inventory system.
Example 9.1 Solution
a) and b) Journal entries – initial recognition
20.7
16 Jan
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Trade inventories (SFP)
75 000
(Purchases (P/L))
VAT input (SFP)
11 250
Payable W (SFP)
Recognise credit purchase
20.7
16 Jan
Receivable R (SFP)
VAT output (SFP)
Sales (P/L)
86 250
11 250
75 000
86 250
Recognise credit sale
20.7
16 Jan
Cost of sales (P/L)
30 000
Trade inventories (SFP)
30 000
Recognise cost of sales
(This journal occurs only if the perpetual
inventory system is used)
a) and b) Journal entries – derecognition due to payment
20.7
14 Feb Payable W (SFP)
86 250
Bank (SFP)
Derecognise trade payable due to
settlement
86 250
20.7
14 Feb Bank (SFP)
86 250
Receivable R (SFP)
86 250
Derecognise trade receivable due to
settlement
Remarks in respect of the solution to Example 9.1 (a) and (b)
1
The R75 000 (invoice price excluding VAT) is calculated as R86 250 x 100/115 and the
R11 250 (VAT) is calculated as R86 250 x 15/115.
2
Accountants are usually involved with only one of the parties to the purchase contract,
namely either the purchaser or the seller.
344
c) R Entity’s records (purchasing entity)
Dr
L17 Payable W
Date
20.7
14 Feb
Contra account
Bank
Fol
Amount
Date
20.7
86 250 16 Jan
J2
Cr
Contra account
Fol
Trade inventories and
VAT input
(Purchases and
VAT input)
J1
Contra account
Fol
Amount
86 250
d) W Entity’s records (selling entity)
Dr
D11 Receivable R
Date
20.7
16 Jan
Contra account
Sales and
VAT output
Fol
J1
Amount
Date
20.7
86 250 14 Feb
Cr
Bank
J2
Amount
86 250
Remarks in respect of the solution to Example 9.1 (c) and (d)
1
Note that the one party’s (purchasing entity’s) records deal with a payable and that the
other party’s (selling entity’s) records deal with a receivable.
2
The accounts should contain comparable transactions on the opposite sides. The
purchasing entity will use this mutual comparability to verify the transactions with the
supplier. This process is known as a reconciliation with the payable’s statement and is
discussed in paragraphs 38 to 54.
3
The selling entity sends out a statement to each of the entity’s debtors (trade
receivables) on a monthly basis. The statement is basically a representation of the
trade receivable’s account, as it appears in the seller’s/creditor’s records. The purpose
of the statement is primarily to remind the trade receivable that a payment has to be
made.
Partial derecognition of a trade payable or trade receivable due to
returns
18
On receipt of the purchased trade inventories the goods received department of the
purchasing entity compares the goods received with the original order as well as the
accompanying invoice. The trade inventories are furthermore thoroughly inspected for any
sign of damage. It does however occur that, in respect of the traded goods which have
already been recognised in the records of the purchasing entity as well as the selling entity,
goods show a defect only at a later stage or that it appears only at a later stage that the
goods received are not in accordance with the specifications of the order. If the purchasing
entity returns the goods to the selling entity, it is in Accounting referred to as returns and
more specifically as returns (out) for the purchasing entity and returns (in) for the selling
entity.
345
19
Returns of traded trade inventories are regulated by the initial purchase contract. The
purchasing entity will return the goods together with a document called a debit note, which
declares the purchasing entity’s intention to debit the selling entity’s payables account in the
records of the purchasing entity. Should the selling entity agree, then the selling entity will
issue a credit note which confirms that the supplier (the selling entity) credited the purchasing
entity’s receivable account.
20
Returns are therefore recognised by both entities based on the credit note issued by the
selling entity. The effective date on which the purchasing entity should recognise the
transaction, is the date of the credit note.
Example 9.2 Derecognition of a trade payable or trade receivable due to returns
R Entity and W Entity are both registered as vendors in terms of the VAT Act.
W Entity is a wholesaler and one of the suppliers of products to R Entity.
Both entities use the perpetual inventory system.
Transactions
1
Trade inventories that were sold and delivered by W Entity on 8 December 20.7, were
received by R Entity. The invoice amount of R207 000 (including VAT) is payable on
7 January 20.8. The cost price of these trade inventories, according to the records of
W Entity, is R80 000. (This amount obviously excludes VAT).
2
On 14 December 20.7, R Entity returned some of the trade inventories that were received on
8 December 20.7, to W Entity. The amount on the debit note is R28 750 (including VAT) and
the reason is indicated as “latent defects”.
3
On 17 December 20.7, W Entity issued a credit note dated 17 December 20.7 to the amount
of R28 750 (including VAT) to R Entity. The cost price of the inventories received back from
R Entity, amounts to R10 000 for W Entity.
Required:
a)
Journalise the abovementioned transactions in the records (general journal) of R Entity.
b)
Journalise the abovementioned transactions in the records (general journal) of W Entity.
c)
Show W Entity’s account in the records of R Entity after accounting for the abovementioned
journal entries.
d)
Show R Entity’s account in the records of W Entity after accounting for the abovementioned
journal entries.
Remark in respect of Example 9.2
1
Where applicable, the solution will time and again, between brackets and in italics,
indicate the change in the account if both entities use the periodic inventory system.
346
Example 9.2 Solution
a) and b) Journal entries – initial recognition
20.7
8 Dec
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Trade inventories (SFP) 180 000
(Purchases (P/L))
VAT input (SFP)
27 000
Payable W (SFP)
Recognise credit purchase
20.7
8 Dec
Receivable R (SFP)
VAT output (SFP)
Sales (P/L)
207 000
27 000
180 000
207 000
Recognise credit sale
20.7
8 Dec
Cost of sales (P/L)
80 000
Trade inventories (SFP)
80 000
Recognise cost of sales
(This journal occurs only if the perpetual
inventory system is used)
a) and b) Journal entries – partial derecognition due to returns
20.7
17 Dec
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Payable W (SFP)
28 750
VAT input (SFP)
3 750
Trade inventories (SFP)
25 000
(Returns (out) (P/L))
Partially derecognise trade payable due to
returns (out)
20.7
17 Dec
Returns (in) (P/L)
VAT output (SFP)
Receivable R (SFP)
25 000
3 750
28 750
Partially derecognise trade receivable due to
returns (in)
20.7
17 Dec
Trade inventories (SFP)
10 000
Cost of sales (P/L)
10 000
Recognise write back in cost of sales
(This journal occurs only if the perpetual
inventory system is used)
Remarks in respect of the solution to Example 9.2 (a) and (b)
R Entity’s records (the purchasing entity)
1
In this work, a trade payable is derecognised only due to the following transactions:
•
partial derecognition as a result of returns (out); and
•
partial or total derecognition because the trade payable was paid. (Refer
Example 9.1)
347
W Entity’s records (the selling entity)
2
3
In this work, a trade receivable is derecognised only due to the following transactions:
•
partial derecognition as a result of returns (in);
•
partial or total derecognition because the trade receivable paid (Refer
Example 9.1); and
•
total derecognition because the balance of the trade receivable is written off as
irrecoverable. (Refer Example 9.8)
Returns (in) is closed off against sales on the reporting date. Returns (out) appears only
in the periodic inventory system and is closed off against the purchases account on the
reporting date.
c) R Entity’s records (purchasing entity)
Dr
Date
20.7
17 Dec
31 Dec
K17 Payable W
Contra account
Fol
Trade inventories
and VAT input
(Returns (out) and
VAT input)
Balance
J2
Amount
Date
20.7
28 750 8 Dec
cf
Cr
Contra account
Fol
Amount
Trade inventories and
VAT input
(Purchases and
VAT input)
J1
207 000
178 250
207 000
207 000
20.8
1 Jan
Balance
bd
178 250
d) W Entity’s records (selling entity)
Dr
Date
20.7
8 Dec
D11 Receivable R
Contra account
Sales and
VAT output
Fol
Amount
J1
20.7
207 000 17 Dec
Date
31 Dec
207 000
20.8
1 Jan
Balance
bd
178 250
348
Cr
Contra account
Returns (in) and
VAT output
Balance
Fol
Amount
J2
28 750
cf
178 250
207 000
Discounts and the measurement of a transaction at initial
recognition
21
In this section attention will be paid to a number of discounts, which influence the amount at
which trade receivables, trade payables, trade inventories (purchases) and sales are initially
measured.
22
With certain outcomes in mind, wholesalers grant various discounts to retailers. These
discounts can comprise one or two of the following discounts per transaction: trade discount,
cash discount or settlement discount. There are clear guidelines as to how the elements,
arising from these transactions, should be measured:
•
At initial recognition, the trade inventories purchased are measured in the purchasing
entity’s records at the invoice price (as reduced with trade discount and other similar
discounts), excluding VAT.
•
At initial recognition, sales are measured in the selling entity’s records at the invoice
price (as reduced with trade discount and other similar discounts), excluding VAT.
•
At initial recognition, the trade receivable (in the selling entity’s records) and the trade
payable (in the purchasing entity’s records) are measured at the invoice price (as
reduced with trade discount and other similar discounts), including VAT.
Trade discount and the trading (purchase/sale) of trade inventories
23
Trade discount is discount that a supplier grants to selected customers, especially in respect
of large orders. Trade discount is accounted for when the invoice for the goods are issued.
For example, if the selling entity grants a trade discount of 10% to selected customers, the
price of a number of units to a non-selected customer and a selected customer will differ as
follows:
The invoice price for a non-selected customer will for instance amount to R103 500 (including
VAT).
The invoice price for a selected customer will then for the same units amount to R93 150
(including VAT).
R93 150 = R103 500 x 90% or (R103 500 – (10% x R103 500)).
24
Trade discount is not included in the accounting records of either the purchasing entity or the
selling entity. Recognition occurs from the invoice, of which the invoice amount reflects the
price already after the trade discount, if applicable.
Example 9.3 Trade discount on the purchase/sale of trade inventories
R Entity and W Entity are both registered as vendors in terms of the VAT Act.
W Entity is a wholesaler that grants 10% trade discount to selected customers.
On 12 January 20.7, R Entity, one of the selected customers of W Entity, ordered a container with
100 units of a specific product. The normal price for 100 units of the product amounts to R103 500
(including VAT). On 15 January 20.7, the goods were delivered to the premises of R Entity. The
invoice indicates the amount, after accounting for a 10% trade discount, and is payable on
15 February 20.7.
Both entities use the perpetual inventory system.
349
Required:
a)
Provide the journal entries to recognise the purchase of the trade inventories in the records
(general journal) of R Entity.
b)
Provide the journal entries to recognise the sale of the trade inventories in the records
(general journal) of W Entity.
Note: The journal for the recognition of the cost of sales is not required.
Remark in respect of Example 9.3
1
Where applicable, the solution will time and again, between brackets and in italics,
indicate the change in the account if both entities use the periodic inventory system.
Example 9.3 Solution
a) and b) Journal entries – initial recognition
20.7
15 Jan
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Trade inventories (SFP)
(Purchases (P/L))
VAT input (SFP)
Payable W (SFP)
20.7
15 Jan
81 000
12 150
Receivable R (SFP)
VAT output (SFP)
Sales (P/L)
93 150
12 150
81 000
93 150
Recognise credit purchase after trade discount
Recognise credit sale after trade discount
Remarks in respect of the solution to Example 9.3
1
The invoice amount is R93 150 (R103 500 x 90%) or (R103 500 – (R103 500 x 10%))
2
The invoice could have contained the following amounts:
Normal sales price (including VAT)
Trade discount – 10%
Invoice price
R103 500
(R10 350)
R93 150
R Entity’s records (the purchasing entity)
3
Trade inventories are recognised at cost price, in other words the invoice price
excluding VAT, after accounting for the 10% trade discount. VAT input is a separate
asset.
4
The trade payable is recognised at the invoice price including VAT after accounting for
the 10% trade discount (the amount payable).
W Entity’s records (the selling entity)
5
Sales are recognised at the invoice price excluding VAT, after accounting for the 10%
trade discount. VAT output is a separate liability.
6
The trade receivable is recognised at the invoice price including VAT after accounting
for the 10% trade discount (the amount receivable).
350
Cash discount and the trading (purchase/sale) of trade inventories
25
Apart from trade discount, which is a discount for selected customers, wholesalers can also
grant a cash discount to customers who pay cash at the point of sale. The granting of trade
credit is regulated in the RSA by the National Credit Act. The Credit Act requires that specific
procedures are followed before a trade credit limit is granted to a customer. Some customers
will in accordance with this process not qualify for a trade credit limit. Consequently these
customers’ purchases have to take place in cash.
26
Wholesalers might sometimes deem it fit to encourage customers to purchase more in cash
by granting cash discounts to these customers that pay in cash. A cash discount can either
be granted to customers that have an unutilised trade credit limit or it can be granted to all
customers that purchase in cash.
27
From an accounting perspective, cash discount is dealt in a similar manner as trade discount.
Refer to Example 9.4 below.
Example 9.4 Cash discount on trade inventories purchased/sold
R Entity and W Entity are both registered as vendors in terms of the VAT Act.
W Entity is a wholesaler that currently grants a 5% cash discount to customers who pay cash for
their purchases.
On 12 January 20.7, R Entity, one of the selected customers of W Entity, ordered a container with
100 units of a specific product, on a cash-on-delivery (COD) basis. R Entity usually purchases on
credit from W Entity and has a credit term of 30 days. The normal price for 100 units of the product
is R310 500 (including VAT). On 15 January 20.7, the goods were delivered to R Entity’s premises.
The invoice indicates the COD amount, after accounting for the 5% cash discount.
Both entities use the perpetual inventory system.
Required:
a)
Provide the journal entry to recognise the purchase of the trade inventories in the records
(general journal) of R Entity.
b)
Provide the journal entry to recognise the sale of the inventories in the records (general
journal) of W Entity.
Note: The journal for the recognition of the cost of sales is not required.
Remark in respect of Example 9.4
1
Where applicable, the solution will time and again, between brackets and in italics,
indicate the change in the account if both entities use the periodic inventory system.
351
Example 9.4 Solution
a) and b) Journal entries – initial recognition
20.7
15 Jan
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Trade inventories (SFP) 256 500
(Purchases (P/L))
VAT input (SFP)
38 475
Bank (SFP)
294 975
Recognise cash purchase after cash discount
20.7
15 Jan
Bank (SFP)
VAT output (SFP)
Sales (P/L)
294 975
38 475
256 500
Recognise cash sale after cash discount
Remarks in respect of the solution to Example 9.4
1
The invoice amount is R294 975 (R310 500 x 95%) or (R310 500 – (R310 500 x 5%))
2
The invoice could have contained the following amounts:
Normal sales price (including VAT)
Cash discount – 5%
Invoice price
R310 500
(R15 525)
R294 975
R Entity’s records (the purchasing entity)
3
Trade inventories are recognised at cost price, in other words the invoice price
excluding VAT, after accounting for the 5% cash discount. VAT input is a separate
asset.
4
Bank is credited with the invoice price including VAT after accounting for the 5% cash
discount (the amount paid).
W Entity’s records (the selling entity)
5
Sales are recognised at the invoice price excluding VAT, after accounting for the 5%
cash discount. VAT output is a separate liability.
6
Bank is debited with the invoice price including VAT after accounting for the 5% cash
discount (the amount received).
Settlement discount
28
Wholesalers might sometimes deem it fit to encourage customers, who should pay only after
the elapse of a credit term of for example 30 days, to pay within seven or ten days, by
granting a settlement discount. A settlement discount can for instance be structured as
follows: Customers with a credit term of 30 days receive a settlement discount of 2% if
payment occurs within seven days from delivery.
29
If it is probable that the customer will make use of the settlement discount (since the
customer always made use of the settlement discount in the past), the wholesaler and the
retailer will recognise the transaction at an amount which is reduced with the settlement
discount. If the customer fails to pay in time, an adjustment will be made that has the effect
where the result of the following paragraph is achieved.
352
30
If it is not likely that the customer will make use of the settlement discount (since the
customer never made use of the settlement discount in the past), the wholesaler and the
retailer will recognise the transaction at an amount that is not reduced with the settlement
discount.
Example 9.5 Settlement discount
R Entity and W Entity are both registered as vendors in terms of the VAT Act.
W Entity is a wholesaler who currently grants 2% settlement discount to customers with a credit
term of 30 days, but who make their payment within 7 days.
On 12 January 20.7, R Entity, one of W Entity’s selected customers, ordered a container with 100
units of a specific product. On 15 January 20.7, the goods were delivered to R Entity’s premises.
The invoice indicated the amount as R207 000 and the credit term as 30 days. The invoice
furthermore indicated that a settlement discount of 2% is granted if the amount is paid within seven
days. R Entity has always made use of the settlement discount in the past.
The cost price of these inventories, according to the records of W Entity, is R117 600.
Both entities use the perpetual inventory system.
Required:
Provide journal entries in the records (general journal) of R Entity and the records (general journal)
of W Entity to:
a)
recognise the purchase/sales transaction;
b)
recognise the payment of R202 860 by R Entity on 21 January 20.7;
c)
recognise the payment as well as the adjustment that has to be made if it is accepted that,
due to an oversight, R Entity only paid on 14 February 20.7 (that is, after more than 7 days),
and indeed an amount of R207 000; and
d)
recognise the purchase/sale of the trade inventories if it is accepted that on 12 January
20.7, with the placement of the order, R Entity indicated that they will not make use of the
offered settlement discount.
Remark in respect of Example 9.5
1
Where applicable, the solution will time and again, between brackets and in italics,
indicate the change in the account if both entities use the periodic inventory system.
Example 9.5 Solution
a) Journal entries – initial recognition
20.7
15 Jan
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Trade inventories (SFP) 176 400
(Purchases (P/L))
VAT input (SFP)
26 460
Payable W (SFP)
202 860
Recognise credit purchase and recording of
probable settlement discount
20.7
15 Jan
353
Receivable R (SFP)
VAT output (SFP)
Sales (P/L)
202 860
26 460
176 400
Recognise credit sale and recording of
probable settlement discount
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
20.7
15 Jan
Cost of sales (P/L)
117 600
Trade inventories (SFP)
117 600
Recognise cost of sales
(This journal occurs only if the perpetual
inventory system is used)
Remarks in respect of the solution to Example 9.5 (a)
1
The invoice amount is R202 860 (R207 000 x 98%) or (R207 000 – (R207 000 x 2%))
2
The invoice could have contained the following amounts:
Normal sales price (including VAT)
Settlement discount – 2%
Invoice price
R207 000
(R4 140)
R202 860
R Entity’s records (the purchasing entity)
3
Trade inventories are recognised at cost price, in other words invoice price excluding
VAT, after the 2% settlement discount was taken into account. VAT input is a separate
asset.
4
Payable W is recognised at the invoice price including VAT after the 2% settlement
discount was taken into account (the amount payable).
W Entity’s records (the selling entity)
5
Sales are recognised at the invoice price excluding VAT, after the 2% settlement
discount was taken into account. VAT output is a separate liability.
6
Receivable R is recognised at the invoice price including VAT after the 2% settlement
discount was taken into account (the amount receivable).
b) Journal entries – derecognition due to payment
20.7
21 Jan
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Payable W (SFP)
202 860
Bank (SFP)
202 860
Derecognise trade payable due to
settlement
20.7
21 Jan
354
Bank (SFP)
Receivable R (SFP)
202 860
202 860
Derecognise trade receivable due to
settlement
c) Journal entries – correction and payment
20.7
22 Jan
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Trade inventories (SFP)
3 600
(Purchases (P/L))
VAT input (SFP)
540
Payable W (SFP)
4 140
Recognise adjustment. Settlement discount
of 2% forfeited due to late payment
20.7
14 Feb Payable W (SFP)
207 000
Bank (SFP)
207 000
Derecognise trade payable due to
settlement
20.7
22 Jan
Receivable R (SFP)
VAT output (SFP)
Sales (P/L)
4 140
540
3 600
Recognise adjustment. Settlement discount
of 2% forfeited due to late payment
20.7
14 Feb Bank (SFP)
207 000
Receivable R (SFP)
207 000
Derecognise trade receivable due to
settlement
Remark in respect of the solution to Example 9.5 (c)
1
2
The net effect of the journals in (a) and (c) (the adjustment) above is, in respect of
R Entity and W Entity respectively, the same as the journal in (d) below.
The adjustment to reverse the discount is made on the date of the expiry of the 7 days
(that is, 22 January).
d) Journal entries – initial recognition
20.7
15 Jan
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Trade inventories (SFP) 180 000
(Purchases (P/L))
VAT input (SFP)
27 000
Payable W (SFP)
Recognise credit purchase
20.7
15 Jan
Receivable R (SFP)
VAT output (SFP)
Sales (P/L)
207 000
27 000
180 000
207 000
Recognise credit sale
20.7
15 Jan
Cost of sales (P/L)
Trade inventories (SFP)
117 600
117 600
Recognise cost of sales
(This journal occurs only if the perpetual
inventory system is used)
Remark in respect of the solution to Example 9.5 (d)
1
The invoice price is R207 000 since there is no settlement discount.
355
Recognition of interest charged by the selling entity
31
Credit sales of trade inventories are one of the main characteristics of the modern economy.
If trade inventories are sold to a customer on credit, payment does not take place with the
delivery of the trade inventories to the customer since there is a credit term that can elapse
before the payment has to take place. A credit term can be 30 days or 60 days or sometimes
even 90 days. This concession by suppliers to customers is referred to as trade credit and as
a result of the relative short credit term, no interest is charged. The amount due is a single
amount payable on the settlement date.
32
Should a receivable fail to adhere to the repayment conditions, the agreement between the
selling entity and the purchasing entity will provide for the fact that interest will be charged on
the outstanding debt at an agreed interest rate.
33
Interest added (charged) to the account of a receivable that is in arrears and who has the
ability to pay, satisfies (for the selling entity) the definition and recognition criteria of the
element income. In the records of the selling entity, such interest income is debited against
the account of the relevant receivable and credited against the account “Interest income on
receivables in arrears”. In this regard, refer to the interest income on a term deposit in
Chapter 5 paragraphs 277 to 289, since the accounting treatment is the same.
34
In the records of the purchasing entity, the interest in respect of the outstanding amounts
which is added by the selling entity to the relevant payable’s account in arrears satisfies the
definition and recognition criteria of the element expenses. In the records of the purchasing
entity, such interest expense is credited to the account of the relevant payable and debited
against the account “Interest expense on payables in arrears”. In this regard, refer to the
interest expense on a supplier’s loan in Chapter 5 paragraphs 195 to 205, since the
accounting treatment is the same.
Example 9.6 Recognition of interest on an outstanding amount
R Entity and W Entity are both registered as vendors in terms of the VAT Act.
W Entity is as wholesaler one of the suppliers of products to R Entity.
On 16 January 20.7, R Entity received trade inventories, which were ordered from W Entity on
12 January 20.7. The invoice amount is R345 000 (including VAT) and is payable on or before
14 February 20.7. The cost price of these inventories is R120 000 according to W Entity’s records.
Both entities use the perpetual inventory system.
The following transactions occurred on the dates as indicated below:
•
On 1 March 20.7, W Entity debited Receivable R’s account with an amount of R2 436 in
respect of interest charged on the outstanding debt, since the invoice amount was still due.
On this date, a debit note dated 1 March 20.7 to the amount of R2 436 was sent electronically
to Receivable R.
•
On 31 March 20.7, R Entity made a direct deposit of R347 436 into W Entity’s bank account.
•
On 1 April 20.7, W Entity debited Receivable R’s account with an amount of R5 851 in
respect of interest charged on the outstanding debt (for the period 1 March 20.7 to 31 March
20.7). On this date, a debit note dated 1 April 20.7 to the amount of R5 851 was sent
electronically to Receivable R.
356
Required:
a)
Provide journal entries to recognise the transactions in the records (general journal) of
R Entity.
b)
Provide journal entries to recognise the transactions in the records (general journal) of
W Entity.
Remark in respect of Example 9.6
1
Where applicable, the solution will time and again, between brackets and in italics,
indicate the change in the account if both entities use the periodic inventory system.
Example 9.6 Solution
a) and b) Journal entries – initial recognition
20.7
16 Jan
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Trade inventories (SFP) 300 000
(Purchases (P/L))
VAT input (SFP)
45 000
Payable W (SFP)
Recognise credit purchase
20.7
16 Jan
Receivable R (SFP)
VAT output (SFP)
Sales (P/L)
345 000
45 000
300 000
345 000
Recognise credit sale
20.7
16 Jan
Cost of sales (P/L)
120 000
Trade inventories (SFP)
120 000
Recognise cost of sales
(This journal occurs only if the perpetual
inventory system is used)
a) and b) Journal entries – recognition of interest charged (15 February – 28 February)
20.7
1 Mar
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Interest expense on
payables in arrears (P/L)
Payable W (SFP)
20.7
1 Mar
2 436
2 436
Recognise interest expense on outstanding
debt
357
Receivable R (SFP)
2 436
Interest income on
2 436
receivables in
arrears (P/L)
Recognise interest income on outstanding
debt
a) and b) Journal entries – derecognition due to payment
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
20.7
31 Mar Payable W (SFP)
347 436
Bank (SFP)
347 436
Derecognise trade payable due to
settlement
20.7
31 Mar Bank (SFP)
347 436
Receivable R (SFP)
347 436
Derecognise trade receivable due to
settlement
a) and b) Journal entries – recognition of interest charged (1 March – 31 March)
20.7
1 Apr
R Entity
W Entity
Purchasing entity – A retailer
Selling entity – A wholesaler
Interest expense on
payables in arrears (P/L)
Payable W (SFP)
20.7
1 Apr
5 851
5 851
Recognise interest expense on outstanding
debt
35
Receivable R (SFP)
5 851
Interest income on
5 851
receivables in
arrears (P/L)
Recognise interest income on outstanding
debt
It often occurs that various payment options exist in respect of retailers who sell goods to the
public. Examples of such payment options are:
•
Cash sales (notes, coins and payments with debit or credit cards);
•
Credit sales (to clients who qualify), where the amount due has to be paid in a single
amount within for example 60 days; or
•
Credit sales (to clients who qualify), where the amount due has to be repaid over a
period of for example six months. Interest is appropriately added to the debt on a
monthly basis.
36
To understand these interest calculations a basic knowledge of the time value of money is
required. The time value of money and the use of the effective interest rate method are dealt
with only in Section A of Chapter 15.
37
The amount of interest charged on a receivable/payable in arrears will always be provided in
this chapter.
358
Payables reconciliation
38
In the following paragraphs, an aspect that relates only to the purchasing entity will be
discussed, namely the payables reconciliation.
39
Every month, the payables department of the purchasing entity prepares a payables
reconciliation in respect of each payable. The regular incurrence of purchase contracts for the
credit purchase/sale of trade inventories between two parties (a wholesaler and a retailer)
has reference. For the wholesaler, it is a sales transaction which affects the trade
receivable’s account and sales, amongst others. For the retailer it is a purchase transaction
which affects trade inventories (purchases) and the trade payable’s account, amongst others.
Other transactions, such as returns and payments, also flow from the original purchase/sale.
The account for the trade receivable (in the wholesaler’s records) and the account for the
trade payable (in the retailer’s records) contain on opposite sides comparable entries.
Compare Examples 9.1 and 9.2.
40
Every month, the selling entity (wholesaler) sends a statement to the purchasing entity
(retailer) with the primary goal to remind the purchasing entity (who is a trade receivable in
the wholesaler’s records) that payment/settlement must take place. The statement that the
wholesaler sends to the retailer is a representation of the receivables account (of the retailer)
in the wholesaler’s records.
41
The retailer will use this mutual comparability to verify the transactions with the wholesaler.
The control is executed by the retailer by reconciling the payables account (of the wholesaler)
in the retailer’s records with the statement that is received from the wholesaler.
42
After comparing the statement from the selling entity with the purchasing entity’s own
records, errors or omissions caused by the reporting entity (purchasing entity) are corrected
in the purchasing entity’s records by way of correcting journals. Errors caused by the selling
entity are reflected in the reconciliation statement for correction by the selling entity.
Example 9.7 Payables reconciliation
R Entity and W Entity are both registered vendors in accordance with the VAT Act. Both entities
use the perpetual inventory system.
W Entity is as wholesaler one of R Entity’s suppliers of products.
The following information was obtained from the records of R Entity (the purchasing entity):
1
The credit balance on Payable W’s account on 1 July 20.7 amounts to R322 000.
2
Trade inventories that were purchased from W Entity were received and recognised on 2 July
20.7. Invoice W117 amounts to R78 200 (including VAT) and is payable on 1 August 20.7.
3
On 4 July 20.7 an amount of R178 250 was paid to Payable W by means of an electronic
funds transfer (EFT 111) in respect of invoice W101 to the amount of R178 250, which is
included in the balance on 1 July 20.7.
4
On 18 July 20.7 credit note W37, dated 14 July 20.7 and to the amount of R8 625 (including
VAT), was received from W Entity. The credit note relates to trade inventories that were
purchased by R Entity on 2 July 20.7 and that were returned by R Entity to W Entity on
11 July 20.7.
5
On 31 July 20.7 an amount of R143 750 was paid to Payable W by means of an electronic
funds transfer (EFT 167) in respect of invoice W87. This invoice (to the amount of R143 750)
is included in the balance on 1 July 20.7.
All of the abovementioned transactions have already been accounted for in the records of R Entity.
The following information represents the account of Payable W (K17) in the records of R Entity:
359
R Entity’s records
K17 Payable W
Date
Contra accounts
20.7
1 Jul Balance bd
2 Jul Trade inventories and VAT input
(Purchases and VAT input)
4 Jul Bank
14 Jul Trade inventories and VAT input
(Returns (out) and VAT input)
31 Jul Bank
Document
Dr
Cr
322 000
78 200
W117
Balance
322 000
400 200
EFT 111
KN W37
178 250
8 625
221 950
213 325
EFT 167
143 750
69 575
On 3 August 20.7, the following statement was received electronically from W Entity:
W Entity
Street address Postal address Telephone Fax e-mail
Date
1 Jul
2 Jul
4 Jul
14 Jul
28 Jul
Statement of R Entity
31 July 20.7
Contra accounts
Document
Balance bd
Sales and VAT output
W117
Bank
EFT 111
Returns (in) and VAT output
KN W37
Sales and VAT output
W162
Dr
322 000
78 200
Cr
178 250
8 625
87 400
Balance
322 000
400 200
221 950
213 325
300 725
Invoice W162 represents the sale of trade inventories by W Entity to R Entity, which were delivered
and received by R Entity on 28 July 20.7. R Entity’s payables clerk inadvertently entered the
transaction into the account of Payable V (K16).
Remarks in respect of the set of facts to Example 9.7
1
Note that the two accounts do not reflect the historical T-account format. The two
accounts are in the column format of accounts, which is commonly used in practice.
From now on, in this work, both the historical T-account format and the formal column
format for accounts will be used.
2
The formal column format accounts contain more detail about the source documents.
Required:
Compare the account of W Entity as it appears in the records of R Entity as at 31 July 20.7, with
the July 20.7 statement received from W Entity, and:
a)
If it appears that W Entity’s account (in the records of R Entity) is incomplete or contains
errors:
i)
Journalise the necessary entry/entries in the records (general journal) of R Entity; and
ii)
Open W Entity’s account (in the records of R Entity) with the credit balance of R69 575
and post the journal(s) in (a)(i) to this account. The account must be provided in the
formal column format.
360
b)
If it appears that the statement from W Entity is incomplete or contains errors, prepare a
payables reconciliation as at 31 July 20.7.
Remark in respect of the required to Example 9.7(b)
1
The payables reconciliation procedure will be dealt with in more detail after the solution
to Example 9.7.
Example 9.7 Solution
a)(i) Journal entry on 31 July 20.7 – R Entity’s records
J1
20.7
28 Jul
Payable V (SFP)
Payable W (SFP)
Correction of error. Purchases as per invoice W162 from
W Entity was erroneously credited to the account of
V Entity
Dr
87 400
Cr
87 400
a)(ii) Post journal to Payable W’s account – R Entity’s records
K17 Payable W
Date
Contra accounts
20.7
31 Jul Balance bd
28 Jul Payable V
Document
Dr
Cr
69 575
87 400
W162
Balance
69 575
156 975
b) Payables reconciliation as at 31 July 20.7
Reconcile Payable W’s account (in R Entity’s records) with the statement received from W Entity.
20.7
31 Jul Balance as per statement
31 Jul EFT 167 not accounted for
Dr
300 725
Cr
143 750
Balance
300 725
156 975
Remarks in respect of the solution to Example 9.7(b)
1
A payables reconciliation is in essence a “completion” of the statement received from
the payable.
2
The completed account for Payable W in (a)(ii) above and the “completed” statement in
(b) show the same closing balance, namely R156 975. This consequently means that
the completed account for Payable W is correct.
361
Payables reconciliation – a summary of the procedure
43
Consider the following case: The trade payable’s account in the records of the purchasing
entity (R Entity) has already been completed up to 31 July 20.7. A few days thereafter
R Entity received the statement for July 20.7 electronically from the trade payable, W Entity.
44
Subsequently, the procedures that are carried out during a payables reconciliation are dealt
with.
Identify differences
45
An employee of the purchasing entity will compare the trade payable’s account (in the
purchasing entity’s records) for a specific month with the statement for the same month
(which is received from the payable). There will usually be differences. These differences
between the entries in the payable’s account (in the purchasing entity’s records) and the
entries on the statement (which is received from the payable) fall into two categories, namely
time differences and errors. The time differences and errors can relate to the payable’s
account as well as to the statement. A time difference will usually result in the following:
•
A payment that is made by R Entity (the purchasing entity) at the end of the month (e.g.
31 July 20.7), will already be reflected on this day in the payable’s (W Entity) account in
the records of R Entity. However, in the records of W Entity (the selling entity), the
payment will only be reflected on the account of Receivable R in August 20.7.
•
Goods that were returned by R Entity to W Entity (returns (out)) on 24 July 20.7 are
recognised in R Entity’s records only when a credit note is received from W Entity. If the
July 20.7 statement, that is received from W Entity, reflects that W Entity issued a credit
note for the returns on 30 July 20.7, the statement contains an item that does not
appear in the records of R Entity as at 31 July 20.7.
Complete and adjust the payable’s account, where necessary
46
The payable’s account (in the records of the purchasing entity) must be completed in respect
of returns (out) for which the payable issued a credit note on or before 31 July 20.7, but of
which the purchasing entity was not aware. The purchasing entity identified the returns, as
reflected on the statement, as a difference. In such a case, the purchasing entity would have
already returned the goods, whilst the transaction is recognised based on the credit note
issued by the payable. Returns (out) are recognised on the date of the credit note.
47
Errors made by the purchasing entity are corrected in the records of the purchasing entity
through journals. Payable W has reference. Consider the following as examples of errors that
can occur:
•
Invoice W162 (from W Entity) was credited to Payable V’s account in the records of the
purchasing entity; or
•
Invoice AE191 (from AE Entity) was credited to Payable W’s account in the records of
the purchasing entity.
362
48
After the aforementioned has been done, the balance on 31 July 20.7 on Payable W’s
account in R Entity’s records will still mostly differ with the balance on 31 July 20.7 on the
statement that is received from Payable W. The reason for the difference is usually
attributable to one or more of the following:
•
An error that occurs on the statement; or
•
A payment that was made by the purchasing entity to the payable at month end only
appears on the first day of the new month on the statement, as prepared by the
payable.
Complete and adjust the statement, where necessary
49
The statement (which is received from the payable) is “completed” by the purchasing entity in
that a payables reconciliation is prepared for the relevant month end.
50
A payables reconciliation takes on the format of the payables statement and begins with the
closing balance on the statement.
51
Items, especially payments to the payable, which do not appear on the statement, are merely
inserted in the appropriate column on the payables reconciliation.
52
Errors on the statement are corrected on the payables reconciliation. The following errors,
amongst others, can occur:
•
There can be errors on the invoice, for example trade discount and/or settlement
discount were not accounted for; or
•
An invoice that relates to another payable, appears on the purchasing entity’s
statement (which was received from the selling entity) or vice versa.
53
After completion of the abovementioned steps, the balance on the payables account (as
completed and adjusted) will agree with the closing balance of the payables reconciliation.
54
The benefits of the payables reconciliation procedure for the purchasing entity are as follows:
•
Confirmation is obtained that the purchasing entity’s records are now a complete and
accurate version of the transactions entered into with the payable; and
•
Confirmation is obtained from an external source that the payments which were made
to the payable were indeed for purchases by the purchasing entity.
Trade payables – summary
55
Initial recognition of trade payables takes place when the definition and recognition criteria of
a liability are satisfied. Initial recognition occurs in accordance with the double entry
bookkeeping system.
56
Measurement with initial recognition occurs at the invoice amount including VAT (after
accounting for trade discount, cash discount or settlement discount that will probably be
utilised, if applicable).
57
Returns (out) decrease the obligation to the trade payable. The trade payable is consequently
partially derecognised by debiting the trade payable and crediting trade inventories
(returns (out)) and VAT input. The amount is the agreed amount, including VAT, as reflected
on the credit note from the supplier, and recognition occurs on the date as reflected on the
credit note.
363
58
A trade payable is furthermore only partially or totally derecognised on the date on which a
payment is made to the trade payable. (Debit the trade payable and credit bank.)
59
Subsequent measurement (that is measurement of the outstanding trade payables on the
reporting date) occurs at the outstanding invoice amount if no interest is charged. This
amount is the balance as reflected on the payable’s account. If interest is charged,
subsequent measurement occurs at amortised cost, therefore at the outstanding invoice
amount (which includes VAT) plus accrued interest.
60
The sum of all the trade payables of the purchasing entity on the reporting date is presented
in the statement of financial position under the classification current liabilities as the line-item
“Trade and other payables”.
Impairment of trade receivables and bad debts
61
Subsequently, two aspects that relate only to the selling entity will be dealt with, namely the
impairment of trade receivables and bad debts.
Impairment of trade receivables
62
In the preceding parts of this chapter, the initial measurement of trade receivables has been
dealt with in full. The measurement with the initial recognition of trade receivables occurs at
the invoice amount including VAT (after accounting for trade discount, cash discount or
settlement discount which will probably be used, if applicable).
63
Subsequent measurement of trade receivables is the measurement of trade receivables on
the reporting date. Trade receivables must be measured on the reporting date at the
amortised cost thereof, which is the outstanding invoice amount if no interest is charged. If
interest is charged, then amortised cost is the outstanding invoice amount (including VAT)
plus accrued interest.
64
If trade inventories are sold to a customer on credit, payment does not take place with
delivery of the trade inventories to the customer since there is a credit term that can elapse
before payment has to take place. A credit term can be 30 days or 60 days or sometimes
even 90 days.
65
Notwithstanding the prudent manner in which trade credit is granted to a customer, there is
still a risk (which is known as a credit risk) that a trade receivable will not pay the
outstanding amount. Possible reasons for this could be that the trade receivable is dishonest
(the receivable “disappears”) or that the trade receivable will experience financial problems
as a result of the downturn of the economy.
66
When it is evident that the trade receivable may not pay the contractual cash flows of the
debt, and that the trade receivable is likely to make different or lower payments instead, the
trade receivable must be measured to reflect the probable future economic benefits that will
flow from the trade receivable. This adjustment to reflect the probable future economic
benefits is called an impairment of the trade receivable.
67
Accordingly, the entity must recognise and measure a loss allowance at an amount equal to
the lifetime expected credit losses on the trade receivables in accordance with IFRS9 to
determine the impairment on the trade receivables since their initial recognition. (For
purposes of this work, the simplified approach according to IFRS9 for the impairment of trade
receivables is adopted.) The expected credit losses on the trade receivables will be
measured in a way that reflects:
364
•
an unbiased and probability-weighted amount that is determined by evaluating a
range of possible outcomes; and
•
reasonable and supportable information that is available without undue cost or effort
at the reporting date about past events, current conditions and forecasts of future
economic conditions. (IFRS9:5.5.17)
68
The entity will therefore calculate the amount of the expected credit losses based on the
timing, amounts and uncertainty of the future cash flows associated with the trade receivable.
(IFRS9 BC5.264) A range of possible scenarios between (a) credit losses occurring and (b)
credit losses not occurring are determined. Statistical probability weights are then attached to
each of the scenarios to determine the expected credit losses. The period over which the
credit losses are calculated is limited to the contractual period over which the entity will be
exposed to the credit risk of each trade receivable.
69
The calculation of the lifetime expected credit losses is outside the scope of this work. The
lifetime expected credit losses will be provided for each reporting date and students will not
be required to calculate the expected credit losses. In theory, the lifetime expected credit loss
should be recognised with the initial measurement of the trade receivable. However, this is
onerous, and in practice such loss allowances are recognised and measured at the reporting
date. It is reassessed at each reporting period end with changes recognised in profit or loss.
This is also the approach followed in this work.
70
By evaluating the individual trade receivables in this manner, an estimate can be made of the
amount of the total trade receivables that will probably not be collected. The impairment that
occurred in respect of trade receivables is therefore determined through a process prescribed
by IFRS9 and is not calculated as the product of a percentage of the outstanding trade
receivables.
71
Although the total impairment that occurred in respect of trade receivables was determined
by evaluating individual trade receivables, the impairment is recognised in total. It will be an
error of judgement to credit the individual trade receivables’ accounts as such a credit on the
statement of the trade receivable will precisely encourage non-payment.
72
In this regard, it is convention to recognise an “allowance for doubtful debts”. The allowance
for doubtful debts is an account with a credit balance and is in essence part of the credit side
of the relevant trade receivables’ accounts (the accounts in respect of which payment is
doubtful). Instead of crediting the individual trade receivables with the probable impairment,
the “Allowance for doubtful debts” account is credited. This adjustment has no VAT
implications.
73
If trade receivables are merely presented as the sum of the balances of the individual
receivables’ accounts on the reporting date, it is probable that the asset trade receivables is
overstated and the expense bad debts is understated. Consequently, the preparer of the
financial statements must, by cautiously applying judgement in accordance with IFRS9, place
a value on the trade receivables. The requirement that an impairment must be recognised, on
the reporting date, in respect of trade receivables, originates from the fundamental qualitative
characteristic of financial information, namely relevance and faithful representation.
365
Bad debts – the derecognition of a trade receivable
74
As soon as (after numerous warnings) it becomes confirmed that the trade receivable is not
going to pay its debt, and the entity’s credit manager authorises the write-off of the debt, the
trade receivable no longer satisfies the definition of a financial asset, since the entity waives
its contractual right to receive payment. Such a trade receivable must be derecognised by
crediting the trade receivable’s account and debiting the bad debts expense account and the
VAT input account.
75
Bad debts are an example of an expense that arises because an asset decreases. The writeoff of debt as irrecoverable must be approved in writing by the owner or the credit manager.
The decrease of the trade receivable is recognised as soon as the write-off is approved.
76
Review Chapter 5 paragraphs 153 to 167 as well as Examples 5.10 and Chapter 8 Examples
8.3 and 8.4.
77
The double entry rules in respect of the allowance for doubtful debts and bad debts, are as
follows:
•
Create/increase the allowance for doubtful debts
Debit bad debts (expense) and credit the allowance for doubtful debts account;
•
Decrease the allowance for doubtful debts
Debit the allowance for doubtful debts account and credit bad debts (expense);
•
Write-off of bad debts
Debit bad debts (expense), debit VAT input and credit the trade receivable;
•
Bad debts recovered
Debit bank and credit bad debts (expense) and VAT output.
Example 9.8 Bad debts and the allowance for doubtful debts
AP Entity conducts business as a retailer that sells goods for cash or on credit. AP Entity is a
registered vendor in accordance with the VAT Act.
On 31 December 20.6 and 31 December 20.7, the following balances, amongst others, appeared in
the records of AP Entity:
Dr
Cr
31 December 20.6 (the first reporting date)
Trade receivables
420 000
31 December 20.7
Trade receivables
Bad debts (expense)
504 000
28 957
Additional information
Trade receivables must be presented on the reporting date at the amount that will probably be
received from the trade receivables.
366
Consequently, during the period between the reporting date and the date on which the financial
statements are authorised, the probable recoverability of each trade receivable must be evaluated
with reference to the lifetime expected credit losses calculation.
The result of this process, as at 31 December 20.6, is as follows:
Receivable DP
Receivable DY
Receivable DD
Balance
31 Dec 20.6
14 500
4 500
45 500
Receivable DW
80 500
30 000
Receivable DR
35 500
15 000
Receivable DN
37 200
20 000
Other receivables
202 300
420 000
Write off
Allowance
14 500
4 500
25 000
19 000
Reason/Action
Insolvent
Disappeared
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
90 000
As at 31 December 20.6:
•
R19 000 of bad debts still has to be written off. (The credit manager authorised the write-off
on 20 January 20.7); and
•
the allowance for doubtful debts still has to be created.
On 30 June 20.7, the following trade receivables were written off as irrecoverable and the write-offs
have already been recognised in the records of AP Entity:
•
Receivable DD, an amount of R12 000,
•
Receivable DN, an amount of R14 800; and
•
Receivable DR, an amount of R6 500.
It can be assumed that the difference between the outstanding balances on 31 December 20.6 and
the amounts written off as irrecoverable on 30 June 20.7, have been received in cash from the
respective trade receivables before 30 June 20.7.
367
The result in respect of the review of trade receivables during the period between the reporting date
(31 December 20.7) and the date on which the financial statements are authorised, is as follows:
Receivable DC
Receivable DE
Receivable DF
Balance
31 Dec 20.7
8 800
16 500
32 800
Receivable DG
46 200
21 000
Receivable DI
36 200
16 000
Receivable DJ
34 000
14 000
Receivable DL
18 800
8 000
Receivable DO
19 200
9 500
Receivable DQ
22 200
12 000
Other receivables
269 300
504 000
Write off
Allowance
8 800
16 500
20 000
25 300
Reason/Action
Disappeared
Placed under liquidation – insolvent
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
Lifetime expected credit losses
calculation
100 500
As at 31 December 20.7:
•
R25 300 of bad debts still has to be written off. (The credit manager authorised the write-off
on 18 January 20.8); and
•
the allowance for doubtful debts still has to be adjusted to R100 500.
Required:
a)
Journalise the transactions that, according to the set of facts, still have to be recognised in
the records (general journal) of AP Entity as at 31 December 20.6.
b)
Journalise the transactions that, according to the set of facts, still have to be recognised in
the records (general journal) of AP Entity as at 31 December 20.7.
c)
Present the bad debts expense and trade receivables in the appropriate financial statements
of AP Entity for the reporting periods ended 31 December 20.6 and 31 December 20.7.
Example 9.8 Solution
a) Journal entries – 31 December 20.6
J1
20.6
31 Dec
Bad debts (P/L)
VAT input (SFP)
Receivable DP (SFP)
Receivable DY (SFP)
Derecognise receivables DP and DY as per authorisation
by the credit manager. See the letter dated 20 Jan 20.7
368
Dr
16 522
2 478
Cr
14 500
4 500
J2
20.6
31 Dec
Bad debts (P/L)
Allowance for doubtful debts (SFP)
Recognise an allowance for doubtful debts in respect of
specific trade receivables based on lifetime expected
credit losses calculations.
Dr
90 000
Cr
90 000
b) Journal entries – 31 December 20.7
Jx (This journal was not required, but is provided for purposes of completeness)
20.7
Dr
30 Jun Bad debts (P/L)
28 957
VAT input (SFP)
4 343
Receivable DD (SFP)
Receivable DN (SFP)
Receivable DR (SFP)
Derecognise receivables as per authorisation by the credit
manager. See the letter dated 30 June 20.7
J1
20.7
31 Dec
J2
20.7
31 Dec
Bad debts (P/L)
VAT input (SFP)
Receivable DC (SFP)
Receivable DE (SFP)
Derecognise receivables as per authorisation by the credit
manager. See the letter dated 18 Jan 20.8.
Bad debts (P/L)
Allowance for doubtful debts (SFP)
Recognise an allowance for doubtful debts in respect of
specific trade receivables based on lifetime expected
credit losses calculations.
R10 500 = R100 500 – R90 000
Dr
22 000
3 300
Cr
12 000
14 800
6 500
Cr
8 800
16 500
Dr
10 500
Cr
10 500
Remarks in respect of Journal J2 above
1
2
The method that must be followed in this work is to calculate the adjustment that must
be made to the allowance for doubtful debts, as the difference between the allowance
required as on the current reporting date and the allowance as on the previous
reporting date.
An alternative method is to, on the current reporting date, close off the allowance for
doubtful debts as on the previous reporting date against the current reporting period’s
bad debts expense (debit allowance for doubtful debts as at the beginning of the
369
current reporting period and credit bad debts expense for the current reporting period).
Subsequently, the bad debts expense for the current reporting period is debited and the
allowance for doubtful debts is credited with the total amount of the allowance for the
current reporting period, and not only the difference between the allowance required as
on the current reporting date and the allowance as on the previous reporting date. The
methods produce the same result.
c) Presentation in the appropriate financial statements
AP ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
20.7
R
Sales
Cost of sales
Gross profit
////
Bad debts (dr 28 957 dr 22 000 dr 10 500) / (dr 16 522 dr 90 000)
Profit for the year
20.6
R
xxx
(xxx)
xxx
xxx
(xxx)
xxx
(61 457)
XXX
(106 522)
XXX
AP ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
ASSETS
Current assets
Trade receivables
(dr 504 000 cr 100 500 cr 25 300) / (dr 420 000 cr 90 000 cr 19 000)
20.7
R
20.6
R
378 200
311 000
Trade receivables – summary
78
Initial recognition of trade receivables takes place when the definition and recognition criteria
of an asset are satisfied. Initial recognition occurs in accordance with the double entry
bookkeeping system.
79
Measurement with initial recognition occurs at the invoice amount including VAT (after
accounting for trade discount, cash discount or settlement discount which will probably be
used, if applicable).
80
Returns (in) decrease the obligation of the trade receivable. Consequently the trade
receivable is partially derecognised by crediting the trade receivable and debiting returns (in)
and VAT output. The amount is the agreed amount, including VAT, as reflected on the credit
note and recognition occurs on the date indicated on the credit note.
81
A receivable is furthermore only partially or totally derecognised on the date on which a
payment is made by the trade receivable or on the date on which authorisation is given that
the debt of the trade receivable must be written off as irrecoverable.
370
82
Subsequent measurement (that is measurement of the outstanding trade receivables on the
reporting date) occurs at the outstanding invoice amount if no interest is charged. This
amount is the amount as reflected on the account of the trade receivable. If interest is
charged, then the trade receivable is measured at amortised cost which is the outstanding
invoice amount (including VAT) plus accrued interest. Subsequently a process must be
carried out in respect of each trade receivable to determine the lifetime expected credit
losses on the trade receivable. The impairment is recognised by debiting the bad debts
expense account and crediting the allowance for doubtful debts.
83
On the reporting date, the sum of all the trade receivables of the selling entity is reduced with
the balance of the allowance for doubtful debts account and is presented in the statement of
financial position under the classification current assets as the line-item “Trade receivables”.
371
Chapter 10 Cash and cash equivalents
Contents
Introduction
Means of payment in South Africa
Cheque payments
Debit and credit cards
Debit orders
The agreement between the entity and the bank is a financial instrument
Recordkeeping by the entity and by the bank
Transactions that affect the bank account of the entity
Receipts and the bank account of the entity
Receipt of notes and coins, cheques as well as payment with debit and credit
cards
Direct transfers into the entity’s bank account
Payments and the bank account of the entity
Payments initiated by the entity itself
Payments initiated by the entity’s bank
The procedure of identifying the differences
The bank reconciliation statement
The nature of the bank reconciliation statement
Internal control
Cash equivalents
373
Paragraph
1
3
4
7
10
11
14
18
19
19
23
25
27
30
34
37
37
41
43
Examples
Example
10.1
10.2
10.3
Bank reconciliation
Bank reconciliation – opening balance of the bank account and the cheque account
statement differs
Bank transactions – journal entries
374
Chapter 10 Cash and cash equivalents
Introduction
1
Cash and cash equivalents consist of bank balances (cash) and highly liquid call deposits
(cash equivalents). In this chapter cheque accounts (called current account or just bank
account) and the control thereof will mainly be dealt with. Historically, the term cheque
account was an appropriate term seeing that in the past most of the payments occurred by
cheque. Nowadays the term current account is used next to the term cheque account.
2
The use of a cheque account (current account) is an essential requirement for effective
participation in the modern economy. The relationship between the entity and the bank is
governed by a contract between the two parties. The contract will, amongst others, contain
the following stipulations with regards to:
•
the obligations of the bank, which include amongst others:
-
protecting the funds of the entity against unlawful appropriations;
-
executing lawful appropriation instructions with care and promptness;
-
providing bank statements (cheque account statements) electronically as agreed
upon (daily, weekly or monthly), followed by a paper copy;
-
making electronic platforms available to the client for dealing with cash deposits
and payment instructions to the bank;
-
crediting the entity’s bank statement (cheque account statement) on a monthly
basis at an agreed-upon rate with interest on the daily credit balance;
•
charging of service fees/bank charges by the bank at agreed-upon rates;
•
the obligations of the client, which include amongst others:
•
-
keeping unused cheques and internet user names and pin codes safe with due
care;
-
not overdrawing the bank account nor exceeding the overdraft facility limit;
-
providing a set of financial statements to the bank within three months after the
end of the entity’s reporting period every year;
the overdraft facility limit (if any), that include amongst others:
-
the interest rate that will be used to calculate the interest on the daily balance of
the bank overdraft – the interest is debited monthly against the cheque account
statement of the client;
-
the term of the facility and that it will be revised annually;
-
the security that must be provided, which usually includes a guarantee by the
owner, as well as a notarial bond over trade inventories and/or receivables in
favour of the bank.
375
Means of payment in South Africa
3
The following means of payment are mostly used in South Africa:
•
Notes and coins;
•
Cheques;
•
EFT payments; and
•
Card payments (debit cards and credit cards).
Cheque payments
4
A cheque is a written instruction to the bank to pay a specific amount of money from the
cheque issuer’s (drawer’s) account to a beneficiary (a specific person or institution). Due to
the increase in cheque fraud, cheques are in most cases only accepted if arrangements were
made in advance with the beneficiary. Over the past decade, the use of cheques decreased
significantly.
5
The clearance of cheques between banks takes place at night and is facilitated by the
Automatic Clearing Bureau (ACB).
6
If there are insufficient funds in the cheque account of the cheque issuer (the payer), the
cheque issuer’s bank sends the cheque back to the beneficiary’s bank. The beneficiary’s
bank will debit the cheque account statement of the beneficiary and send the cheque back to
the beneficiary.
Debit and credit cards
7
Debit cards are cards on which the holder of the card deposits an amount on the card, after
which the holder can use the card to make payments. As soon as the funds on the card are
depleted, the card holder must again deposit an amount on the card. A debit card can also be
directly linked to the holder’s cheque account. When the card holder makes a payment, a
transaction takes place between the card holder’s cheque account and the cheque account of
the beneficiary.
8
A credit card is a card on which the holder receives a credit limit from the card division of the
particular bank. When considering the credit limit, the bank must comply with the stipulations
of the Credit Act. The holder of the card uses the card to make payments. In accordance with
an arrangement with the bank, the account must be paid monthly. Every month, the holder of
the card pays either the minimum amount or a higher amount. The bank charges interest on
the daily balance of the credit card, which is added monthly. The available credit on the card
is the difference between the credit limit and the balance on the card. Assuming your credit
limit is R50 000, and the amount drawn is R20 000, the available balance will be R30 000.
9
An employee of the entity that receives the card as a means of payment, swipes the card
through a card reader. The card reader is electronically connected to the BANKSERVE
system, which reserves the amount on the customer’s card. If the transaction is successful,
the card reader shows the message “approved”. If sufficient funds are not available on the
customer’s card, the card reader will indicate it. Card transactions are cleared at night via the
BANKSERVE system between the selling entity’s bank and the other banks involved.
376
Debit orders
10
A debit order is a written agreement between a beneficiary and a customer (the payer) who
has to pay regular monthly amounts. The monthly payments can be a fixed amount for 12
months, for example insurance premiums or an amount for rent. The amount can also vary
monthly, for example for telephone usage. The agreement provides the beneficiary with the
right to give his/her bank an electronic instruction on a monthly basis to recover the debit
order amount on a determined date (as agreed upon between the beneficiary and the
customer) from the customer’s bank. The clearance of debit orders between banks takes
place at night and is facilitated by the Automatic Clearing Bureau (ACB). A trade entity is
usually involved in debit orders as a customer (payer). A trade entity can however, as lessor
of unused office space, recover rent income as beneficiary from a lessee by way of a debit
order.
The agreement between the entity and the bank is a financial
instrument
11
A financial instrument is defined as any contract that gives rise to a financial asset of one
entity and a financial liability or equity instrument of another entity.
12
The contract between the entity and the bank is such that in the case of a debit balance on
the bank account in the entity’s records, a financial asset arises in the entity’s records and a
financial liability in the bank’s records. (IAS 32.11) A financial asset is an asset that is cash,
an equity instrument of another entity, a contractual right to (i) receive cash or another
financial asset from another entity or to (ii) to exchange financial assets or financial liabilities
with another entity under conditions that are potentially favourable to the entity. In this case,
the bank receives money on behalf of the entity. The money, although in the bank’s custody,
does not belong to the bank, but to the entity. Hence, the bank will recognise a financial
liability and the entity a financial asset.
13
In the case of a credit balance (overdraft balance) on the bank account in the entity’s records,
the contract between the entity and the bank is such that a financial liability arises in the
entity’s records and a financial asset arises in the bank’s records. (IAS 32.11) A financial
liability is any liability that is a contractual obligation to (i) deliver cash or another financial
asset to another entity, or to (ii) exchange financial assets or financial liabilities with another
entity under conditions that are potentially unfavourable to the entity. In this case the entity
will have to pay an appropriate amount into the bank account on the date on which the
overdraft facility expires.
Recordkeeping by the entity and by the bank
14
In the records of the entity the transactions that affect bank are recorded in the bank account.
The entity opens a cheque account with a bank and deposits all receipts into the cheque
account at the bank on a daily basis. The entity gives the bank instruction (in writing or
electronically) when some of the funds in the cheque account must be paid to a third party on
behalf of the entity, for example through a debit order or electronic funds transfer (EFT).
15
The bank also keeps a record (a general ledger account) of each client’s cheque account.
When the bank provides the client with detail of the contents of the client’s general ledger
account, it is referred to as a bank statement. The entity receives a bank statement from the
bank usually on a monthly basis. The entity can also obtain electronic access to the cheque
377
account statement at the bank. The entity compares the bank statement with the bank
account in the entity’s records in order to determine, amongst others:
16
•
if there are direct debits or credits on the cheque account statement that the entity still
has to recognise;
•
if there are items in the bank account (in the entity’s records) that must still appear on
the bank statement; and
•
if the bank or the entity has made a mistake.
The following represents the abbreviated bank statement in respect of AC Entity’s cheque
account in the accounting records of AB Bank as well as the bank account in the accounting
records of AC Entity for January 20.7:
AB Bank’s accounting records
Cheque account of AC Entity
20.7
1 Jan
12 Jan
30 Jan
31 Jan
Detail
Balance bd
Direct deposit (Receivable D)
EFT (Payable K)
Bank charges and VAT output
Dr
Cr
22 850
29 070
13 680
342
Balance
22 850
51 920
38 240
37 898
Cr
Cr
Cr
Cr
AC Entity’s accounting records
Bank
20.7
1 Jan
12 Jan
30 Jan
31 Jan
1 Feb
Detail
Balance bd
Receivable D
Payable K
Bank charges and VAT input
Balance cf
Dr
22 850
29 070
51 920
37 898
Balance bd
Cr
13 680
342
37 898
51 920
Remark
1
17
It is clear from the above information that the bank account in the entity’s records and
the bank statement in the bank’s records contain comparable entries on opposite sides.
In the following section the focus will be on the bank account. However, reference will also be
made to the bank statement.
Transactions that affect the bank account of the entity
18
The majority of transactions that an entity enters into have an effect on the bank account of
the entity. In the entity’s records, the bank account is debited with receipts and credited with
payments. Receipts comprise notes and coins, cheques, payments by customers with debit
or credit cards as well as direct deposits by customers. Payments comprise inter alia the
issue of a cheque, a debit order recovery, an electronic funds transfer, payments by debit or
credit cards or the appropriation of a garage card.
378
Receipts and the bank account of the entity
Receipt of notes and coins, cheques as well as payments with debit and credit cards
19 A trading entity daily receives notes and coins, cheques as well as payments made by
customers with debit and credit cards in respect of the following transactions:
•
for cash sales (coins, notes and card payments); and
•
payments by receivables (coins, notes, cheques and card payments).
20
The above receipts are received at the “Electronic Funds Transfer Point-Of-Sale terminals”
(EFTPOS) in the sales area of a modern trading entity. Designated staff members capture the
receipts and the details thereof with the EFTPOS terminals onto the accounting system.
21
The EFTPOS terminals are centrally linked and will provide the following totals on a daily
basis:
Card payments received on (for example) 2 December 20.7
Transactions
Receipts from sales
Means of payment
Cards
Receipts from receivables
Cards
Amount
14 375
29 002
43 377
Remark
1
The above represents card payments received during the day (e.g. 2 Dec 20.7). The
card payments were approved during the day by the BANKSERVE system via the card
readers at the terminals. In the evening of the relevant day (e.g. 2 Dec 20.7) the
BANKSERVE system will credit the totals as one amount onto the cheque account
statement of AC Entity. Journal J122 below is prepared from this detail.
J122
20.7
2 Dec
Bank (SFP)
Sales (14 375 x 100/115) (P/L)
VAT output (14 375 x 15/115) (SFP)
Receivables (SFP)
Recognise card receipts for the day as per
EFTPOS totals. Also refer to the deposit slip of
2 Dec 20.7
Nr
A30
I1
L14.1
A21.1
Dr
43 377
Cr
12 500
1 875
29 002
Remark
1
The R43 000 appears on 2 December 20.7 as a debit amount in the bank account in
AC Entity’s records and as a credit amount on the bank statement. Refer to
Example 10.1.
379
Coins, notes and cheques received on (for example) 2 December 20.7
Transactions
Receipts from sales
Notes & coins
23 000
Receipts from receivables
Cheques
Total
23 000
33 996
18 662
52 658
56 996
18 662
75 658
Remark
1
The above represents detail of receipt of notes, coins and cheques on the relevant day,
(e.g. 2 Dec 20.7). Journal J123 below is prepared from this detail.
J123
20.7
2 Dec
Bank (SFP)
Sales (23 000 x 100/115) (P/L)
VAT output (23 000 x 15/115) (SFP)
Receivables (SFP)
Recognise receipts (notes, coins and cheques)
for 2 Dec 20.7 as per EFTPOS totals for the day
Nr
A30
I1
L14.1
A21.1
Dr
75 658
Cr
20 000
3 000
52 658
Remarks
22
1
During the evening of the relevant day (e.g. 2 Dec 20.7) a deposit slip is completed for
the R75 658. The notes and coins appear as two separate line items on the deposit slip
while detail of each cheque making up the R18 662, will also appear as separate line
items on the deposit slip. During the following morning (e.g. 3 Dec 20.7) the amount is
deposited in AC Entity’s bank account.
2
The deposit does not require a separate transaction, but the copy of the deposit slip is
part of the source documents for journal J123.
3
On the relevant day (e.g. 2 Dec 20.7) the R75 658 appears as a debit amount in the
bank account in AC Entity’s records and on the following morning (e.g. 3 Dec 20.7) as a
credit amount on the bank statement. Refer to Example 10.1.
4
The individual receivable accounts are in time credited with the relevant payments
made.
5
In the previous chapters it was assumed for educational purposes that cash receipts
are deposited into the bank account of the entity per transaction.
From the above it can be clearly seen that the bank account in the entity’s records and the
bank statement in the bank’s records contain comparable entries on opposite sides.
Direct transfers into the entity’s bank account
23 Direct deposits into an entity’s bank account often occur. These amounts appear as credits
on the bank statement. Some examples are as follows:
•
A receivable can, by making use of his bank’s electronic banking services, pay his
account with the entity through an electronic transfer of funds from his bank account to
the entity’s bank account.
380
24
•
A lessee can pay the monthly rent amount to the entity by means of an electronic
transfer of funds.
•
A receivable can deposit an amount into the entity’s bank account at a branch of the
relevant bank. The direct deposit will appear on the same day as a credit on the bank
statement of the entity.
•
If the agreement with the bank stipulates as such, the bank has to credit the bank
statement every month with an amount for interest as calculated daily on the credit
balance of the bank statement. Refer to Example 5.15.
The entity receives an electronic version of the bank statement for the previous day on a daily
basis. An appropriate employee of the entity will identify direct deposits that are reflected on
the bank statement as credits and will for example recognise the following journal entries in
the entity’s records:
20.7
5 Apr
20.7
5 Apr
20.7
5 Apr
20.7
30 Apr
Nr
Bank (SFP)
A30
Receivables (Receivable A nr D1) (SFP)
L21.1
Recognise direct deposit by Receivable A. (Refer
to bank statement 37)
(B1 is the amount of the EFT received)
Bank (SFP)
VAT output (SFP)
Rent income (P/L)
Recognise direct EFT deposit by lessee for rent.
(Refer to bank statement 37)
(B1 is the amount of the EFT received)
Bank (SFP)
VAT input (SFP)
Bad debts (P/L)
Recognise direct EFT deposit in respect of an
amount that was previously written off as
irrecoverable. (Refer to bank statement 37)
(B1 is the amount of the EFT received)
Refer to Examples 5.10 and 8.4
Bank (SFP)
Interest income (P/L)
Recognise interest credited by the bank on the
cheque account for April 20.7. (Refer to bank
statement 37)
(B1 is the amount of the credit for interest on the
bank statement)
Refer to Examples 5.15 and 8.10
381
Dr
Cr
B1
B1
Nr
A30
L14
I4.1
Dr
Nr
A30
A25
U11
Dr
Nr
A30
I4.3
Dr
Cr
B1
VAT
B1 – VAT
Cr
B1
VAT
B1 – VAT
Cr
B1
B1
Remark
1
The procedure that is followed to identify the direct credits on the bank statement is
dealt with in paragraph 33.
Payments and the bank account of the entity
25
Payments comprise inter alia the issue of a cheque, a debit order recovery, an electronic
funds transfer, payments by debit or credit cards or the appropriation of a garage card.
Internal control procedures require that all cash received by an entity be banked in total on a
daily basis and that, to the extent that it is practically executable, all payments occur per
cheque or per electronic bank transfer between bank accounts. Chapter 5 paragraphs 86 to
89 deals with a cash advance system (petty cash) for smaller expenses.
26
Payments are reflected as credit amounts on the bank account in the records of the entity
and as debit amounts on the cheque account statement of the bank.
Payments initiated by the entity itself
27 Cheque payments and payments by way of electronic fund transfers (EFTs) are initiated by
the entity itself.
28
A cheque payment is recognised in the entity’s records as a credit against the bank account
and as a debit against the appropriate account(s) on the day on which it is issued and
delivered to the beneficiary. Delivered means handed over, delivered to the premises of the
beneficiary or posted to the beneficiary. The latter alternative is not commonly used any
longer. The cheque will normally only appear on the bank statement as a debit a day or three
after it has been presented for payment.
29
The instruction for a payment by way of an EFT is done online on the electronic banking
services facility of the entity’s bank. Instructions for multiple payments can be created. For
each instruction a payment date must be entered. The payment date possibilities are the
current day, the following day, or the day thereafter. An EFT payment is recognised in the
entity’s records on the payment date as a credit against the bank account and as a debit
against the appropriate account(s). During the night of the payment date the EFT payments
are cleared between the banks. An EFT payment will usually appear the same day as a debit
on the bank statement of the bank.
Payments that are initiated by the entity’s bank
30 Payments that are initiated by the entity’s bank include, amongst others, the charging of bank
charges, the charging of interest on debit balances on the bank statement, debit orders as
well as cheques that were previously deposited, but dishonoured. These payments will
appear as debits on the bank statement of the bank and are recognised by the entity from the
bank statement. The entity receives an electronic version of the bank statement for the
previous day on a daily basis. Bank charges were dealt with in Chapter 5 paragraphs 82 to 85
and in Example 5.4. Interest expense on an overdraft bank balance was dealt with in Chapter
5 paragraphs 206 to 220. Revise paragraph 10 above in respect of debit orders.
31
As known, an entity receives notes, coins and cheques resulting from cash sales and
payments by receivables on a daily basis. The receipts for a day are deposited in total on the
following morning. At the end of each day a clearance between banks takes place through
the ACB system in respect of cheques deposited at all banks during the day. Subsequent to
the clearance, it sometimes happens that some of the cheques are dishonoured since the
drawer (cheque issuer/payer) had insufficient funds in his bank account. The entity’s bank will
return this cheque (that was previously deposited by the entity) to the entity marked “Refer to
Drawer (RD) – insufficient funds” and will debit the entity’s bank statement on this day.
382
32
The entity receives an electronic version of the bank statement for the previous day on a daily
basis. An appropriate employee of the entity will identify direct entries that are reflected on
the bank statement as debits and will for example recognise the following journal entries in
the entity’s records:
20.7
30 Apr
20.7
30 Apr
20.7
2 Apr
20.7
2 Apr
20.7
15 Apr
Bank charges (P/L)
VAT input (SFP)
Bank (SFP)
Recognise bank charges for April 20.7. (Refer to
bank statement 37)
B1 is the debit on the bank statement
Interest expense (P/L)
Bank (SFP)
Recognise interest charged by the bank on the
overdraft for April 20.7. (Refer to bank statement 37)
B1 is the debit on the bank statement
Insurance (P/L)
VAT input (SFP)
Bank (SFP)
Recognise debit order for insurance premium for
April 20.7. (Refer to bank statement 37)
B1 is the debit on the bank statement
Rent expense (P/L)
VAT input (SFP)
Bank (SFP)
Recognise debit order for rent amount for April
20.7. (Refer to bank statement 37)
B1 is the debit on the bank statement
Receivables (Receivable A nr D1) (SFP)
Bank (SFP)
Recognise cheque from receivable that was
deposited on 12 April 20.7, but returned by the
bank – refer to drawer. (Refer to bank statement
37)
B1 is the debit on the bank statement
383
Nr
U15
A25
A30
Nr
U30.1
A30
Dr
B1 – VAT
VAT
B1
Dr
Cr
B1
B1
Nr
U8
A25
A30
Dr
B1 – VAT
VAT
Nr
U12
A25
A30
Dr
B1 – VAT
VAT
Nr
A21.1
A30
Cr
Cr
B1
Cr
B1
Dr
Cr
B1
B1
Remark
1
33
The procedure that is followed to identify the direct debits on the bank statement is
discussed in paragraph 33.
From the preceding text it is clear that it is essential for a trading entity to receive the previous
day’s bank statement on a daily basis. The statement is downloaded by the entity by making
use of the bank’s electronic banking services. The statement is used to recognise direct
debits and credits that appear on the statement in the records of the entity. These direct
debits and credits on the bank statement are identified by ticking off the debits and credits
that appear in the bank account in the entity’s records against the corresponding amounts on
the bank statement (credits and debits). Any incorrect debits and credits are pointed out to
the bank.
The procedure of identifying the differences
34
The approach used in comparing the bank account in the general ledger of the entity’s
records with the bank statement, is as follows:
•
The first step is to tick amounts that appear on both documents. Amounts that
appropriately correspond are ticked off on the bank account and bank statement.
•
The bank account in the entity’s records for 30 April 20.7 (as example), as well as
unmarked amounts (amounts not ticked off) that appear on the bank account for
previous days, are compared to the bank statement for 30 April 20.7, which is received
on 1 May 20.7. The unmarked amounts on the bank account in the entity’s records will
comprise the following items:
-
Amounts received or paid by the entity that have not yet reflected on the bank
statement. These amounts would therefore be included in the bank account but
not on the bank statement.
-
Amounts that appear on both the statement and bank account in the entity’s
records, but recorded incorrectly by the entity. An unmarked credit amount(s) in
respect of cheques issued and delivered by the entity to beneficiaries, but the
cheques still have to be presented by the respective beneficiaries to the entity’s
bank for payment and will therefore only appear on a bank statement as a debit(s)
a few days later.
(This paragraph declares why a bank statement for a particular day is always compared
with the bank account for the day as well as unmarked amounts on the bank account
for previous days).
•
The unmarked amounts on the bank statement of 30 April 20.7 can comprise the
following items:
-
Amounts received or paid directly by the bank that have not yet been recognised
in the bank account in the entity’s records. These amounts would therefore be
included in the bank statement but not on the bank account in the ledger.
-
Amounts that appear on both the bank statement and bank account in the ledger,
but recorded incorrectly by the bank.
From the discussion above, it is important to note that unmarked items will be due to
omissions or errors, by either party. Omissions or errors by the bank are corrected on the
bank reconciliation statement. Omissions or errors by the entity are corrected on the updated
bank account in the general ledger.
384
35
The unmarked items on the bank statement are recognised in the records of the entity on the
date of the bank statement (30 April 20.7). After the items had been recognised, the balance
of the bank account on 30 April 20.7 will differ from the balance of the bank statement on
30 April 20.7. The difference is attributable to the unmarked items on the bank account in the
entity’s records.
36
Some entities make use of the bank’s electronic banking services platform to perform the
comparison of the bank account with the bank statements.
The bank reconciliation statement
The nature of the bank reconciliation statement
37
The concept reconciliation statement is used in Accounting to refer to the document that
reconciles/explains the difference between two related amounts (that should be the same) on
a determined date. Subsequently, the aspects involved in the drafting of a bank reconciliation
are dealt with. As at the last day of a particular month, a bank reconciliation reconciles the
balance on the bank account in the entity’s records to the balance on the bank statement.
Entities that make use of the bank’s electronic banking services platform to perform the
comparison between the bank account and the bank statements, usually draft the bank
reconciliation statement on a daily basis.
38
In this work, the bank reconciliation is dealt with against the background that the entity
receives an electronic version of the bank statement for the previous day on a daily basis.
This implies that all direct debits and all direct credits on the bank statements for a day, for
example from 1 April 20.7 to 30 April 20.7, have already been appropriately recognised in the
entity’s accounting records. The unmarked items on the bank account are included in the
bank reconciliation on 30 April 20.7.
39
A bank reconciliation takes on the format of the bank statement and starts with the balance of
the statement (e.g. 30 April 20.7). Refer to Example 10.1.
40
Incorrect direct debits and credits (if any) have already been pointed out to the bank and the
bank should already have made the necessary corrections. Incorrect debits and credits (if
any) on the bank account have already been corrected by the entity.
Internal control
41
A sound system of internal control is important to ensure that the business organisation is run
effectively and efficiently, that the assets are safeguarded, and that the financial statements
faithfully present the information which they purport to present. The internal control system is
integral to ongoing business operations and is as important for the continuation of the
business as market opportunities and cash flows. Internal control is a subdivision of the
subject field Auditing.
385
42
The following is a few of the internal control aspects in respect of receipts and payments:
•
All cash that an entity receives must be banked in total on a daily basis and all
payments must occur by means of cheques or per electronic bank transfers between
bank accounts.
•
As the cash is received, electronic totals must be maintained and appropriate
documentation must be created electronically at the point of receipt.
•
The deposit for a day must be made up by an employee that is not involved in the
receipt of cash. An appropriate employee must check that the deposit corresponds with
the electronic total that is maintained at the point of receipt. The make-up of the deposit
(coins, notes and cheques) must furthermore correspond with the sub-totals that are
maintained electronically.
•
During the relevant night, the deposit must be locked away in the safe of which the keys
are kept by two senior employees. The necessary precautions must be taken to ensure
the safe transport of the deposit to the bank.
•
All cheques must be signed by two senior employees. The same two employees must
authorise all EFT payments.
Cash equivalents
43
Cash equivalents consist of highly liquid call deposits. The amount is upon request (on call)
available for transfer to the cheque account. The interest income that is received on the daily
credit balances of the cheque account is relatively low. Consequently, the entity will transfer
excess cash in the bank account to a daily call deposit such as a money market account at
the bank. The interest rate on a money market account is up to two percentage points higher
than the interest rate applicable to credit balances on cheque accounts.
44
The transfer of funds to and from a money market account is recognised as follows:
20.7
5 Apr
20.7
17 Apr
Nr
Money market (SFP)
A31
Bank (SFP)
A30
Recognise electronic transfer of funds to the
money market account
(B1 is the amount of the EFT)
Dr
Nr
Bank (SFP)
A30
Money market (SFP)
A31
Recognise electronic transfer of funds from the
money market account to the cheque account
(C1 is the amount of the EFT)
Dr
386
Cr
B1
B1
Cr
C1
C1
20.7
30 Apr
Money market (SFP)
Interest income (P/L)
Recognise interest credited by the bank against
the money market account
(B1 is the amount of the interest credited)
Nr
A31
I4.5
Dr
Cr
B1
B1
Remark
1
45
The interest is calculated on the daily credit balance of the call account (money market
account) and is credited by the bank on the last day of the month.
The transfer of funds between the bank account and a daily call deposit such as a money
market account is known as cash management. As opposed to this, an investment in a term
deposit is rather an investment decision.
Example 10.1 – Bank reconciliation
AC Entity is a registered VAT vendor. Every morning of a weekday, AC Entity receives the previous
weekday’s cheque account statement by making use of the bank’s electronic banking services
platform. The cheque account statement is then compared with the bank account in AC Entity’s
records.
The following represents the bank account in AC Entity’s records and the cheque account
statements for December 20.7. (See the remark directly below.) The bank account has already
been appropriately checked against the cheque account statement for each day in order to:
•
tick off related items that appear on the bank account as well as on the cheque account
statement; and
•
identify direct debits and credits that appear on the cheque account statement and to
recognise these items in the entity’s records. These amounts are then also appropriately
ticked off on the bank account and the cheque account statement.
Remark
1
The number of transactions per day is intentionally limited and there are also not
transactions for each day. Consequently, the cheque account statement also contains
only a limited number of transactions per day and the amounts on the cheque account
statement are reflected on one cheque account statement for educational purposes. In
practice, the cheque account statement for a specific day can cover several pages.
AC Entity’s records
A30 Bank
Date
20.7
01/12
01/12
01/12
02/12
Contra account
Balance
Insurance & VAT
Rent expense & VAT
Various accounts
Card receipts
02/12 Various accounts
08/12 Telkom & communication & VAT
09/12 Payable K
J-nr
bd
DO921 3 120
DO470 3 121
BS10410 3 122
Dep308 3 123
EFT1061 3 124
EFT1062 3 125
387
Debit
Credit
3 240
60 000
43 000
75 000
8 450
85 202
Balance
1 911 203
1 907 963
1 847 963
1 890 963
Dr
Dr
Dr
Dr
1 965 963 Dr
1 957 513 Dr
1 872 311 Dr
AC Entity’s records
A30 Bank (continue)
Date
09/12
12/12
17/12
27/12
28/12
28/12
28/12
29/12
30/12
31/12
31/12
31/12
31/12
31/12
Contra account
Payable L
Fuel
Water and electricity & VAT
Fuel
Employee benefits
Various accounts
Card receipts
Various accounts
Bad debts & VAT
Payable O
Payable N
Bank charges & VAT
Interest income
Various accounts
Card receipts
Various accounts
J-nr
EFT1063
BS10222
EFT1064
BS10822
EFT1065
BS10910
3
3
3
3
3
3
126
127
128
129
130
131
Debit
Credit
Balance
208 785
720
40 826
704
150 680
1 663 526
1 662 806
1 621 980
1 621 276
1 470 596
1 522 596
Dr
Dr
Dr
Dr
Dr
Dr
2 030 838
2 046 438
1 994 238
1 789 958
1 779 958
1 785 708
1 835 708
Dr
Dr
Dr
Dr
Dr
Dr
Dr
52 000
Dep309
EFT455
Cheque78
EFT1066
BS491
BS491
BS11411
3 132
3 133
134
3 135
3 137
3 138
3 139
508 242
15 600
Dep310
140
354 250
52 200
204 280
10 000
5 750
50 000
2 189 958 Dr
AB BANK
Cheque account statement for AC Entity for December 20.7
Date
01/12
01/12
01/12
02/12
03/12
08/12
09/12
09/12
12/12
17/12
27/12
28/12
28/12
29/12
29/12
31/12
31/12
31/12
31/12
31/12
Transaction description
Balance
DO921 Debit Santam
DO922 Debit Rent
Card settlement
Deposit
Debit Telkom
Payable K
Payable L
Garage card Debit Stanfuel
Jozi Water and electricity
Garage card Debit Stanfuel
Salaries bank 284 879 111
Card settlement
Deposit
Direct deposit AB Executors
Payable N
Bank charges/Transaction costs
Interface fee
ACB Credit Interest
Card settlement
Debit
DO921
DO470
BS10410
Dep308
EFT1061
EFT1062
EFT1063
BS10222
EFT1064
BS10822
EFT1065
BS10910
Dep309
EFT455
EFT1066
HK
HK
HK
BS11411
388
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
Credit
3 240
60 000
43 000
75 000
8 450
85 202
208 785
720
40 826
704
150 680
52 000
508 242
15 600
204 280
8 250
1 750
5 750
50 000
Balance
1 911 203
1 907 963
1 847 963
1 890 963
1 965 963
1 957 513
1 872 311
1 663 526
1 662 806
1 621 980
1 621 276
1 470 596
1 522 596
2 030 838
2 046 438
1 842 158
1 833 908
1 832 158
1 837 908
1 887 908
Required:
a)
List the debits and credits on the bank account that were recognised from direct debits and
credits on the cheque account statement.
b)
Prepare the bank reconciliation as at 31 December 20.7.
Example 10.1 Solution
a) List of debits and credits that were recognised from direct debits and credits on the
cheque account statement
AC Entity
Date
20.7
01/12
01/12
12/12
27/12
29/12
31/12
31/12
Contra account
Insurance & VAT
Rent expense & VAT
Fuel
Fuel
Doubtful debts & VAT
Bank charges
Interest income
J-nr
DO921
DO470
BS10222
BS10822
EFT455
S491
S491
3
3
3
3
3
3
3
120
121
127
129
133
137
138
Debit
Credit
3 240
60 000
720
704
15 600
10 000
5 750
b) Bank reconciliation as at 31 December 20.7
Date
31/12
31/12
Transaction description
Debit
Balance – Cheque account statement
Credit
1 887 908
Items that must still appear on the bank statement
Deposit
Cheque
Balance – Bank account
Dep310
Cheque78
354 250
52 200
2 189 958
2 242 158
2 242 158
Example 10.2 Bank reconciliation – opening balance of the bank account and the cheque
account statement differs
AC Entity is a registered VAT vendor. Every morning of a weekday, AC Entity receives the previous
weekday’s cheque account statement by making use of the bank’s electronic banking services
platform.
The following represents the bank account in AC Entity’s records for January 20.8, the bank
reconciliation on 31 December 20.7 and the cheque account statements for January 20.8. (See the
remark directly below.) The bank account and the bank reconciliation on 31 December 20.7 have
already been appropriately checked against the cheque account statement for each day in order to:
•
tick off related items that appear on the bank account, the bank reconciliation of 31 December
20.7 as well as on the cheque account statement; and
•
identify direct debits and credits that appear on the cheque account statement and to
recognise these items in the entity’s records. These amounts are then also appropriately
ticked off on the bank account and the cheque account statement.
389
Remark
1
The number of transactions per day is intentionally limited and there are also not
transactions for each day. Consequently, the cheque account statement also contains
only a limited number of transactions per day and the amounts on the cheque account
statement are reflected on one cheque account statement for educational purposes. In
practice, the cheque account statement for a specific day can cover several pages.
AC Entity’s records
A30 Bank
Date
20.8
01/1
03/1
03/1
03/1
03/1
03/1
04/1
10/1
14/1
14/1
15/1
15/1
16/1
17/1
28/1
28/1
28/1
28/1
28/1
28/1
28/1
31/1
31/1
Contra account
Balance
Money market
Insurance & VAT
Rent expense & VAT
Various accounts
Card receipts
Various accounts
Fuel
J-nr
Debit
bd
EFT1068 3 147
DO1321 3 148
DO485
3 149
BS11785
Dep311
BS11823
Telkom & communication & VAT EFT1069
Payable K
EFT1070
Payable L
EFT1071
Various accounts
Card receipts
BS12281
Various accounts
Dep312
Fuel
BS12404
Water and electricity & VAT
EFT1072
Various accounts
Card receipts
BS12766
Various accounts
Dep313
Money market
EFT1073
Employee benefits
EFT1074
Loan from Supplier N
EFT1075
Payable K
EFT1076
Payable L
EFT1077
Various accounts
Card receipts
BS12965
Various accounts
Dep314
3
3
3
3
3
3
150
151
152
153
154
155
45 000
105 200
3
3
3
3
156
157
158
159
58 500
256 500
3
3
3
3
3
3
3
160
162
163
164
165
166
167
44 750
255 300
500 000
3 168
169
45 200
258 096
Credit
Balance
1 000 000
3 240
60 000
2 189 958
1 189 958
1 186 718
1 126 718
Dr
Dr
Dr
Dr
950
9 250
182 400
237 120
1 171 718
1 276 918
1 275 968
1 266 718
1 084 318
847 198
Dr
Dr
Dr
Dr
Dr
Dr
980
54 030
905 698
1 162 198
1 161 218
1 107 188
Dr
Dr
Dr
Dr
180 500
494 000
178 410
226 176
1 151 938
1 407 238
1 907 238
1 726 738
1 232 738
1 054 328
828 152
Dr
Dr
Dr
Dr
Dr
Dr
Dr
873 352 Dr
1 131 448 Dr
Bank reconciliation on 31 December 20.7
Date
Transaction description
Debit
31/12
Balance – Cheque account statement
Credit
1 887 908
Items that must still appear on the bank statement
Deposit
Cheque
Balance – Bank account
Dep310
78
390
3
3
354 250
52 200
2 189 958
2 242 158
2 242 158
Remarks
1
The bank reconciliation of 31 December 20.7 explains the difference in the balances of
the bank account and the cheque account statement of 1 January 20.8.
2
The two items are ticked off against the related amounts on the relevant cheque
account statements for January 20.8
AB BANK
Cheque account statement for AC Entity
Date
Transaction description
01/1
01/1
03/1
03/1
04/1
03/1
04/1
04/1
04/1
10/1
14/1
14/1
15/1
16/1
16/1
17/1
28/1
28/1
28/1
28/1
28/1
28/1
28/1
31/1
31/1
31/1
31/1
31/1
31/1
Balance
Deposit
Money market
DO921 Debit Santam
DO922 Debit Rent
Card settlement
Deposit
Payable O
Garage card Debit Stanfuel
Debit Telkom
Payable K
Payable L
Card settlement
Deposit
Garage card Debit Stanfuel
Jozi Water and electricity
Card settlement
Deposit
Money market
Salaries bank 284 879 111
Payable N
Payable K
Payable L
Bank charges/Transaction costs
Interface fee
ACB Credit Interest
RD Receivable D
Direct credit Receivable B
Card settlement
Debit
3
Dep310
EFT1068 3
3
DO1321
3
DO485
BS11785 3
3
Dep311
Cheque78 3
BS11823 3
EFT1069 3
EFT1070 3
EFT1071 3
BS12281 3
3
Dep312
BS12404 3
EFT1072 3
BS12706 3
3
Dep314
EFT1073 3
EFT1074 3
EFT1075 3
EFT1076 3
EFT1077 3
HK
HK
HK
HK
EFT409
BS12965 3
Credit
354 250
1 000 000
3 240
60 000
45 000
105 200
52 200
950
9 250
182 400
237 120
58 500
256 500
980
54 030
44 750
255 300
500 000
180 500
494 000
178 410
226 176
8 750
1 750
2 650
31 350
21 168
45 200
Balance
1 887 908
2 242 158
1 242 158
1 238 918
1 178 918
1 223 918
1 329 118
1 276 918
1 275 968
1 266 718
1 084 318
847 198
905 698
1 162 198
1 161 218
1 107 188
1 151 938
1 407 238
1 907 238
1 726 738
1 232 738
1 054 328
828 152
819 402
817 652
820 302
788 952
810 120
855 320
Remark
1
Each cheque account statement is compared with the bank account as well as the bank
reconciliation of 31 December 20.7. As soon as all the items on the bank reconciliation
of 31 December 20.7 have been ticked off, the comparison occurs only with the bank
account.
391
Required:
a)
Open the bank account in the records of AC Entity with the balance as at 31 January 20.8
and appropriately recognise the unmarked items on the cheque account statement of
31 January 20.8 directly in the bank account.
b)
On 15 January 20.8 the bank account was debited with R256 500 resulting from the receipt of
notes, coins and cheque payments from cash sales (R51 300) as well as from payments from
receivables. Provide the journal entry for this transaction.
c)
Prepare a bank reconciliation as at 31 January 20.8.
Example 10.2 Solution
a)
AC Entity’s records
A30 Bank
Date
Contra accounts
J-nr
Debit
Credit
Balance
20.8
31/1
31/1
31/1
31/1
31/1
Balance
Bank charges & VAT
Interest income
Receivable
Receivable D
S448
S448
EFT511
S448
3
3
3
3
bd
170
171
172
173
10 500
2 650
21 168
31 350
1 131 448
1 120 948
1 123 598
1 144 766
1 113 416
Dr
Dr
Dr
Dr
Dr
b) Journal entry
20.8
15 Jan
Bank (SFP)
Sales (P/L) (51 300 x 100/115)
VAT output (51 300 x 15/115) (SFP)
Receivables (SFP)
Recognise receipt (notes, coins and cheques) for
15 Jan 20.8 as per EFTPOS totals for the day
Nr
A30
I1
L14
A21.1
Dr
256 500
Cr
44 609
6 691
205 200
c) Bank reconciliation on 31 January 20.8
Date
Transaction description
Debit
31/12
Balance – Cheque account statement
Credit
855 320
Items that must still appear on the bank statement
Deposit
Balance – Bank account
Dep314
258 096
1 113 416
1 113 416
392
1 113 416
Example 10.3 Bank transactions – journal entries
The following transactions, amongst others, relate to AC Entity, a registered VAT vendor.
The electronic version of the relevant bank statement for February 20.7 reflects the following
debits, amongst others:
Date
20.7
01/2
01/2
03/2
13/2
28/2
28/2
Transaction description
Debit
DO123 Atterbury – Rent
DO992 Santam – Insurance
BS 1111 Stanfuel R1197
VT Receivable D
HK Bank charges/Transaction costs
HK Interface fee
68 400
3 648
1 197
30 210
2 109
969
The electronic version of the relevant bank statement for February 20.7 reflects the following
credits, amongst others:
Date
20.7
04/2
16/2
Transaction description
Credit
EFT479 Receivable G
EFT 678 Liquidator XX (iro Receivable Z)
9 690
6 270
The EFTPOS terminals reflect the following totals in respect of receipts on 27 February 20.7:
Card receipts
Transaction
Receipts from sales
Means of payment
Cards
Amount
14 478
Receipts from receivables
Cards
28 728
43 206
Cash and cheque receipts
Transaction
Receipts from sales
Means of payment
Notes & coins
10 830
Receipts from receivables
10 830
Amount
Cheques
10 830
15 960
15 960
15 960
26 790
Required:
Recognise the abovementioned transactions in the records (general journal) of AC Entity.
Note: Journal narrations are required.
393
Example 10.3 Solution
J1
20.7
1 Feb
J2
20.7
1 Feb
J3
20.7
3 Feb
J4
20.7
13 Feb
J5
20.7
28 Feb
Rent expense (P/L) (68 400 x 100/115)
VAT input (SFP) (68 400 x 15/115)
Bank (SFP)
Recognise debit order for rent amount for Feb 20.7.
(Refer to cheque account statement NN)
Insurance (P/L) (3 648 x 100/115)
VAT input (SFP) (3 648 x 15/115)
Bank (SFP)
Recognise debit order for insurance premium for
Feb 20.7. (Refer to cheque account statement NN)
Fuel (P/L)
Bank (SFP)
Recognise fuel purchases – Garage card 3 Feb
20.7. (Refer to cheque account statement NN)
Receivable D (SFP)
Bank (SFP)
Cheque previously deposited is dishonoured by the
bank. (Refer to cheque account statement NN)
Bank charges (P/L) (3 078 x 100/115)
VAT input (SFP) (3 078 x 15/115)
Bank (SFP) (2 109 + 969)
Recognise bank charges for Feb 20.7. (Refer to
cheque account statement NN)
394
Nr
U12
A25
A30
Dr
59 478
8 922
Nr
U8
A25
A30
Dr
3 172
476
Nr
U9
A30
Dr
1 197
Nr
D104
A30
Dr
30 210
Nr
U15
A25
A30
Dr
2 677
401
Cr
68 400
Cr
3 648
Cr
1 197
Cr
30 210
Cr
3 078
J6
20.7
4 Feb
J7
20.7
16 Feb
J8
20.7
27 Feb
J9
20.7
27 Feb
Bank (SFP)
Receivable G (SFP)
Recognise direct deposit by Receivable G. (Refer to
cheque account statement NN)
Bank (SFP)
VAT input (SFP) (6 270 x 15/115)
Bad debts (P/L) (6 270 x 100/115)
Recognise direct EFT deposit in respect of an
amount previously written off as irrecoverable. (Refer
to cheque account statement NN)
Bank (SFP)
Sales (P/L) (14 478 x 100/115)
VAT output (SFP) (14 478 x 15/115)
Receivables (SFP)
Recognise card receipts for the day as per EFTPOS
totals
Bank (SFP)
Sales (P/L) (10 830 x 100/115)
VAT output (SFP) (10 830 x 15/115)
Receivables (SFP)
Recognise receipts (notes, coins and cheques) for
27 Feb 20.7 as per EFTPOS totals for the day. Also
refer to the deposit slip of 27 Feb 20.7
395
Nr
A30
D107
Dr
9 690
Nr
A30
A25
U11
Dr
6 270
Nr
A30
I1
L14
A21.1
Dr
43 206
Nr
A30
I1
L14
A21.1
Dr
26 790
Cr
9 690
Cr
818
5 452
Cr
12 590
1 888
28 728
Cr
9 417
1 413
15 960
Chapter 11 Computerised accounting systems
Contents
Introduction
Background
Organisational structure of the financial division
Functionalities of a computerised accounting system
Requisition template (Module A)
Order template (Module A)
Purchase of goods and services template (Module A)
Request for payment template (Module D)
EFT payment instruction template – payables (Module D)
Corrections to payables template (Module B)
Issue of GRN template (Module S)
Inventories sub record template (Module S)
Inventory quantities
Unit prices
Transfer of inventories to the sales room
EFTPOS receipts and sales template (Module C and Module D)
Corrections to receivables template (Module C)
HR sub record template (Module P)
Monthly payroll template (Module Q)
EFT payment instruction template – salaries (Module D)
Direct bank statement items template (Module D)
Bank reconciliation items template (Module D)
Money market transfer template (Module D)
EFT payment instruction template – investments (Module D)
PPE sub record template (Module R)
Miscellaneous
Loans
Insurance
Budgets
Journal template (Module F)
Closing journal template (Module F)
General ledger
Closing remark
397
Paragraph
1
4
10
13
16
19
21
28
30
33
36
40
41
42
43
44
46
49
51
51
55
57
59
60
63
66
67
69
70
71
76
78
79
Chapter 11 Computerised accounting systems
Introduction
1
In this chapter computerised accounting systems are dealt with on an introductory basis.
2
The development of computerised accounting systems occurred broadly as follows:
Automated bookkeeping machines, which were initially used to maintain individual receivable
records, individual payable records as well as inventory records, were available from 1920.
By 1940 bookkeeping machines that were able to perform posting to the general ledger were
available and by 1960 certain bookkeeping machines contained hard drive memory. During
1970 the first desktop was developed and since 1980, the use of desk tops is customary.
3
The desktop lead to available computerised accounting systems (accounting software) that
were used for the accumulation of transactions and events in the records/accounts of an
entity, to become more sophisticated and user friendly. Examples of this accounting software
are SAP, Oracle and Pastel. When developing and updating these computer systems,
changes that take place in the economic environment and in IFRS statements are accounted
for. Obviously, the recognition of transactions/events still occurs in accordance with the
double entry bookkeeping system. Computerised accounting systems usually comprise
various integrated modules. The users obtain access to the system and are not necessarily
aware of the different modules. Refer to the schematic representation below of a modern
computerised accounting system.
Business intelligence solutions/
Analitical solutions
DBI Daily business intelligence
EPB Enterprise planning and budgeting
Financial modules
A
B
C
D
Purchases
Payables
Receivables
Cash and cash
equivalents
E Investments and
loans
F Adjustments and
closing off
General
ledger
Reporting
Financial statements
Other
398
P Human resources
(HR)
Q Payroll
R Property, plant and
equipment
S Inventories
Background
4
The abovementioned representation of a modern computerised accounting system in
conjunction with the schematic structure of the financial function of a trading entity (refer to
paragraph 10) represents the background for the discussion in the rest of the chapter.
5
The accounting software is centrally uploaded onto a server and is accessible through the
keyboards of desk tops that are distributed throughout the entity.
6
Access to the functionalities of the software is mainly limited to the staff members of the
financial division. To obtain access to the functionalities of the software, staff members must
first register on the accounting system in order to obtain a unique username and an 8
character alphanumeric password. The system administrator assigns access rights to each
user name. After a user signed in, access rights assigned to that username appears on the
screen of the user’s desktop in the form of a list of options. For example, the staff members of
the order division have access to only one functionality namely “Complete an order”, whilst a
payables clerk’s list of options could be as follows: “Purchase of goods and services”,
“Request for payment” and “Corrections to payables”. Only the head accountants, CFO and
the financial director will be given access right to all the templates. Some of the financial
division’s staff members will have no access rights, whilst other staff members will have
access to only one or two templates.
7
Transactions and events are recorded per transaction/event from the source document(s) by
completing a template on the computer screen. Each template usually displays all the
essential characteristics of the relevant journal entry.
8
An important benefit of a modern computerised accounting system is that immediately after
authorisation, the system posts the transactions/events that were captured on the respective
templates, to the general ledger accounts.
9
As already known, in this work all transactions and events are recognised by means of
journal entries, where after the rest of the accounting process follows. Journalising with
insight is the basis for effective education. Such an approach also provides an internalised
knowledge to time and again reduce the completed computer screen templates to the journal
entry that were recognised through the completion of the relevant template, when using
accounting software.
399
Organisational structure of the financial division
10
The following presentation represents a typical organisational structure of the financial
division of a trading entity.
Financial director
(CA(SA))
CFO (CA(SA))
Head accountant
Head accountant
Central finance
Bank
Investments
Loans
PPE
Insurance
Budgets
Ledger
Journals
Internal audit
Head
Head
Head
Head
Head
Order
division
Store
division
Payables
division
Sales
division
Payroll
division
11
The head of a division is usually an expert on the specific area. The staff members
associated with the divisions are usually referred to as order clerks, warehouse clerks,
payables clerks, receivables clerks and payroll clerks.
12
Central finance is responsible for a number of key areas with regards to the operation of the
financial division. The staff members are all recognised accountants. The different areas can
be grouped together and managed as such by one or two staff members, e.g. bank,
investments and loans can be allocated to two staff members, the PPE sub records and
insurance can be allocated to one staff member, budgets can be allocated to one staff
member and the ledger as well as the journals, including the closing journals, can be
allocated to a particularly knowledgeable staff member.
400
Functionalities of a computerised accounting system
13
Computerised accounting systems usually comprise various integrated modules. (Refer to
the schematic presentation in paragraph 3.) Each of the modules has specific functionalities
that are made available to the users on an integrated basis. The users obtain access to the
system and are not necessarily aware of the different modules.
14
The functionalities are made available to the users in the form of templates that are
completed on the computer screen through the use of the keyboard. The templates
sometimes provide help to users by giving appropriate options.
15
Subsequently a number of templates are discussed against the background of the
organisational structure of a financial division. In this section of the chapter it is important to
take note of the following:
•
The flow and merger of documentation;
•
No employee can totally complete the recognition of a transaction/event. Usually there
is at least two or more people involved in the completion of a transaction/event; and
•
All EFT payments are authorised by two senior employees.
Requisition template (Module A)
16
Users of the template: specific staff members, as nominated by the head of the respective
divisions, who may place requisitions for the purchase of goods (e.g. sales division), services
and non-current assets.
17
The template is used to place a request with the order division to order specific goods. The
template is also used to request the warehouse (store) to issue certain inventory items to the
sales room.
18
The template is completed with reference to the instruction received from, for example, the
head of the sales division. After the head of the sales division authorised the requisition, the
requisition is sent electronically to the head of the order division or to the head of the store
division.
Order template (Module A)
19
Users: only the staff members of the order division.
20
The function of the order division is to place orders based on an appropriately authorised
requisition. The order division operates within the framework of comprehensive control
procedures which inter alia includes that orders may only be placed with a supplier that
appears on the authorised list of suppliers.
Purchase of goods and services template (Module A)
21
Users: only the staff members of the payables division.
401
22
23
24
25
26
The activities of the payables division are usually divided as follows between the payables
clerks:
•
One clerk is responsible for the general administration of the entity’s payables, which
are functions (i) and (v) below.
•
The other clerks are each responsible for specific payables of the entity that are divided
between the clerks on an alphabetical basis, for example. These clerks each perform in
respect of the payables allocated to them, functions (ii), (iii) and (iv) below.
The functions of the payables division comprise inter alia the following:
i)
Attach to each invoice received from suppliers, copies of the following relevant
documents: an order, a goods received note (“GRN”) as well as a delivery note from the
supplier. Subsequently confirm the accuracy of the detail on the invoice (e.g. quantity,
type of product and price per unit).
ii)
Perform a reconciliation between the statement from the payable (which is received
electronically) and the payable’s account in the entity’s records in respect of all the
payables that are allocated to a specific clerk. The reconciliation is reviewed by the
head of the payables division.
iii)
Recognise transactions on the “Purchase of goods and services” template or the
“Corrections to payables” template.
iv)
Identify invoices that are payable. This is a recurring action that is performed by all the
payables clerks. As soon as an invoice is payable, the payables clerks complete a
“Request for payment” template. (Refer to paragraph 28.)
v)
Subsequent to the authorisation of the “Request for payment” template, a payment
advice is sent to the relevant payable and the invoice and accompanying documents
are clearly marked as “paid”. Thereafter a copy of the invoice is sent to the inventories
clerk of the store.
The payables clerk completes the “Purchase of goods and services” template with reference
to the invoice and all the relevant documents that are attached to the invoice. The template is
completed by capturing inter alia the following:
•
Name of the payable;
•
Invoice number and amount; and
•
Whether VAT is applicable or not.
The authorisation of the “Purchase of goods and services” template by the head of the
payables division results in the purchase of for example trade inventories to be immediately
recorded in the general ledger by:
•
debiting the inventories account (perpetual inventory system) or purchases account
(periodic inventory system) with the amount excluding VAT (if applicable); and
•
debiting VAT input (if applicable) with the VAT amount; and
•
crediting the payable’s account with the amount including VAT (if applicable).
Note that the payables’ individual accounts are part of the general ledger.
402
27
The “Purchase of goods and services” template is, as the name indicates, also used to
recognise the purchase of services (e.g. cleaning services) and non-current assets (e.g.
vehicles). In the case of the purchase of non-current assets, copies of the invoice and other
relevant documents are forwarded to the clerk that is responsible for the PPE sub records.
(Refer to paragraph 63.)
Request for payment template (Module D)
28
Users: only the payables clerks in the payables division.
29
This template is completed by each payables clerk in respect of the payables for which they
are responsible with regards to invoices that are payable. The template is completed by
capturing inter alia the following:
•
Detail of the payable;
•
Date on which payment must take place; and
•
The amounts and numbers of the invoices that must be paid. (The template itself
provides a total.)
The authorisation of this template by the head of the payables division results in the request
for payment being automatically loaded onto an “EFT payment instruction”. (Refer to
paragraph 30.)
EFT payment instruction template – payables (Module D)
30
Users: only the two head accountants, CFO and the financial director.
31
This template is created by the system after authorisation of the “Request for payment”
template. (The payment instruction therefore contains payments to more than one payable).
The template must be authorised by any two of the users mentioned above.
32
The authorisation of the “EFT payment instruction” template results in the:
•
bank debiting the entity’s bank statement and transferring the funds to the bank of the
payable to be credited against the payable’s bank statement; and
•
amounts being immediately credited against the bank account (in the entity’s records)
and debited against the individual payables’ accounts.
Corrections to payables template (Module B)
33
Users: only the payables clerks to whom individual payables are allocated.
34
This template is completed by the payables clerks and is authorised by the head of the
payables division. The template is used, for example, to rectify errors made by the payables
clerks during capturing. The authorisation of the template results in the amounts being
immediately (‘in time”) posted electronically to the ledger.
35
For example, a “Corrections to payables” template contains the detail that the amount of an
invoice, which has previously been captured as R890, should be R980. The authorisation of
the template by the head of the payables division results in the correction being immediately
recorded in the ledger by:
•
debiting the inventories account (perpetual inventory system) or the purchases account
(periodic inventory system) with R78.26 (if VAT is applicable); and
403
•
debiting VAT input (if applicable) with R11.74; and
•
crediting the payable’s account with R90.
Issue of GRN template (Module S)
36
Users: only the store reception clerks in the store division.
37
The function of the store division is to:
•
Take delivery of goods;
•
Maintain inventory records;
•
Provide goods with sales price tags in consultation with the sales division;
•
Issue goods to the sales room;
•
Regularly count the inventories in the store and compare it to the inventory records; and
•
Forward detail of shortages, as authorised by the head of the store division, to the staff
member responsible for the general ledger and general journals in order to be
journalised.
38
The template is completed by the store reception clerk in the store division by capturing the
detail and quantities of the goods received.
39
Subsequent to authorisation by the head of the store division, the GRN is sent electronically
to the inventories clerk of the store division (who is responsible for the input to the inventory
system). The system allocates consecutive numbers to the GRN’s.
Inventories sub record template (Module S)
40
User: only the inventories clerk who is responsible for the input of inventory quantities and
unit prices.
Inventory quantities
41
The inventories clerk captures the detail and quantities of the goods received onto the
“Inventories sub record” template with reference to the GRN. Subsequent to authorisation by
the head of the store division, inventory quantities are recorded in the inventory records (sub
records).
Unit prices
42
There is usually a time lapse between the input of inventory quantities and unit prices. The
inventories clerk calls up the “Inventories sub record” template on which detail and quantities
of the goods received were previously captured. Subsequently, the unit price is captured from
the copy of the supplier’s invoice. After authorisation by the head of the store division, unit
prices are recorded in the inventory records (sub records). The inventories clerk receives the
copy of the invoice from the payables clerk only after the payment thereof. (Refer to
paragraph 23(v).)
404
Transfer of inventories to the sales room
43
With reference to the requisition received from the sales division (refer to paragraph 18), the
detail and quantities of the goods that have to be transferred to the sales room are captured
onto the “Inventories sub record” template. Subsequent to authorisation by the head of the
store division:
•
a transfer note is sent to the head of the sales division; and
•
the inventories are transferred to the sales room where the head of the sales room
signs for receipt of the goods.
EFTPOS receipts and sales template (Module C and Module D)
44
Users: senior staff members of the sales division.
45
The functions of the staff members in the sales division entails inter alia:
i)
Credit management. (With reference to credit legislation and the entity’s credit policy,
each customer is allocated a credit facility, which is loaded onto the customer’s profile.);
ii)
Customer service. (Assistance to customers in the sales room and taking care of the
sales room.);
iii)
Sending statements (mainly electronically), collecting outstanding debt and identifying
bad debts;
iv)
Issuing requisitions to the order division and the store division; and
v)
Utilising EFTPOS terminals (“Electronic Funds Transfer Point-Of-Sale terminals”) and
making up daily cash deposits.
Remarks in respect of the utilisation of EFTPOS terminals
1
The entity sells trade inventories for cash and on credit by means of the EFTPOS
terminals. The daily receipts in respect of cash sales comprise cash as well as debit
and credit card payments (cheques are not accepted). Receipts in respect of payments
by receivables also comprise cash as well as debit and credit card payments. Credit
sales also take place on the EFTPOS terminals.
2
The “EFTPOS receipts and sales” template is prepared by the system directly after
business hours, based on information that are captured by the cashiers onto the
EFTPOS terminals during the course of the day when servicing the customers. (Refer
to Chapter 10 paragraph 18.) The service delivered by the cashiers entail the scanning
of goods sold, packing of the goods into packets, receiving payment from the customer
(if it is a cash sale) and handing over of the goods and a slip (the invoice) to the
customer.
3
For security purposes, the cash drawer of the EFTPOS terminals is emptied at least
three times during the course of the day. This provides the opportunity to start with the
make-up of the daily cash deposit during the course of the day.
405
4
After the “EFTPOS receipts and sales” template is completed, it contains the following
totals (refer to Chapter 10 paragraph 19):
14 February 20.7
Cash receipts
Bank1 (cash received)
Sales1
VAT output1
Receivables2 (cash payments)
Debit/credit card receipts
Bank1 (debit- or credit card payments received)
Sales1
VAT output1
Receivables2 (debit- or credit card payments)
Credit sales to customers
Receivables2 (sales to receivables on credit)
Sales1
VAT output1
R
R
43 377
12 500
1 875
29 002
75 658
20 000
3 000
52 658
55 200
48 000
7 200
5
The cash deposit (of R43 377) is made up at the end of the day and is deposited into
the bank’s deposit machine, which is situated in the entity’s safe. Hereafter, the cash
deposit is immediately reflected as a credit on the entity’s bank statement. Every
morning the cash in the deposit machine is taken out by an employee of the bank
where after it is taken to the bank. Later in the evening, the R75 658 appears as a
credit on the entity’s bank statement.
6
The amounts in the abovementioned template are posted immediately to the ledger as
follows:
•
Accounts above indicated with a “1”: The individual amounts that make up the
relevant totals are, during the course of the day, immediately summarised per
account so that at the end of the day, after closing off the EFTPOS system, it can
be posted in total to the relevant accounts.
•
Accounts above indicated with a “2”: The individual amounts that make up the
relevant totals are, during the course of the day, posted immediately to the
relevant receivable’s account. (Note: the individual receivable accounts are part
of general ledger.)
Corrections to receivables template (Module C)
46
Users: the receivables clerks to whom individual receivables are allocated.
47
This template is completed by the receivables clerks and is authorised by the head of the
sales division. The template is used, for example, to write off bad debts or to make
corrections to receivables in respect of the utilisation of discount. The authorisation of the
template results in amounts being immediately posted electronically to the ledger.
406
48
For example, a “Corrections to receivables” template contains the detail that an amount of an
invoice which has previously been captured as R1 425, after a 5% settlement discount,
should be R1 500 since the receivable did not make use of the settlement discount as was
expected. The authorisation of the template by the head of the sales division results in the
correction being recorded immediately in the ledger by:
•
debiting the receivable’s account with R75; and
•
crediting the sales account with R65.22 (if VAT is applicable); and
•
crediting the VAT output account with R9.78 (if VAT is applicable).
HR sub record template (Module P)
49
50
The “HR sub record” template is used by the staff members of the human resources division
to capture the following onto each employee’s sub record:
•
Biographical information;
•
Remuneration benefits;
•
Leave and sick leave taken; and
•
Promotions, resignations or retirements.
Other functions of the human resources division includes inter alia the following:
•
Staff development by arranging the necessary courses for staff; and
•
Career planning for staff members.
Monthly payroll template (Module Q)
EFT payment instruction template – salaries (Module D)
51
On pay day, the monthly payroll is prepared electronically based on the information of the
staff members contained in the human resources system. The system also prepares an EFT
payment instruction for the payment of the net remuneration to each employee.
52
The head of the payroll division (an expert) is responsible for reviewing the payroll to ensure
its completeness and accuracy.
53
The authorisation of the two templates by the financial director and the accountant results in:
•
A transfer (for the net remuneration) from the entity’s bank to the respective banks of
the employees.
•
The totals of the payroll being posted as follows to the relevant general ledger
accounts:
Dr
Employee benefits
126 725
Cr
Bank
58 115
Cr
Medical aid fund
14 700
Cr
Pension fund
15 450
Cr
SARS – PAYE
38 460
(Amounts are taken from Example 5.7)
407
•
54
The individual payments being recorded in the employee records (sub records).
The staff members responsible for the payment of the payroll creditors complete an “EFT
payment instruction” template before the seventh of the following month. The authorisation of
this template by the two accountants, results in the payroll creditors’ accounts being debited
and the bank account being credited with the total.
Direct bank statement items template (Module D)
55
The staff member in the central finance division who is responsible for the entity’s bank
account(s) and therefore responsible for identifying direct debits and credits on the bank
statement, completes the “Direct bank statement items” template. Examples of direct debits
on the entity’s bank statement are bank charges, interest expense on an overdraft bank
balance and debit orders. Examples of direct credits on the entity’s bank statement are loan
funds transferred to the entity’s bank account, interest income on a favourable bank balance,
bad debts recovered and direct deposits by receivables.
56
This template is completed by the relevant staff member from the information identified on the
bank statement. After authorisation by the accountant the amounts are immediately posted to
the relevant general ledger accounts. For example:
R
8 922
1 338
Bank charges
VAT input
Bank
R
10 260
Bank
Bad debts
VAT output
19 380
Bank
Receivable B
20 520
16 852
2 528
20 520
Bank
Bank loan
800 000
800 000
Bank
Interest income on favourable bank balance
153
153
Bank reconciliation items template (Module D)
57
Subsequent to completion of this template, the template delivers the bank reconciliation items
which are used to prepare the bank reconciliation statement. Bank reconciliation items are:
•
those items that appear in the bank account in the entity’s records for a specific period
but which do not as yet appear on the bank statement for the same period; or
•
errors on the bank statements for the specific period which still have to be corrected on
the bank statement.
408
58
This template is completed by the staff member in the central finance division who takes care
of the bank by merely capturing the relevant period in respect of which the bank reconciliation
items must be identified. The bank reconciliation items for the period are automatically
identified. (Refer to Chapter 10.)
Money market transfer template (Module D)
59
The “Money market transfer” template is used to transfer amounts to and from the money
market account based on a request by the accountant. The template is completed by
capturing inter alia the following onto the template: the amount as well as whether the
transfer is to or from the money market account. After authorisation by the head accountant:
•
the transfer is immediately reflected on the bank statement as well as on the money
market statement in the records of the bank; and
•
the system debits the transfer in the entity’s records against the money market account
and credits the bank account (in respect of a transfer to the money market account).
EFT payment instruction template – investments (Module D)
60
Investment decisions are made by the financial director in consultation with the CFO. If a
specific investment in shares is purchased, the financial director gives an instruction to a
stockbroker. As soon as the stockbroker purchased the shares, the financial director receives
a broker’s note which indicates the cost of the shares, where after the financial director gives
and instruction that an EFT payment must be made to the broker.
61
Subsequent to authorisation by the accountant or the financial director the EFT payment
instruction is executed, which results in:
62
•
a transfer from the entity’s bank to the stock broker’s bank; and
•
the investment account in the entity’s ledger being immediately debited with the amount
of the investment and the bank account being immediately credited with the same
amount.
The number of investments of a trading entity (the predominant focus in this work) is limited
and consequently a trading entity will not purchase Module E. Other transactions/events that
involve investments (dividends, fair value adjustment of the investment and the sale of
investments) will be recognised by means of the functionalities of Module D and Module F.
(Investments are comprehensively dealt with in Chapter 17.)
PPE sub record template (Module R)
63
64
The staff member who is responsible for the control of the entity’s PPE items must inter alia:
•
attach a tag with a unique number on it to each asset item;
•
arrange for a yearly physical inspection of the asset items; and
•
in respect of each asset item purchased, complete the “PPE sub record” template.
The following detail is captured on this template: group to which the item belongs (five
options: land, buildings, equipment, furniture and computer equipment), description of the
PPE item, location, cost price, useful life and depreciation method.
409
Remarks regarding the sub record in respect of property, plant and equipment:
1
Module R provides the functionality to maintain records of the individual PPE items.
These records are known as sub records and are not part of the ledger. The sub record
of an asset item may contain inter alia the following information:
Group:
Computer equipment
Description and location:
Depreciation method:
Date
Cost price
Dell Latitude E5530 lap top, Office 677
Straight-line with a useful life of 5 years
Accumulated
Depreciation Accumulated
depreciation
depreciation
for the
end of the
beginning of the
month
month
month
40 000
1 667
41 667
1 Jan 20.7
31 Jan 20.7
2
100 000
At month end, the PPE sub records provides in respect of each asset group:
•
the total of the cost prices of the asset items in the group;
•
the total of the depreciation expense for the month of the asset items in the
group; and
•
the total of the accumulated depreciation of the asset items in the group.
As at the end of the month, these totals are (with reference to the computer equipment)
respectively equal to the balances of the following accounts in the general ledger:
65
•
Computer equipment;
•
Depreciation – computer equipment; and
•
Accumulated depreciation – computer equipment.
Module R calculates the depreciation per month for each item in accordance with the
depreciation method applicable to the item. The monthly depreciation per PPE group is
recognised by the staff member who is responsible for journals by appropriately completing a
“Journal” template based on the detail provided by the staff member who is responsible for
the PPE sub records. (Refer to paragraph 71.)
Miscellaneous
66
Central finance comprise of a number of experts who each report directly to the relevant
accountant. These staff members take care of a number of key areas, which can be grouped
together as follows:
•
Bank, investments and loans;
•
PPE sub records and insurance;
•
Budgets; and
•
Ledger, journals and closing journals.
410
Loans
67
Finance decisions are taken by the financial director in consultation with the CFO.
68
Loans received are recognised with the completion of the “Direct bank statement items”
template. (Refer to paragraph 55.) Due to the limited number of loans, a trading entity (the
predominant focus in this work) will not purchase Module E. Other transactions/events that
involve loans (interest accrued and payments of loans) will be recognised by means of the
functionalities of Module D and Module F. (Refer to paragraph 75.) (Loans are
comprehensively dealt with in Chapter 15.)
Insurance
69
The annual renewal of the insurance policy is managed by a knowledgeable staff member in
consultation with the two accountants and the insurance broker.
Budgets
70
Budgets are prepared by an expert in consultation with the financial director, the accountants
and divisional heads. Budget control is exercised by means of the accounting system.
Journal template (Module F)
71
Journals (in the format of a general journal) are completed on the “Journal” template by the
staff member that is responsible for the ledger and journals.
72
Examples in respect of which journals are necessary:
•
errors in general ledger accounts as pointed out by the heads of divisions and the two
accountants; or
•
errors identified by the staff member who is responsible for the ledger; or
•
journal requests by heads of divisions, e.g. write-off of inventory shortages, write-down
of inventories to net realisable value, adjustment of the allowance for doubtful debts,
recognition of interest expense on a loan, recognition of interest income on a money
market investment and recognition of the depreciation expense per asset group.
73
Subsequent to authorisation by both accountants, the journals are posted immediately
against the relevant accounts in the ledger.
74
When interest accrues on a money market investment, the staff member who is responsible
for the money market account directs a journal request to the staff member who is
responsible for journals to recognise interest income. The staff member who is responsible
for journals completes a “Journal” template. The authorisation of the relevant “Journal”
template by the accountant results in the journal being immediately posted to the ledger by:
debiting the money market account with the amount of the interest income and crediting the
interest income account with the same amount.
75
When interest accrues on a loan, the staff member who is responsible for the loan account
directs a journal request to the staff member who is responsible for journals to recognise
interest expense. The staff member who is responsible for journals completes a “Journal”
template. The authorisation of the relevant “Journal” template by the accountant results in the
journal being immediately posted to the ledger by: debiting the interest expense account with
the amount of the interest expense and crediting the loan account with the same amount.
411
Closing journal template (Module F)
76
As at the reporting date, the closing journal closes off sales and cost of sales against gross
profit and thereafter all other expense accounts and all other income accounts against
retained earnings.
77
The closing journal is authorised by the financial director and an accountant as at the
reporting date. (Refer to Chapter 7.)
General ledger
78
The staff member (an especially knowledgeable person) who is responsible for the ledger
continually reviews the completeness and accuracy of the ledger.
Remarks in respect of the ledger
1
The general ledger contains all the accounts of the entity including the individual
accounts of the receivables and payables. The ledger for a specific month contains in
respect of the previous month only the opening balance as at the beginning of the
current month. The format of the ledger is the column format and contains for example
a date column, one detail column, a reference column, a column for debits, a column
for credits and a balance column. The balance is indicated after each transaction/event
as an amount with a “dr” or a “cr” behind the amount.
2
Transactions/events are posted immediately to the ledger after the relevant template is
authorised.
3
Full access rights to the ledger are limited to the staff member who is responsible for
the ledger and general journals, the two head accountants, CFO and the financial
director.
4
The ledger has sophisticated data extraction functionalities. This relevant template is
allocated to the head accountants. The information as extracted is inter alia used in the
provision of daily information to management.
Closing remark
79
This chapter dealt with computerised accounting systems on a mere introductory basis. In
later years of study, attention will be given more comprehensively to accounting software as
well as the practical application thereof. In order to use the accounting software successfully,
a thorough knowledge of financial accounting is extremely important.
412
Chapter 12 Property, plant and equipment
Contents
Introduction
Definition of property, plant and equipment
Aspects that will be dealt with
Recognition of a PPE item
Measurement at initial recognition
Constituent elements of the cost price of a PPE item
Measurement of cost
Subsequent measurement of PPE items
Allocation of a PPE item’s cost to the depreciation expense
Depreciable amount of a PPE item
Useful life
Residual value
Carrying amount
Depreciation methods
The straight-line method
The diminishing balance method
The units of production method
Choice of a depreciation method
Derecognition of a PPE item
Trade-in of a PPE item
Impairment of assets
Losses and compensation from an insurer
Miscellaneous aspects
The component approach
The asset register
Presentation and disclosure of PPE items in the financial statements
Notes regarding accounting policy
Other notes
413
Paragraph
1
3
5
6
10
11
14
15
17
20
24
29
33
35
38
43
48
50
53
55
56
69
74
76
79
83
86
88
Examples
Example
12.1
12.2
12.3
12.4
12.5
12.6
12.7
12.8
12.9
12.10
12.11
12.12
12.13
12.14
12.15
12.16
Cost elements of a PPE item
Purchase of a PPE item with a supplier’s loan
Change in the estimate of the useful life
Change in the estimate of the residual value
Straight-line method
Diminishing balance method
Units of production method
Change in depreciation method
Sale of a PPE item
Scrapping of a PPE item
Donation of computer equipment to an institution
Trade-in of a PPE item
Impairment
Trade-in and compensation for loss
Component approach with initial recognition
Presentation and disclosure of PPE items in the financial statements
414
Chapter 12 Property, plant and equipment
Introduction
1
Property, plant and equipment (PPE) usually forms a substantial part of the assets of an
entity. In this chapter various aspects in respect of this asset grouping will be dealt with, by
referring to IAS 16 Property, plant and equipment.
2
As previously indicated there are, besides the Conceptual Framework 2010, fifteen IFRSs as
well as 41 IASs. Each of these standards deals with a specific accounting aspect (e.g.
property, plant and equipment) and indicates in respect of the specific aspect the recognition,
presentation and disclosure requirements that must be followed. It is recommended that the
user of this work also consult IAS 16. In this regard, note that the revaluation model
(IAS16.30 to 16.42) is not dealt with in this work.
Definition of property, plant and equipment
3
4
Property plant and equipment are tangible assets that:
•
are held for use in the production or supply of goods or services, for rental to others, or
for administrative purposes; and
•
are expected to be used for more than one reporting period (IAS 16.6).
PPE is therefore the tangible component of non-current assets and are in this chapter divided
into the following groups/classes: land, buildings, machinery, vehicles, computer equipment
as well as furniture and equipment.
Aspects that will be dealt with
5
In this chapter, the following aspects in respect of the asset grouping property, plant and
equipment (PPE), will be dealt with:
•
Recognition of a PPE item
•
Measurement with initial recognition of a PPE item
•
•
-
cash equivalent of the cost price
-
constituent elements of the cost price
Subsequent measurement
-
allocation of cost to the depreciation expense
-
depreciable amount of a PPE item
-
useful life
-
residual value
-
carrying amount
Depreciation methods
-
straight-line method
-
diminishing balance method
-
units of production method
415
•
Derecognition of a PPE item
-
sale
-
scrapping
-
donation
-
trade-in
•
Impairment – recognition and measurement
•
Losses and compensation from insurer
•
Miscellaneous aspects
•
-
the component approach
-
the asset register
Presentation and disclosure of PPE
-
accounting policy
-
other notes
Recognition of a PPE item
6
Recognition is in essence the accounting process, but sometimes the concept recognition is
used to refer to only a part of the process, for example to recognise transactions in the
journal or to account for transactions in accounts.
7
A PPE item is recognised as an asset if the definition of an asset and the recognition criteria
of an asset are satisfied.
8
In this chapter control of an asset is obtained when the risks and rewards associated with the
right of ownership of the asset are obtained. Right of ownership of an asset transfers to the
purchasing entity with delivery of the asset. The purchasing entity therefore controls the asset
from the day on which delivery took place. Right of ownership of an acquired asset therefore
does not transfer with the placement of an order, the mere signing of a purchase contract or a
payment to the supplier.
9
Right of ownership of land and buildings (property) transfers to the purchaser when the deeds
office registers the property in the name of the purchasing entity. The purchasing entity
receives a title deed which indicates that the purchaser is the owner of the property. Right of
ownership of acquired vehicles transfers to the purchasing entity when the local authority
registers the vehicle in the name of the purchasing entity. Right of ownership of acquired
machinery as well as acquired furniture and equipment transfers to the purchasing entity
when these asset items are delivered to the purchasing entity.
Measurement at initial recognition
10
A PPE item that qualifies for recognition must, with initial recognition, be measured at the
historical cost price thereof.
416
Constituent elements of the cost price of a PPE item
11
The cost price of a PPE item comprises the following:
•
The purchase price, including legal and brokerage fees and import duties, after
deducting trade discount, cash discount or settlement discount. If the purchasing entity
is a registered VAT vendor the VAT input does not form part of the cost price of the
asset. In the case where the purchaser is not a registered VAT vendor or if the VAT
input on the asset (e.g. a passenger vehicle) cannot be claimed, the VAT input forms
part of the cost price of the PPE item.
•
Any costs that are directly attributable to bringing the PPE item to the location and
condition necessary for it to be capable of operating in the manner intended by
management. The following are examples of such directly attributable costs which must
be capitalised as part of the cost price of the PPE item:
•
12
13
-
initial delivery costs;
-
installation and assembly costs;
-
costs to test whether the PPE item functions properly less the proceeds obtained
from the sale of the test products.
The initial estimate of the costs of dismantling and removing a PPE item and restoring
the site on which it was located. (IAS 16.16 and 16.17).
The following costs do not form part of the cost price of a PPE item (IAS 16.19):
•
costs associated with opening a new facility;
•
costs associated with introducing a new product/service (including advertising and
promotion costs);
•
costs associated with conducting business in a new area or with a new class of
customer (including staff training costs);
•
administration and other general overhead costs; and
•
borrowing costs (except for in the circumstances dealt with in Chapter 15).
These costs must be recognised as expenses when they are incurred and may not be
capitalised as part of the cost price of a PPE item.
Example 12.1 Cost elements of a PPE item
AC Entity as well as all of AC Entity’s suppliers are registered VAT vendors. On 1 January 20.7,
AC Entity purchased a machine for R1 462 719 (including VAT). During January 20.7, AC Entity
incurred the following costs (which, where applicable, include VAT):
•
Delivery costs to deliver the machine to the premises of AC Entity to the amount of R143 750;
and
•
Installation costs by an external service provider to the amount of R258 750.
During January 20.7, AC Entity’s engineer incurred the following costs to modify the machine so
that it can produce/operate as required by AC Entity:
•
Material to the amount of R85 000. AC Entity used its own maintenance material on hand;
and
•
Labour costs to the amount of R90 000. AC Entity used its own maintenance employees.
417
During January 20.7, two of AC Entity’s employees were trained to operate the machine. The
following costs were incurred in this regard:
•
Costs of an external expert instructor to the amount of R14 250; and
•
Employee benefits in respect of the two employees for the period of the training to the
amount of R8 000.
During February 20.7 the machine was tested. The following costs were incurred in this regard:
•
Material to the amount of R48 421. The test products were sold as scrap for R6 900; and
•
Employee benefits in respect of AC Entity’s employees that were involved in test runs in
respect of the machine to the amount of R22 000.
On 1 March 20.7, the machine was ready for use and was also put into service on this date.
Due to the low levels of orders AC Entity suffered a loss of R48 000 during March 20.7 from
operating the machine.
In the production process, the machine produces water that is contaminated with a specific
chemical. The water is purified on site. At the end of the useful life of the machine, which is
estimated at 10 years, AC Entity has to dismantle the machine and rehabilitate the direct
environment. On 1 March 20.7, the present value of the dismantling and rehabilitation costs was
estimated at R215 000 (excluding VAT).
Required:
a)
Indicate what the cost of the machine is at initial recognition.
b)
Provide a journal entry (in the general journal of AC Entity) to correctly account for the
applicable part of the cost of the employee benefits in respect of the machine.
c)
Provide a journal entry (in the general journal of AC Entity) to correctly account for the cost to
rehabilitate the environment.
Example 12.1 Solution
a) Cost of the machinery item at initial recognition
Purchase price (R1 462 719 x 100/115)
Delivery (R143 750 x 100/115) – directly attributable cost
Installation (R258 750 x 100/115) – directly attributable cost
Preparation costs:
Material (VAT has already been accounted for at acquisition date)
Labour (No VAT on salaries)
Training costs (R14 250 + R8 000) – not directly attributable cost
Testing costs:
Material (Cost less proceeds from sale) ((R48 421 – R6 900) x 100/115)
Employee benefits / labour
Operating loss – not directly attributable cost
Present value of dismantling and rehabilitation costs
418
R
1 271 930
125 000
225 000
85 000
90 000
36 105
22 000
215 000
2 070 035
b) Journal entries – employee benefits
J1
20.7
31 Jan
Machinery (SFP)
Employee benefits (P/L)
Recognise the capitalisation of employee benefits that were
incurred to bring the machine into a condition ready for use
as intended by the entity
Dr
90 000
Cr
90 000
Remark in respect of the above journal
1
J2
20.7
28 Feb
It can be accepted that the employee benefits were not recognised as an expense at
the end of January 20.7, but capitalised as part of the cost of PPE.
Machinery (SFP)
Employee benefits (P/L)
Recognise the capitalisation of employee benefits that were
incurred to bring the machine into a condition ready for use
as intended by the entity
Dr
22 000
Cr
22 000
Remark in respect of the above journal
1
It can be accepted that the employee benefits were not recognised as an expense at
the end of February 20.7, but capitalised as part of the cost of PPE.
c) Journal entry – rehabilitation costs
J1
20.7
1 Mar
Machinery (SFP)
Provision for future rehabilitation costs (SFP)
Recognise the provision for future rehabilitation costs
Dr
215 000
Cr
215 000
Remark in respect of the above journal
1
In Accounting, the concept provision is reserved to describe a liability of which the date
of settlement or the amount is uncertain. Provisions are dealt with in Chapter 19.
Measurement of cost
14
A PPE item that qualifies for recognition must be measured at the historical cost price
thereof. If the initial payment of the cost price is deferred beyond normal credit terms, the cost
is the present value of the future payments. A PPE item is therefore measured at initial
recognition at the cost price, which represents the cash price equivalent on the date of
acquisition.
419
Example 12.2 Purchase of a PPE item with a supplier’s loan
AL Entity’s reporting date is 31 December. AL Entity is a registered VAT vendor. During the year
ended 31 December 20.7, the entity incurred the following loan:
On 2 January 20.7, AL Entity purchased machinery for R920 000 (including VAT). The supplier of
the machinery, ES Entity, provided credit to AL Entity as follows: a loan of R850 000 and trade
credit of R70 000 with a credit term of 30 days.
The applicable stipulations of the loan agreement are as follows:
•
The primary debt is R850 000 and the loan term is 36 months.
•
The interest rate is 10% per year and the interest is calculated by using the effective interest
rate method.
•
The interest is added every year on 31 December.
•
Interest charged over the term of the loan, amounts to R281 350.
•
The primary debt, as well as the interest, is repayable in one amount on 31 December 20.9.
The interest schedule for the loan is as follows:
Date
2 Jan 20.7
31 Dec 20.7
31 Dec 20.8
31 Dec 20.9
Detail
Primary debt
Interest
Interest
Interest
Interest at
10% per year
85 000
93 500
102 850
281 350
Amortised cost of
the loan
R
850 000
935 000
1 028 500
1 131 350
On 2 January 20.7, the machinery was delivered to AL Entity’s premises and also put into service.
Required:
a)
Indicate what the cost of the machinery is at initial recognition.
b)
Provide the journal entry (in the general journal of AL Entity) for the initial recognition of the
PPE item.
c)
Provide the loan account in the records of AL Entity for the period 2 January 20.7 to
31 December 20.9.
Example 12.2 Solution
a) Cost at initial recognition
The cost of the PPE item at initial recognition is R800 000 (R920 000 x 100/115), which is the
invoice price excluding VAT, since AL Entity is a registered VAT vendor.
If a portion of the payment for the PPE item is deferred beyond normal credit terms, it is also about
the purchase of a PPE item with a (supplier’s) loan. Where the purchase of a PPE item takes place
partly with trade credit and partly with a supplier’s loan, the cost price of the PPE item is the
amount of the trade credit granted (R70 000) plus the present value of all the future payments on
the loan. The present value (value on 2 January 20.7) of the payment of R1 131 350 on
31 December 20.9, is R850 000. The cost price of the machine is therefore R800 000 (R70 000 +
R850 000 = R920 000 less VAT of R120 000) and over the term of the loan interest to the amount
of R281 350 becomes payable.
420
In the subject Financial Management present value calculations are dealt with comprehensively.
b) Journal entry
J1
20.7
2 Jan
Machinery (SFP)
VAT input (SFP)
Payable ES (SFP)
Loan from ES Entity (SFP)
Recognise machinery purchased with trade credit and a
supplier’s loan
Dr
800 000
120 000
Cr
70 000
850 000
Remark in respect of Example 12.2
1
In the set of facts, the finance provided by the supplier is structured as a long term loan.
The finance could however also have been structured as follows as a short term loan:
For example, the invoice price is R920 000 (including VAT) and is payable as follows:
R70 000 is payable on or before 31 January 20.7 in accordance with normal trade
credit and R935 000, which includes an amount for interest, is payable on 31 December
20.7. The interest portion is clearly R85 000 and the cash equivalent of the purchase
price is R850 000. Refer to Example 5.2 where the supplier’s loan is also a short term
loan.
c) Loan account of ES Entity in the records of AL Entity – 1 Jan 20.7 to 31 Dec 20.9
Dr
Date
L4 Loan from ES Entity
Contra account
Fol
20.7
31 Dec
Balance
cf
20.8
31 Dec
Balance
cf
20.9
31 Dec
Bank
J2
Amount
Date
20.7
935 000 2 Jan
31 Dec
935 000
20.8
1 028 500 1 Jan
31 Dec
1 028 500
20.9
1 131 350 1 Jan
31 Dec
1 131 350
421
Cr
Contra account
Fol
Amount
Machinery
Interest expense
J1
J2
850 000
85 000
935 000
Balance
Interest expense
bd
J1
935 000
93 500
1 028 500
Balance
Interest expense
bd
J1
1 028 500
102 850
1 131 350
Subsequent measurement of PPE items
15
The measurement basis that is used in this work for the initial and subsequent measurement
of PPE items is the historical cost model.
16
The subsequent measurement of PPE items occurs as follows:
•
Land: at cost price less any accumulated impairment losses; and
•
Other PPE items: cost price less accumulated depreciation and less any accumulated
impairment losses. Impairment losses are dealt with later in this chapter. (IAS 16.29
and 16.30)
Allocation of a PPE item’s cost to the depreciation expense
17
The economic benefits associated with PPE items are utilised by the entity as the entity uses
the asset. The proper treatment is to recognise a portion of the cost of each PPE item (except
for land) as an expense during each reporting period over the useful life of the assets. The
expense is referred to as depreciation. PPE items, with the exception of land, therefore have
a limited useful life. The useful life of PPE items is estimated with the acquisition of the assets
and is annually reviewed at the end of the reporting period. In Accounting the concept
depreciation does not mean a depreciation in value, but the allotment of a portion of the cost
price of a PPE item to an expense named depreciation.
18
Depreciation is allotted from the date on which the PPE item is available for utilisation. The
PPE item is available for utilisation if it is in the location and condition necessary for it to be
capable of operating in the manner intended by management (IAS 16.55).
19
Depreciation is suspended when:
•
the PPE item is fully depreciated;
•
the decision is taken to scrap the asset. (An idle/unutilised PPE item is depreciated up
until the decision is taken to scrap the item. If the units of production method is used,
the depreciation on the idle/unutilised PPE item will however be zero.); and
•
the decision is taken to dispose of (sell, trade-in or donate) the PPE item. In this work
the date of the delivery of the PPE item and the date on which the decision to dispose
was taken, are deemed to be the same date.
Depreciable amount of a PPE item
20
The depreciable amount of a PPE item must be allocated to the depreciation expense on a
systematic basis, over the useful life of the item. (IAS 16.50)
21
The depreciable amount of a PPE item is the cost price less the residual value of the item.
(IAS 16.6)
22
The residual value of a PPE item is the estimated amount that would currently be obtained
from the disposal of the PPE item, after deducting the estimated costs of disposal, if the asset
were already of the age and in the condition expected at the end of its useful life. (IAS 16.6)
23
The purpose of recognising a depreciation expense is to allocate the depreciable amount of a
PPE item, over the useful life thereof, against the income that it generates. The depreciable
amount is recouped through the use/utilisation and the residual value is recouped with the
disposal of the PPE item. Depreciation represents the amount of economic benefits derived
422
by the entity during the reporting period. Accumulated depreciation represents the amount of
economic benefits derived by the entity from use of the asset up to the date the accumulated
depreciation is determined. The extent of the depreciation expense is influenced by the
following three aspects:
•
useful life;
•
expected residual value; and
•
the depreciation method.
Useful life
24
The useful life of an asset is the period over which the PPE item is expected to be available
for use by the entity or the number of units which the PPE item is expected to produce.
(IAS 16.6)
25
The following factors are taken into account when determining the useful life:
•
the expected usage of the PPE item, assessed with reference to the item’s expected
capacity of physical output;
•
the expected physical wear and tear, which depends on operational factors such as the
number of shifts, the repair and maintenance program as well as the care and
maintenance of the PPE item while idle; and
•
technical or commercial obsolescence arising from changes or improvements in
production or changes in the market demand for the product or service output of the
PPE item. (IAS 16.56)
26
Land and buildings are often purchased as a unit, but are separable assets and are treated
separately for accounting purposes. Land usually has an unlimited useful life and is therefore
not depreciated. Buildings on the other hand have a limited useful life and are depreciated.
27
The determination of the useful life of a PPE item requires that professional judgement is
exercised. With the acquisition of a depreciable asset, the useful life of the asset must be
estimated. The estimate takes place with reference to the facts that are available at that point
in time. If it appears at a later stage that the estimate was incorrect as a result of changed
circumstances or new information, the initial estimate must be altered. In Accounting, this is
known as a change in accounting estimates. A change in the estimate of the useful life of a
depreciable asset is an integral part of accounting for PPE items and is not accounting errors.
The useful life of depreciable assets should be reviewed annually. (IAS 16.51)
28
A change in the estimate of the useful life of a depreciable asset is never corrected with
retrospective effect. The depreciation expense for the current year and future years are
recalculated with reference to the altered useful life. In a note to the depreciation expense,
information regarding the effect of the change in the estimate is disclosed.
Example 12.3 Change in the estimate of the useful life
On 1 January 20.7 the following balances, amongst others, appeared in the records of AC Entity:
Dr
720 000
Plant at cost price – 1 Jan 20.5
Accumulated depreciation – plant
Cr
288 000
423
Additional information
At initial recognition of the asset the useful life of the plant was estimated at 5 years. Depreciation
is calculated by using the straight-line method. No residual value is accounted for.
At the end of 20.7 the remaining useful life of the plant is estimated at three years.
Required:
a)
Recognise the depreciation expense for 20.7 in the records (general journal) of AC Entity.
b)
Present the depreciation expense in the statement of profit or loss of AC Entity for the
reporting period ended 31 December 20.7. Disclose applicable detail of the change in the
estimate in a note to the depreciation expense.
c)
Present the plant in the statement of financial position of AC Entity as at 31 December 20.7.
Remark in respect of the set of facts of Example 12.3
1
A decision regarding a change in estimate is usually made either at the beginning or at
the end of a reporting period. The change in estimate is however always applicable
from the beginning of the reporting period in which the decision was made.
Example 12.3 Solution
a) Depreciation expense for 20.7
Calculation
Carrying amount of plant on 1 Jan 20.7 (R720 000 – R288 000)
Estimated useful life on 1 Jan 20.7 (3 at the end of year = 4 beginning of the year)
Depreciation per year for 20.7, 20.8, 20.9 and 20.10 (R432 000 ÷ 4)
R432 000
4 years
R108 000
Depreciation for 20.7 on old estimate (R720 000 ÷ 5)
Effect of the change in estimate on the depreciation expense for 20.7 is a
decrease in the expense with (R144 000 – R108 000)
R144 000
R36 000
Remarks in respect of the above calculation
1
If the useful life had already been estimated at 6 years on 1 Jan 20.5, the depreciation
would have amounted to R120 000 (R720 000 ÷ 6) per year. The new extended useful
life however only applies from 1 January 20.7. The accumulated depreciation on
1 January 20.7 can however not be changed. The change in estimate has an effect only
on the four years, namely 20.7 up to and including 20.10, where the depreciation will be
R108 000 per year.
2
The depreciation amounts of R144 000 and R108 000 articulate as follows with the
R120 000: The first two years “too much” depreciation amounting to R24 000
(R144 000 – R120 000) per year was written off, therefore R48 000 in total. The
depreciation expense for each of the years 20.7 to 20.10 is now reduced with R12 000
(R48 000 ÷ 4) per year, which gives R108 000 (R120 000 – R12 000) per year.
424
Journal entry
J1
20.7
31 Dec
Depreciation – plant (P/L)
Accumulated depreciation – plant (SFP)
Recognise depreciation on plant for 20.7
Dr
108 000
Cr
108 000
b) Presentation and disclosure of the depreciation expense
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Note
///
Gross profit
////
Depreciation
24
Profit for the year
R
xxx
(108 000)
XXX
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
24 Change in estimate
During 20.7 the remaining estimated useful life of plant as at the beginning of 20.7 was
changed from 3 years to 4 years. The effect of the change in estimate reduced the
depreciation expense for 20.7 with R36 000.
c) Presentation of plant
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
ASSETS
Non-current assets
Plant (dr 720 000 (cr 288 000 cr 108 000))
20.7
R
324 000
Residual value
29
The residual value of a PPE item is the estimated amount that would currently be obtained
from the disposal of the PPE item, after deducting the estimated costs of disposal, if the asset
was already of the age and in the condition expected at the end of its useful life. (IAS 16.6)
30
The determination of the residual value of a PPE item requires that professional judgement is
exercised. With the acquisition of a depreciable asset, the useful life as well as the residual
value of the asset must be estimated. The estimate takes place with reference to the facts
that are available at that point in time. If it appears at a later stage that the estimate was
incorrect as a result of changed circumstances or new information, the initial estimate must
be altered. In Accounting, this is known as a change in accounting estimates. The residual
value of depreciable assets should be reviewed annually. (IAS 16.51)
425
31
A change in the estimate of the residual value of a depreciable asset is never corrected with
retrospective effect. The depreciation expense for the current year and future years is
recalculated with reference to the altered residual value and remaining useful life. In a note to
the depreciation expense, information regarding the effect of the change in the estimate is
disclosed.
32
Residual values are usually negligible in practice and will often be equal to nil.
Example 12.4 Change in the estimate of the residual value
On 1 January 20.7 the following balances, amongst others, appeared in the records of AC Entity:
Dr
830 000
Plant at cost price – 1 Jan 20.5
Accumulated depreciation – plant
Cr
320 000
Additional information
At initial recognition of the asset, the useful life of the plant was estimated at 5 years and the
residual value at R30 000. Depreciation is calculated by using the straight-line method.
At the end of 20.7 the residual value of the plant was estimated to be nil.
Required:
a)
Recognise the depreciation expense for 20.7 in the records (general journal) of AC Entity.
b)
Present the depreciation expense in the statement of profit or loss of AC Entity for the
reporting period ended 31 December 20.7. Present applicable detail of the change in the
estimate in a note to the depreciation expense.
c)
Present plant in the statement of financial position of AC Entity as at 31 December 20.7.
Remark in respect of the set of facts of Example 12.4
1
A decision regarding a change in estimate is usually made at the end of a reporting
period. The change in estimate is however always applicable from the beginning of the
reporting period in which the decision was made.
Example 12.4 Solution
a) Depreciation expense for 20.7
Calculation
Carrying amount of plant on 1 Jan 20.7 (R830 000 – R320 000)
Remaining useful life on 1 Jan 20.7 (The R510 000 therefore has to be
depreciated over the next 3 years, on the straight-line method, to nil)
R510 000
3 years
Depreciation per year for 20.7, 20.8 and 20.9 ((R510 000 – 0) ÷ 3)
R170 000
Depreciation for 20.7 on old estimate ((R830 000 – R30 000) ÷ 5)
R160 000
Effect of the change in the estimate on the depreciation expense for 20.7 is an
increase in the expense of (R170 000 – R160 000)
426
R10 000
Remarks in respect of the above calculation
1
If the residual value had already been estimated at nil on 1 Jan 20.5, the depreciation
would have amounted to R166 000 (R830 000 ÷ 5) per year. The new residual value of
nil however only applies from 1 January 20.7. The accumulated depreciation on
1 January 20.7 can however not be changed. The change in estimate has an effect only
on the three years, namely 20.7 up to and including 20.9, where the depreciation will be
R170 000 per year.
2
The depreciation amounts of R160 000 and R170 000 articulate as follows with the
R166 000: The first two years “too little” depreciation amounting to R6 000 (R166 000 –
R160 000) per year was written off, therefore R12 000 in total. The depreciation
expense for each of the years 20.7 to 20.9 is now increased with R4 000 (R12 000 ÷ 3)
per year, which gives R170 000 (R166 000 + R4 000) per year.
Journal entry
J1
20.7
31 Dec
Depreciation – plant (P/L)
Accumulated depreciation – plant (SFP)
Recognise depreciation on plant for 20.7
Dr
170 000
Cr
170 000
b) Presentation and disclosure of the depreciation expense
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Note
///
Gross profit
////
Depreciation
Profit for the year
R
xxx
24
(170 000)
XXX
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
24 Change in estimate
During 20.7 the estimated residual value of plant was changed from R30 000 to Rnil. The
effect of the change in estimate was to increase the depreciation expense for 20.7 with
R10 000.
c) Presentation of plant
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
20.7
R
ASSETS
Non-current assets
Plant (dr 830 000 (cr 320 000 cr 170 000))
340 000
427
Carrying amount
33
The carrying amount of a PPE item is the amount at which the PPE item is initially recognised
less the accumulated depreciation less any accumulated impairment. (IAS 16.6)
34
Carrying amount is the amount of future economic benefits still expected to be derived by the
entity. This is consistent with the definition of an asset.
Depreciation methods
35
The depreciable amount of a PPE item must be allocated to the depreciation expense in a
systematic manner/method, over the useful life of the item (IAS 16.50). An entity should
select a depreciation method that reflects the pattern through which it expects to consume
the future economic benefits embodied in the asset. In this work three depreciation methods
will be dealt with, namely the straight-line method, the diminishing balance method and the
units of production method.
36
In this work PPE are divided into the following groups:
37
•
land (which is not depreciated);
•
buildings;
•
plant;
•
machinery;
•
vehicles;
•
computer equipment; and
•
furniture and equipment.
For each of these groups of assets, a depreciation method has to be decided upon. The
choice that an entity makes between acceptable alternatives is known in Accounting as the
accounting policy of the entity. Disclosure of the accounting policy and other information are
dealt with later in this chapter.
The straight-line method
38
The straight-line method depreciates the depreciable amount of a PPE item evenly over the
useful life thereof (here useful life is a period – refer to paragraph 24). Since the depreciable
amount is equal to the cost price less the residual value, the straight-line method can be
described as follows: The straight-line method depreciates the cost of a PPE item in a
straight-line over the useful life to the residual value thereof.
39
The straight-line method results in the depreciable amount of a PPE item being allocated to
the depreciation expense in equal amounts over the useful life of the PPE item. This method
is especially appropriate where the use/utilisation of the economic benefits associated with
the PPE item is mainly a function of time. This method is therefore suited to depreciate for
example buildings, furniture and equipment. The maintenance of such PPE items also usually
reflects a fixed pattern over the useful life of the assets.
40
The annual depreciation expense is calculated as follows:
Depreciable amount (that is cost price less residual value)
Useful life
428
41
The straight-line method therefore entails in essence the application of a constant percentage
on the depreciable amount. The entity uses this method if it expects to derive future
economic benefits evenly over the asset’s useful life.
42
Where a PPE item was purchased during the current reporting period, the depreciation
expense for the current and the last reporting period (of the PPE item’s useful life) will be
reduced proportionately based on the appropriate number of months. Refer to Table 12.1
(directly after Example 12.7’s solution).
Example 12.5 Straight-line method
The current reporting date of AC Entity, who is a registered VAT vendor, is 31 December 20.7.
On 1 April 20.7, a PPE item, which was purchased for R1 380 000 (including VAT), was received.
On 1 May 20.7, the PPE item was available for use as intended by management. On this date, the
useful life of the item was estimated at 5 years and the residual value at R150 000 (excluding VAT).
AC Entity decided to allocate the cost of the PPE item to the depreciation expense by applying the
straight-line method. The straight-line method was chosen since the economic benefits associated
with the PPE item will be utilised evenly over the useful life of the PPE item.
Required:
a)
Calculate the depreciation expense of the PPE item for the reporting periods ended
31 December 20.7 and 31 December 20.8.
b)
Calculate the carrying amount of the PPE item on 31 December 20.7 and 31 December 20.8.
c)
Journalise the depreciation expense for 20.7 in the records (general journal) of AC Entity.
Remark in respect of Example 12.5
1
Refer to Table 12.1 (directly after Example 12.7’s solution) where the depreciation
expense over the useful life is reflected for each of the three depreciation methods.
Example 12.5 Solution
a) Depreciation expense
20.7
Depreciable amount ÷ useful life
((1 380 000 x 100/115) – 150 000) ÷ 5 x 8/12
(1 200 000 – 150 000) ÷ 5
20.8
140 000
210 000
b) Carrying amount
31 Dec 20.7
Cost price less accumulated depreciation
(1 200 000 – 140 000)
(1 200 000 – (140 000 + 210 000)
31 Dec 20.8
1 060 000
850 000
429
c) Journal entry
J1
20.7
31 Dec
Depreciation – class PPE (P/L)
Accumulated depreciation – class PPE (SFP)
Recognise depreciation on (name the specific) PPE class for
20.7
Dr
140 000
Cr
140 000
The diminishing balance method
43
The diminishing balance method depreciates the cost of a PPE item over the useful life (here
useful life is a period – refer to paragraph 24) to the residual value thereof, but in such a
manner that the annual depreciation expense shows a decreasing/diminishing trend. (The
annual depreciation expense decreases exponentially over the useful life of the item.)
44
The diminishing balance method is usually applied where the utilisation of the economic
benefits associated with the PPE item is expected not to be even, but rather to decrease over
the useful life of the item. The maintenance of such PPE items also usually reflects a rising
trend over the useful life of the assets. This method is appropriate to depreciate for instance
machinery and vehicles.
45
The annual depreciation is calculated as the product of the carrying amount at the beginning
of each year and a fixed percentage. The depreciation per reporting period reduces annually
and reflects amongst them an exponential relationship. The calculation of the depreciation
rate is determined by the useful life (a period) and the residual value and requires skills in
respect of calculations that account for the time value of money. The topic time value of
money is dealt with in the subject Financial Management.
46
The annual depreciation expense is calculated as follows:
Carrying amount at the beginning of the year x depreciation rate
(Carrying amount = cost price less accumulated depreciation less accumulated impairment
loss)
47
Note that the residual value plays a role only when calculating the depreciation rate. Under
this method, the residual value is taken into account when determining the rate to use and
need not be deducted when calculating depreciation. The depreciation rate is calculated by
using the following formula:
diminishing balance depreciation rate (%) = 1 – ౤ඥ‡•‹†—ƒŽ˜ƒŽ—‡ ൊ ‘•–’”‹ ‡
where n = estimated useful life in years
In this work the depreciation rate in respect of the diminishing balance method will always be
provided.
Example 12.6 Diminishing balance method
The current reporting date of AC Entity, who is a registered VAT vendor, is 31 December 20.7.
On 1 April 20.7, a PPE item, which was purchased for R1 380 000 (including VAT), was received.
On 1 May 20.7, the PPE item was available for use as intended by management. On this date, the
useful life of the item was estimated at 5 years and the residual value at R150 000 (excluding VAT).
430
AC Entity decided to allocate the cost of the PPE item to the depreciation expense by applying the
diminishing balance method. The diminishing balance method was chosen since the economic
benefits associated with the PPE item will be utilised in a decreasing trend over the useful life of the
PPE item.
The depreciation rate that will produce the outcome as required by management was calculated as
34%.
Required:
a)
Calculate the depreciation expense of the PPE item for the reporting periods ended
31 December 20.7 and 31 December 20.8.
b)
Calculate the carrying amount of the PPE item on 31 December 20.7 and 31 December 20.8.
Remark in respect of Example 12.6
1
Refer to Table 12.1 (directly after Example 12.7’s solution) where the depreciation
expense over the useful life is reflected for each of the three depreciation methods.
Example 12.6 Solution
a) Depreciation expense
20.7
Carrying amount beginning of the year x 34%
((1 380 000 x 100/115 = 1 200 000) x 34% x 8/12)
((1 200 000 – 272 000) x 34%)
20.8
272 000
315 520
b) Carrying amount
31 Dec 20.7
Cost price less accumulated depreciation
(1 200 000 – 272 000)
(1 200 000 – (272 000 + 315 520))
31 Dec 20.8
928 000
612 480
Remarks in respect of Example 12.6
1
If the asset was acquired at the beginning of 20.7, the depreciation for 20.8 would have
been less than that of 20.7. This is as a result of using the diminishing balance method.
Because depreciation is calculated on the carrying amount of the asset, which reduces
over time, the depreciation amount will also decrease.
2
Because the asset was acquired during the year, the depreciation expense is
apportioned for the amount of time that the asset was used for. In this example, in 20.7
the asset was used for 8 months, hence the 8/12 on the depreciation calculation.
The units of production method
48
The units of production method depreciates the depreciable amount of a PPE item over the
useful life thereof with reference to the number of units produced (here useful life is units –
refer to paragraph 24). This method is appropriate to depreciate for example machinery
(useful life is the total estimated units) and delivery vehicles (useful life is the total estimated
kilometres) and earth moving machinery (useful life is the total estimated hours).
431
49
The annual depreciation expense is calculated as follows:
Depreciable amount (that is cost price less residual value)
X
1
Units produced in period
Total estimated units
Example 12.7 Units of production method
The current reporting date of AC Entity, who is a registered VAT vendor, is 31 December 20.7.
On 1 April 20.7, a PPE item, which was purchased for R1 380 000 (including VAT), was received.
On 1 May 20.7, the PPE item was available for use as intended by management. On this date, the
useful life of the item was estimated at 5 000 000 units and the residual value at R150 000
(VAT excluded). (In this case the useful life is units and not a period.)
AC Entity decided to allocate the cost of the PPE item to the depreciation expense by applying the
units of production method. The units of production method was chosen since the economic
benefits associated with the PPE item will be utilised based on the production output of the PPE
item.
The estimated production output is as follows:
Year
20.7
20.8
20.9
20.10
20.11
20.12
Units
640 000
1 120 000
1 040 000
900 000
1 100 000
200 000
5 000 000
Required:
a)
Calculate the depreciation expense of the PPE item for the reporting periods ended
31 December 20.7 and 31 December 20.8.
b)
Calculate the carrying amount of the PPE item on 31 December 20.7 and 31 December 20.8.
Remark in respect of Example 12.7
1
Refer to Table 12.1 (directly after Example 12.7’s solution) where the depreciation
expense over the useful life is reflected for each of the three depreciation methods.
Example 12.7 Solution
a) Depreciation expense
20.7
Depreciable amount x (units for the year ÷ total estimated units)
(1 380 000 x 100/115) – 150 000 = 1 050 000 x 640 000/5 000 000
1 200 000 – 150 000 = 1 050 000 x 1 120 000/5 000 000
20.8
134 400
235 200
Remark in respect of the solution to Example 12.7(a)
1
Useful life is connected to units and not to a period. A period (8 months) is therefore not
accounted for in 20.7.
432
b) Carrying amount
31 Dec 20.7
Cost price less accumulated depreciation
(1 200 000 – 134 400)
(1 200 000 – (134 400 + 235 200))
31 Dec 20.8
1 065 600
830 400
Table 12.1 Comparison of the depreciation methods (assuming same set of facts)
Straight-line
20.7
01 May
31 Dec
31 Dec
20.8
31 Dec
31 Dec
20.9
31 Dec
31 Dec
20.10
31 Dec
31 Dec
20.11
31 Dec
31 Dec
20.12
30 Apr
30 Apr
Diminishing
Units of
balance
production
1 200 000
1 200 000
(272 000)
(134 400)
928 000
1 065 600
Cost price
Depreciation
Carrying amount
1 200 000
(140 000)
1 060 000
Depreciation
Carrying amount
(210 000)
850 000
(315 520)
612 480
(235 200)
830 400
Depreciation
Carrying amount
(210 000)
640 000
(208 243)
404 237
(218 400)
612 000
Depreciation
Carrying amount
(210 000)
430 000
(137 441)
266 796
(189 000)
423 000
Depreciation
Carrying amount
(210 000)
220 000
(90 711)
176 085
(231 000)
192 000
Depreciation
Carrying amount
(70 000)
150 000
(59 869)
116 216
(42 000)
150 000
Remark in respect of Table 12.1
1
The amounts in respect of depreciation in accordance with the diminishing balance
method differs from the amounts in Example 12.6 since the example does not account
for the decimals in the calculated rate, but uses a percentage that was rounded-off
(34%).
Choice of a depreciation method
50
The depreciable amount of a PPE item must be allocated to the depreciation expense in a
systematic manner/method, over the useful life (period or units) of the item. An entity should
select a depreciation method that reflects the expected pattern whereby economic benefits of
the PPE item will be used/utilised.
51
The choice of a depreciation method of a PPE item requires that professional judgement be
exercised. With the acquisition of a depreciable asset, the useful life as well as the residual
value of the asset must be estimated, where after a depreciation method is chosen. The
choice is made with reference to the facts that are available at that point in time. If it appears
at a later stage that the chosen depreciation method was incorrect as a result of changed
circumstances or new information, the method must be changed. The appropriateness of the
depreciation methods applied by the entity should be considered annually.
433
52
A change in the depreciation method is never corrected with retrospective effect. The
depreciation expense for the current year and future years are calculated with reference to
the altered depreciation method.
Example 12.8 Change in depreciation method
On 1 January 20.7 the following balances, amongst others, appeared in the records of AC Entity:
Dr
720 000
Plant at cost price (1 Jan 20.5)
Accumulated depreciation – plant
Cr
288 000
Additional information
At the initial recognition of the asset, the useful life of the plant was estimated at 5 years.
Depreciation is calculated by using the straight-line method. No residual value is accounted for.
The straight-line method was chosen since the economic benefits associated with the PPE item are
expected to be utilised evenly over the useful life of the PPE item.
At the beginning of 20.7 it was decided to change the depreciation method from the straight-line
method to the units of production method. The reason is that the records for the past two years
indicated that the production output for the past two years differ significantly.
Consequently, at the beginning of 20.7 it was estimated that the plant will still produce 25 000 units,
as follows:
Year
20.7
20.8
20.9
Units
5 000
12 000
8 000
25 000
Required:
a)
Journalise the depreciation expense for 20.7 in the records (general journal) of AC Entity.
b)
Present the depreciation expense in the statement of profit or loss of AC Entity for the
reporting period ended 31 December 20.7. Disclose applicable detail of the change in the
depreciation method in a note to the depreciation expense.
c)
Present plant in the statement of financial position of AC Entity as at 31 December 20.7.
434
Example 12.8 Solution
a) Depreciation expense for 20.7
Calculation
Carrying amount of plant on 1 Jan 20.7 (R720 000 – R288 000)
R432 000
Remaining useful life on 1 Jan 20.7 – in units
25 000
Depreciation expense for 20.7: R432 000 x 5 000/25 000
R86 400
Depreciation for 20.7 on the old method R720 000 ÷ 5
R144 000
Effect of the change in estimate (the depreciation method) on the depreciation
expense for 20.7 is a decrease of (R144 000 – R86 400)
R57 600
Depreciation expense for 20.8: R432 000 x 12 000/25 000
R207 360
Depreciation expense for 20.9: R432 000 x 8 000/25 000
R138 240
Remark in respect of the above calculation
1
The carrying amount on 1 Jan 20.7 is depreciated as follows:
Year
20.7
20.8
20.9
R
86 400
207 360
138 240
(as opposed to R144 000 per year under the straight-line method).
Journal entry
J1
20.7
31 Dec
Depreciation – plant (P/L)
Accumulated depreciation – plant (SFP)
Recognise depreciation on plant for 20.7
Dr
86 400
Cr
86 400
b) Presentation and disclosure of the depreciation expense
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Note
///
Gross profit
////
Depreciation of plant
Profit for the year
R
xxx
24
(86 400)
XXX
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
24 Change in estimate
435
From the beginning of 20.7, the depreciation method of plant changed from the straight-line
method to the units of production method.
The effect of the change in the depreciation method was to decrease the depreciation
expense with R57 600.
c) Presentation of plant
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
20.7
R
ASSETS
Non-current assets
Plant (dr 720 000 (cr 288 000 cr 86 400))
345 600
Derecognition of a PPE item
53
When a PPE item no longer satisfies the definition or recognition criteria of an asset, then the
item can no longer be accounted for as an asset. This will occur at the stage when the PPE
item is sold, traded-in, donated or scrapped (permanently withdrawn from use) and when no
further economic benefits will be received from the use or sale of the item. When a PPE item
is sold, traded-in, donated or scrapped, the PPE item must be derecognised. Derecognition
of a PPE item is the removal of the cost price and the accompanying accumulated
depreciation from the records of the entity.
54
The sale, scrapping, donation and trade-in of a PPE item will subsequently be discussed by
means of examples.
Example 12.9 Sale of a PPE item
The current reporting date of AC Entity, who is a registered VAT vendor, is 31 December 20.7. On
1 January 20.7 the entity’s accounting records reflected the following balances, amongst others:
Dr
4 600 000
Machinery at cost price
Accumulated depreciation – machinery
Cr
2 350 000
According to the asset register, the cost price of machinery on 31 December 20.6 and the
accumulated depreciation of machinery on 31 December 20.6 comprise the following:
Cost price
Machine A
Machine B
Machine C
1 800 000
1 600 000
1 200 000
4 600 000
Residual value
(excl VAT)
200 000
175 000
150 000
Useful life
5
5
5
Accumulated depreciation
31 Dec 20.6
800 000
570 000
980 000
2 350 000
On 30 April 20.7, machine C was sold for R201 250 cash.
Another machine, namely machine D, was received on 1 April 20.7. The purchase price of
machine D was R1 610 000 (including VAT). (This machine was purchased from a registered VAT
436
vendor.) On 1 May 20.7, machine D was available for use in the manner intended by management,
but was only put into service on 15 May 20.7. Machine D’s useful life was estimated at 5 years and
the residual value at R200 000 (excluding VAT).
The depreciable amount of machinery is depreciated over the useful life of the items in accordance
with the straight-line method.
Required:
a)
Journalise the depreciation expense in the records (general journal) of AC Entity for the
reporting period ended 31 December 20.7.
b)
Provide the necessary journal entry (entries) to derecognise machine C on 30 April 20.7 in
the records (general journal) of AC Entity.
c)
Present and disclose the relevant balances in the appropriate financial statements of
AC Entity for the reporting period ended 31 December 20.7.
(Disclose means to provide additional information in an appropriate note. Refer to the
remarks after Example 12.9’s solution as well as paragraphs 83 to 88.)
Example 12.9 Solution
Calculations:
Depreciation – 20.7
Machine A
Machine B
Machine C
Machine D
(1 800 000 – 200 000) ÷ 5
(1 600 000 – 175 000) ÷ 5
(1 200 000 –150 000) ÷ 5 x 4/12
((1 610 000 x 100/115) – 200 000) ÷ 5 x 8/12
R
320 000
285 000
70 000
160 000
835 000
Profit on sale of machine C
Proceeds from sale (R201 250 x 100/115)
Carrying amount of machine C on 30 April 20.7
(1 200 000 – (980 000 + 70 000))
Profit on sale of machine C
R
175 000
(150 000)
25 000
a) Journal entry – depreciation
J1
20.7
30 Apr
Depreciation – machinery (P/L)
Accumulated depreciation – machinery (SFP)
Recognise depreciation on machine C for 20.7
Dr
70 000
Cr
70 000
Remark in respect of the above journal
1
The depreciation expense for the current year must be recognised up until the date on
which machine C is derecognised.
437
J2
20.7
31 Dec
Depreciation – machinery (P/L)
Accumulated depreciation – machinery (SFP)
Recognise depreciation on machinery for 20.7
765 000 = 320 000 (A) + 285 000 (B) + 160 000 (D)
Dr
765 000
Cr
765 000
b) Journal entry – derecognition of a PPE item
J1
20.7
30 Apr
Accumulated depreciation – machinery (SFP)
Machinery (SFP)
Bank (SFP)
VAT output (SFP) (201 250 x 15/115)
Profit on disposal of machinery (P/L)
Derecognise cost price and accumulated depreciation of
machine C sold and recognise profit on sale
Dr
1 050 000
Cr
1 200 000
201 250
26 250
25 000
If the asset derecognition account is used to recognise the sale, the journals are as follows:
J1
20.7
30 Apr
Accumulated depreciation – machinery (SFP)
Machinery (SFP)
Asset derecognition account (SFP)
Derecognise cost price and accumulated depreciation of
machine C sold as at 30 April 20.7
Dr
1 050 000
Cr
1 200 000
150 000
Remarks in respect of the above journal
1
The asset derecognition account is known in Accounting as a memorandum account. A
memorandum account is used to facilitate the recognition of transactions and to make
it more understandable.
2
The purpose of the asset derecognition account is to identify the profit or the loss on the
derecognition of the PPE item. Firstly, the carrying amount (cost price and accumulated
depreciation) of the asset are derecognised by transferring it to the memorandum
account. Subsequently, the proceeds (excluding VAT, where applicable) from
derecognition are credited against the asset derecognition account. The balance on the
asset derecognition account is either a loss or a profit and is accounted for in the
statement of profit or loss.
3
In Accounting at school, the memorandum account used in this regard was the asset
disposal account. Such a name is too limiting.
438
J2
20.7
30 Apr
J3
20.7
30 Apr
Bank (SFP)
VAT output (SFP) (201 250 x 15/115)
Asset derecognition account (SFP)
Recognise proceeds from the sale of machine C
Asset derecognition account (SFP)
Profit on disposal of machinery (P/L)
Recognise profit on sale of machine C
Dr
201 250
Cr
26 250
175 000
Dr
25 000
Cr
25 000
Remark in respect of the above journals
1
After accounting for the abovementioned journal (J3) the balance of the asset
derecognition account is nil and the account serves no further purpose. The use of an
asset derecognition account is optional.
c) Presentation and disclosure in the financial statements
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Note
///
Gross profit
Profit on disposal of property, plant and equipment
////
Depreciation
Profit for the year
R
xxx
25 000
(835 000)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
20.7
R
ASSETS
Non-current assets
Property, plant and equipment
5
439
2 665 000
AC ENTITY
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
1
ACCOUNTING POLICY
Property, plant and equipment
Each item of property, plant and equipment is initially recognised as an asset if it is probable
that future economic benefits associated with the item will flow to the entity, and the cost of
the item can be measured reliably. Each item that qualifies for recognition is initially
measured at cost, being the cash equivalent of the purchase price and any costs directly
attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.
Land is shown at cost price. Subsequent to initial recognition, buildings, plant and equipment
are stated at cost less accumulated depreciation and less accumulated impairment losses.
Depreciation is charged so as to allocate the cost of assets less their estimated residual
values over their estimated useful lives to an expense. The following depreciation methods
and annual rates (where applicable) are used to depreciate property, plant and equipment:
Land
no depreciation is written off on land
Buildings
2% per year on the straight-line method
Machinery
hours used method
Equipment
32% per year on the diminishing balance method
Vehicles
20% per year on the straight-line method
If there is an indication that there has been a significant change in the useful life, residual
value or of the utilisation pattern of assets, the depreciation is revised prospectively to reflect
the new estimates.
Impairment of property, plant and equipment
At each reporting date, property, plant and equipment are reviewed to determine whether
there is any indication that those assets have suffered an impairment loss. If there is an
indication of possible impairment, the recoverable amount of any affected asset is estimated
and compared with its carrying amount. If the estimated recoverable amount is lower, the
carrying amount is reduced to its estimated recoverable amount, and an impairment loss is
recognised immediately.
Remark in respect of the PPE accounting policy note
1
This note is an example of a complete accounting policy note in respect of property,
plant and equipment. An entity would only disclose the depreciation methods and rates
in respect of the PPE items reflected in its records.
440
5
Property, plant and equipment
Land
R
Buildings
R
Carrying amount beginning of year
Gross carrying amount
Accumulated depreciation
Additions – purchased
Disposal at carrying amount
Gross carrying amount
Accumulated depreciation
Depreciation
Gross carrying amount
Accumulated depreciation
Carrying amount end of year
Machinery
R
2 250 000
4 600 000
(2 350 000)
Total
R
2 250 000
4 600 000
(2 350 000)
1 400 000
1 400 000
(150 000)
(1 200 000)
1 050 000
(150 000)
(1 200 000)
1 050 000
(835 000)
(835 000)
4 800 000
(2 135 000)
2665 000
4 800 000
(2 135 000)
2 665 000
Remarks in respect of the solution to Example 12.9
1
Up until now focus was placed on the presentation of financial information in the
financial statements. Financial information is presented as line items (a description with
an amount). The amount of a line item is:
•
either the balance on a relevant account on the reporting date, as in the case of
the line item “Profit on disposal of property, plant and equipment” (accept that no
other PPE item was sold) in the statement of profit or loss;
•
or the sum of the balances on two or more relevant accounts on the reporting
date, as in the case of the line item “Property, plant and equipment” in the
statement of financial position. In this case, the accounts machinery and
accumulated depreciation on machinery are relevant.
2
In this chapter the use of notes to the financial statements is imported. In the notes
additional information is disclosed to the user. Also refer to paragraphs 83 to 88.
3
An entity would disclose in the PPE note only the PPE items that are reflected in the
entity’s accounting records. In this example the columns for land and buildings could
therefore have been left out.
441
4
The T-accounts for machinery and accumulated depreciation – machinery are provided
below to explain where the amounts, as disclosed in the PPE note, were obtained from
Dr
Date
20.7
1 Jan
Contra account
Fol
Balance
bd
1 May
Bank
20.8
1 Jan
Balance
Dr
Date
20.7
30 Apr
31 Dec
Machinery
Amount
Date
20.7
4 600 000 30 Apr
1 400 000
6 000 000
bd
31 Dec
Contra account
Accumulated
depreciation and
Bank
Balance
Fol
Cr
Amount
1 200 000
cf
4 800 000
6 000 000
4 800 000
Accumulated depreciation – machinery
Contra account Fol
Amount
Date
Contra account
20.7
Machinery, VAT
1 050 000 1 Jan
Balance
output and Profit
on disposal
Balance
cf
2 135 000 30 Apr Depreciation
31 Dec Depreciation
3 185 000
20.8
1 Jan
Balance
Fol
Cr
Amount
bd
2 350 000
70 000
765 000
3 185 000
bd
3 185 000
Example 12.10 Scrapping of a PPE item
The current reporting date of AC Entity, who is a registered VAT vendor, is 31 December 20.7.
On 31 December 20.7, the following balances, amongst others, appeared in the records of the
entity:
Machinery at cost price (useful life 10 years)
Accumulated depreciation – machinery (1 Jan 20.7)
Proceeds (net of VAT) from sale of scrap
Dr
2 100 000
Cr
945 000
7 000
The cost of machinery is depreciated over its useful life to nil by using the straight-line method.
Depreciation for 20.7 still has to be recognised.
On 30 June 20.7, an instruction was received from the local authority to withdraw a specific
machine since the machine produces severely contaminated waste as by-product. On 1 January
20.7, this machine’s cost price and accumulated depreciation was R750 000 and R337 500,
respectively. The derecognition of this machine has not yet been recorded. Consequently, these
two balances are included in the amounts as provided in the abovementioned list of balances. The
machine was immediately withdrawn and sold as scrap material. The proceeds from the sale
(R8 050 including VAT) have already been recognised.
Required:
a)
Recognise the depreciation expense for 20.7 in the records (general journal) of AC Entity by
using a journal entry.
442
b)
Derecognise the machine that was scrapped on 30 June 20.7, in the records (general journal)
of AC Entity by using a journal entry.
c)
Present the relevant balances in the appropriate financial statements of AC Entity for the
reporting period ended 31 December 20.7. Disclose only the note to the line item “Property,
plant and equipment”.
Example 12.10 Solution
a) Depreciation expense for 20.7
J1
20.7
30 Jun
J2
20.7
31 Dec
Depreciation – machinery (P/L)
Accumulated depreciation – machinery (SFP)
Recognise depreciation on scrapped machine for 20.7
R750 000 ÷ 10 x 6/12 = R37 500
Depreciation – machinery (P/L)
Accumulated depreciation – machinery (SFP)
Recognise depreciation on rest of machinery for 20.7
R135 000 = (R2 100 000 – R750 000) ÷ 10
Dr
37 500
Cr
37 500
Dr
135 000
Cr
135 000
b) Derecognise scrapped machine
J1
20.7
30 Jun
Accumulated depreciation – machinery (SFP)
Machinery (SFP)
Proceeds from sale of scrap (P/L)
Loss on disposal of machinery (P/L)
Derecognise scrapped machine and recognise loss on
scrapping
R375 000 = R337 500 + R37 500
Dr
375 000
Cr
750 000
7 000
368 000
If the asset derecognition account was used, the journal entries would have been as follows:
J1
20.7
30 Jun
Accumulated depreciation – machinery (SFP)
Machinery (SFP)
Asset derecognition account (SFP)
Derecognise cost price and accumulated depreciation of
scrapped machine
443
Dr
375 000
Cr
750 000
375 000
J2
20.7
30 Jun
J3
20.7
30 Jun
Proceeds from sale of scrap (P/L)
Asset derecognition account (SFP)
Close off proceeds from the sale of scrap material in respect
of scrapped machine against the asset derecognition account
Loss on disposal of machinery (P/L)
Asset derecognition account (SFP)
Recognise loss on scrapping of machine
Dr
7 000
Cr
7 000
Dr
368 000
Cr
368 000
If the proceeds from the sale of scrap have not yet been recognised and the amount of R8 050 was
received on 30 June 20.7 by means of an electronic funds transfer, the journal entries in respect of
the derecognition of the machine that was scrapped on 30 June 20.7, would have been as follows:
J1
20.7
30 Jun
J2
20.7
30 Jun
Depreciation – machinery (P/L)
Accumulated depreciation – machinery (SFP)
Recognise depreciation on scrapped machine for 20.7
R750 000 ÷ 10 x 6/12 = R37 500
Accumulated depreciation – machinery (SFP)
Machinery (SFP)
Bank (SFP)
VAT output (SFP)
Loss on disposal of machinery (P/L)
Derecognise scrapped machine and recognise loss on
scrapping
R375 000 = R337 500 + R37 500
Dr
37 500
Cr
37 500
Dr
375 000
Cr
750 000
8 050
1 050
368 000
If the asset derecognition account was used, the journal entries would have been as follows:
J1
20.7
30 Jun
Accumulated depreciation – machinery (SFP)
Machinery (SFP)
Asset derecognition account (SFP)
Derecognise cost price and accumulated depreciation of
scrapped machine
444
Dr
375 000
Cr
750 000
375 000
J2
20.7
30 Jun
J3
20.7
30 Jun
Bank (SFP)
VAT output (SFP)
Asset derecognition account (SFP)
Recognise proceeds from the sale of scrap in respect of the
scrapped machine
Loss on disposal of machinery (P/L)
Asset derecognition account (SFP)
Recognise loss on scrapping of machine
Dr
8 050
Cr
1 050
7 000
Dr
368 000
Cr
368 000
c) Presentation and disclosure in the financial statements
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Note
///
Gross profit
////
Loss on disposal of property, plant and equipment
Depreciation (dr 37 500 dr 135 000)
Profit for the year
R
xxx
(368 000)
(172 500)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
ASSETS
Non-current assets
Property, plant and equipment
5
445
20.7
R
607 500
AC ENTITY
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
5
Property, plant and equipment
Land
R
Buildings
R
Carrying amount beginning of year
Gross carrying amount
Accumulated depreciation
Machinery
R
1 155 000
2 100 000
(945 000)
Additions – purchased
Total
R
1 155 000
2 100 000
(945 000)
0
0
Disposal at carrying amount
Gross carrying amount
Accumulated depreciation
(375 000)
(750 000)
375 000
(375 000)
(750 000)
375 000
Depreciation
(172 500)
(172 500)
1 350 000
(742 500)
607 500
1 350 000
(742 500)
607 500
Gross carrying amount
Accumulated depreciation
Carrying amount end of year
Example 12.11 Donation of computer equipment to an institution
The current reporting date of AC Entity, who is a registered VAT vendor, is 31 December 20.7.
On 31 December 20.7 the following balances, amongst others, appeared in the records of the
entity:
Land
Buildings at cost price
Accumulated depreciation – buildings
Computer equipment at cost price
Accumulated depreciation – computer equipment
Depreciation – buildings
Depreciation – computer equipment
Dr
850 000
2 100 000
Cr
560 000
975 000
414 375
70 000
170 625
Additional information
No depreciation is written off on land.
The cost of buildings is allocated to the depreciation expense over the estimated useful life of the
buildings (30 years) by using the straight-line method. No residual value is accounted for.
The cost of computer equipment is allocated to the depreciation expense over the estimated useful
life of the equipment (4 years) by using the straight-line method and by accounting for residual
values.
446
On 31 December 20.7, computer equipment with a cost price of R180 000 and accumulated
depreciation of R157 500 on that date was donated to a local school. (This transaction has already
been correctly recognised.)
During 20.7, computer equipment was purchased from a registered VAT vendor at a purchase
price of R258 750 (including VAT). (This transaction has already been correctly recognised.) No
other PPE items were purchased or sold during 20.7.
Required:
a)
Provide the necessary journal entry (entries) that would have been recorded to derecognise a
portion of the computer equipment in the records of AC Entity on 31 December 20.7.
b)
Present and disclose the relevant balances in the appropriate financial statements of
AC Entity for the reporting period ended 31 December 20.7.
Example 12.11 Solution
a) Journal entry for derecognition
J1
20.7
31 Dec
Accumulated depreciation – computer equipment (SFP)
Computer equipment (SFP)
VAT output (SFP)
Loss on disposal of computer equipment (P/L)
Derecognise cost price and accumulated depreciation of
computer equipment donated to school
3 375 = (180 000 – 157 500 = 22 500) x 15/100
Dr
157 500
Cr
180 000
3 375
25 875
If the asset derecognition account was used, the journal entries would have been as follows:
J1
20.7
Dr
Cr
31 Dec Accumulated depreciation – computer equipment (SFP)
157 500
Computer equipment (SFP)
180 000
Asset derecognition account (SFP)
22 500
Derecognise cost price and accumulated depreciation of
computer equipment donated
J2
20.7
31 Dec
Loss on disposal of computer equipment (P/L)
VAT output (SFP)
Asset derecognition account (SFP)
Recognise donation of computer equipment to school
447
Dr
25 875
Cr
3 375
22 500
b) Presentation and disclosure
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Note
Gross profit
////
Loss on disposal of property, plant and equipment
Depreciation (dr 70 000 dr 170 625)
Profit for the year
R
Xxx
(25 875)
(240 625)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
20.7
R
ASSETS
Non-current assets
Property, plant and equipment
5
2 950 625
AC ENTITY
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
1
ACCOUNTING POLICY
Property, plant and equipment
Each item of property, plant and equipment is initially recognised as an asset if it is probable
that future economic benefits associated with the item will flow to the entity, and the cost of
the item can be measured reliably. Each item that qualifies for recognition is initially
measured at cost, being the cash equivalent of the purchase price and any costs directly
attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.
Land is shown at cost price. Subsequent to initial recognition, buildings, plant and equipment
are stated at cost less accumulated depreciation and less accumulated impairment losses.
Depreciation is charged so as to allocate the cost of assets less their estimated residual
values over their estimated useful lives to an expense. The following depreciation methods
and annual rates (where applicable) are used to depreciate property, plant and equipment:
Buildings
3.33%
Computer equipment
25%
If there is an indication that there has been a significant change in the useful life, residual
value or in the utilisation pattern of assets, the depreciation is revised prospectively to reflect
the new estimates.
448
5
Property, plant and equipment
Land
Carrying amount beginning of year
Gross carrying amount
Accumulated depreciation
Buildings
Computer
equipment
R
R
1 610 000
528 750
2 100 000
930 000
(490 000)
(401 250)
R
850 000
850 000
Additions – purchased
Gross carrying amount
Accumulated depreciation
Carrying amount end of year
850 000
850 000
R
2 988 750
3 880 000
(891 250)
225 000
225 000
(22 500)
(180 000)
157 500
(22 500)
(180 000)
157 500
(70 000)
(170 625)
(240 625)
2 100 000
(560 000)
1 540 000
975 000
(414 375)
560 625
3 925 000
(974 375)
2 950 625
Disposal at carrying amount
Gross carrying amount
Accumulated depreciation
Depreciation
Total
Trade-in of a PPE item
55
When a new PPE item is purchased, it can happen that the old PPE item is traded in. A value
is therefore placed on the old PPE item which reduces the amount owed on the new PPE
item. The traded-in PPE item must be derecognised completely and the new PPE item must
be recognised in full.
Example 12.12 Trade-in of a PPE item
The current reporting date of AC Entity, a registered VAT vendor, is 31 December 20.7. On 1
January 20.7, the entity’s accounting records reflected the following balances, amongst others:
Dr
2 850 000
Earth moving machinery at cost price
Accumulated depreciation – earth moving machinery
Trucks at cost price
Accumulated depreciation – trucks
Furniture and equipment at cost price
Accumulated depreciation – furniture and equipment
Cr
1 371 600
1 050 000
714 750
464 000
178 640
Earth moving machinery
The following information was obtained from the asset register on 1 January 20.7:
Earth moving
machinery
Machine A
Machine B
Cost price
31 Dec 20.6
Residual value
(excluding VAT)
1 350 000
1 500 000
2 850 000
270 000
300 000
449
Useful life
2 000 working hours
2 000 working hours
Accumulated
depreciation
31 Dec 20.6
291 600
1 080 000
1 371 600
Earth moving machinery is depreciated on the hours utilised method. It is estimated that the
machinery can each be used for 2 000 hours. During 20.7, machine A was used for 550 hours and
machine B for 200 hours.
On 1 July 20.7, machine B was traded-in for machine C, which was delivered and also available for
use as intended by the owner on this day. For purposes of the trade-in transaction, a trade-in credit
to the amount of R373 750 (including VAT) was agreed upon. The cost price of machine C was
R1 840 000 (including VAT) and the appropriate amount was paid on 31 July 20.7.
It was estimated that machine C could also be used for 2 000 hours and for 20.7, this machine was
used for 300 hours. The residual value of machine C was estimated at R320 000 (excluding VAT).
Trucks
The following information was obtained from the asset register on 1 January 20.7:
Trucks
Cost price
31 Dec 20.6
Residual value
(excluding VAT)
Truck A
Truck B
520 000
530 000
1 050 000
50 000
51 000
Useful life
5 years
5 years
Accumulated
depreciation
31 Dec 20.6
392 450
322 300
714 750
No trucks were purchased or sold during the year.
The cost of trucks is allocated to the depreciation expense over the estimated useful life of the
trucks (5 years) by using the diminishing balance method. The annual depreciation rate is 37.4%.
At the end of the fifth year the rate of 37.4% will produce the following residual values: Truck A R49
989 and Truck B R50 950).
Furniture and equipment
No furniture or equipment was purchased or sold during the year.
The cost of furniture and equipment is allocated to the depreciation expense over the estimated
useful life of the equipment (10 years) by using the straight-line method. No residual value is
accounted for.
Required:
a)
Provide journal entries to recognise the depreciation expense for 20.7 in the records (general
journal) of AC Entity.
b)
Provide the necessary journal entries to derecognise machine B on 1 July 20.7 and to
recognise machine C in the records (general journal) of AC Entity.
c)
Present and disclose the relevant balances in the appropriate financial statements of
AC Entity for the reporting period ended 31 December 20.7.
450
Example 12.12 Solution
Calculations
Depreciation – 20.7
Machine A
Machine B
Machine C
Truck A
Truck B
Furniture and equipment
R
297 000
120 000
192 000
47 704
77 680
46 400
780 784
(R1 350 000 – R270 000) x 550/2 000
(R1 500 000 – R300 000) x 200/2 000
((R1 840 000 x 100/115) – R320 000) x 300/2 000
(R520 000 – R392 450) x 37.4%
(R530 000 – R322 300) x 37.4%
R464 000 ÷ 10
Profit on trade-in of Machine B
R
Trade-in credit (R373 750 x 100/115)
Carrying amount of machine B on 30 June 20.7
Cost price
Accumulated depreciation (R1 080 000 + R120 000)
Profit on trade-in of PPE item
R
325 000
300 000
1 500 000
(1 200 000)
25 000
a) Journal entries – depreciation for 20.7
J1
20.7
31 Dec
J2
20.7
31 Dec
Depreciation – earth moving machinery (P/L)
Accumulated depreciation – earth moving machinery (SFP)
Recognise depreciation on machine B for 20.7
Depreciation – earth moving machinery (P/L)
Accumulated depreciation – earth moving machinery (SFP)
Depreciation – trucks (P/L)
Accumulated depreciation – trucks (SFP)
Depreciation – furniture and equipment (P/L)
Accumulated depreciation – furniture and equipment (SFP)
Recognise depreciation (on machines A and C) for 20.7
451
Dr
120 000
Cr
120 000
Dr
489 000
Cr
489 000
125 384
125 384
46 400
46 400
b) Journal entries – derecognition of machine B and recognition of machine C
J1
20.7
1 Jul
Accumulated depreciation – earth moving machinery (SFP)
Earth moving machinery (SFP)
Earth moving machinery (SFP) (1 840 000 x 100/115)
VAT input (SFP) (1 840 000 x 15/115)
Vat output (SFP) (373 750 x 15/115)
Payable (SFP) (1 840 000 – 373 750)
Profit on disposal of PPE item (P/L)
Derecognise cost price and accumulated depreciation of
machine B traded-in, recognise machine C as well as profit
on trade-in
Dr
1 200 000
Cr
1 500 000
1 600 000
240 000
48 750
1 466 250
25 000
If the asset derecognition account is used to recognise the trade-in, the journal entries are as
follows:
J1.1
20.7
1 Jul
J1.2
20.7
1 Jul
J1.3
20.7
1 Jul
Accumulated depreciation – earth moving machinery (SFP)
Earth moving machinery (SFP)
Asset derecognition account (SFP)
Derecognise cost price and accumulated depreciation of
machine B
Earth moving machinery (SFP) (1 840 000 x 100/115)
VAT input (SFP) (1 840 000 x 15/115)
Vat output (SFP) (373 750 x 15/115)
Payable (SFP) (1 840 000 – 373 750)
Asset derecognition account (SFP)
Recognise machine C purchased
Asset derecognition account (SFP)
Profit on disposal of PPE item (P/L)
Recognise profit on trade-in of machine B on machine C
452
Dr
1 200 000
Cr
1 500 000
300 000
Dr
1 600 000
240 000
Cr
48 750
1 466 250
325 000
Dr
25 000
Cr
25 000
c) Presentation and disclosure in the financial statements
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Note
///
Gross profit
Profit on disposal of property, plant and equipment
////
Depreciation
Profit for the year
R
xxx
25 000
(780 784)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
20.7
R
ASSETS
Non-current assets
Property, plant and equipment
5
2 618 226
AC ENTITY
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
1
ACCOUNTING POLICY
Property, plant and equipment
Each item of property, plant and equipment is initially recognised as an asset if it is probable
that future economic benefits associated with the item will flow to the entity, and the cost of
the item can be measured reliably. Each item that qualifies for recognition is initially
measured at cost, being the cash equivalent of the purchase price and any costs directly
attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.
Land is shown at cost price. Subsequent to initial recognition, buildings, plant and equipment
are stated at cost less accumulated depreciation and less accumulated impairment losses.
Depreciation is charged so as to allocate the cost of assets less their estimated residual
values over their estimated useful lives to an expense. The following depreciation methods
and annual rates (where applicable) are used to depreciate property, plant and equipment:
Earth moving machinery – hours used method
Trucks – diminishing balance method
37.4%
Furniture and equipment – straight-line method
10%
If there is an indication that there has been a significant change in the useful life, residual
value or in the utilisation pattern of assets, the depreciation is revised prospectively to reflect
the new estimates.
453
5
Property, plant and equipment
Machinery
Carrying amount beginning of year
Gross carrying amount
Accumulated depreciation
Additions – purchased
Disposal at carrying amount
Gross carrying amount
Accumulated depreciation
R
1 478 400
2 850 000
(1 371 600)
Trucks
Furniture and
equipment
R
R
335 250
285 360
1 050 000
464 000
(714 750)
(178 640)
Total
R
2 099 010
4 364 000
(2 264 990)
1 600 000
1 600 000
(300 000)
(1 500 000)
1 200 000
(300 000)
(1 500 000)
1 200 000
Depreciation
(609 000)
(125 384)
(46 400)
(780 784)
Gross carrying amount
Accumulated depreciation
Carrying amount end of year
2 950 000
(780 600)
2 169 400
1 050 000
(840 134)
209 866
464 000
(225 040)
238 960
4 464 000
(1 845 774)
2 618 226
Impairment of assets
56
A PPE item is recognised in the accounting records if it satisfies the definition and recognition
criteria of an asset. The PPE item is initially measured at the cash purchase price as well as
any costs that are directly attributable to bringing the PPE item to the location and condition
necessary for it to be capable of operating in the manner intended by management. The
subsequent measurement of a PPE item (excluding land) occurs in this work at cost price
less accumulated depreciation and less accumulated impairment, if applicable.
57
The extent of the annual depreciation expense and therefore also the accumulated
depreciation is influenced by three aspects, namely the useful life of the PPE item, the
expected residual value of the PPE item and the depreciation method. The objective of
accounting for depreciation is only to allocate the depreciable amount (original cost price less
estimated residual value) of a PPE item over the useful life thereof to a depreciation expense
for each of the reporting periods (as covered by the useful life). The depreciation expense is,
together with the other expenses, accounted for in the statement of profit or loss against the
income for the relevant reporting period. The depreciable amount of an asset is therefore
recouped against income through the depreciation expense. The estimated residual value is
recouped during the disposal of the PPE item.
58
The cost price less accumulated depreciation on a specific reporting date therefore does not
represent the value of the relevant item, but only the portion of the depreciable amount that
still has to be allocated as an expense in the subsequent reporting periods. The estimated
useful life, estimated residual value and the depreciation method are reviewed on each
reporting date and if there is a significant change in any of these, it is dealt with as a change
in an accounting estimate. Estimates are an integral part of Accounting and are not indicative
of an error, but indicate that a previous estimate must be adjusted due to new circumstances.
Despite this annual review of estimates, the cost price less accumulated depreciation still
454
represents only the depreciable amount that must be allocated as an expense in the
subsequent reporting periods.
59
Although the statement of financial position does not reflect the value of an entity, a
procedure is followed in Accounting on each reporting date to ensure that the carrying
amount of a PPE item will indeed be recovered through the operating activities of the entity.
Consequently, the IASB accepted IAS 36 Impairment of assets. The main objective of IAS 36
Impairment of assets is to establish procedures that can be used to ensure that the carrying
amount of a PPE item is not overstated.
60
At each reporting date property, plant and equipment are reviewed to determine whether
there is any indication that those assets have suffered an impairment loss. If there is an
indication of possible impairment, the recoverable amount of any affected asset is estimated
and compared with the carrying amount thereof.
61
An entity should at least consider the following indicators in order to determine whether PPE
items are subject to impairment:
External sources of information
•
During the reporting period, the market value of the PPE item declined significantly
more than what would normally have been the case.
•
Significant changes with a negative effect on the entity occurred during the reporting
period (or will occur in the near future) in the technological, market or economic
environment in which the entity operates.
•
Market related interest rates increased during the reporting period causing the discount
rate, which is used in the calculation of the PPE item’s value in use, to also increase.
The higher discount rate produces a lower value in use and therefore also a lower
recoverable amount for the item.
Internal sources of information
•
Evidence in respect of physical damage or obsolescence of the PPE item becomes
available.
•
Significant changes with a negative effect on the entity occurred during the reporting
period (or will occur in the near future) in the extent to which or the manner in which the
asset is used. For example, the item can be idle for considerable periods.
•
Information contained in internal reports indicates that the economic performance of the
item is worse than expected. (IAS 36.12)
62
If consideration of the abovementioned indicators reflects that the value of a PPE item
possibly declined, the recoverable amount of the PPE item must be calculated.
63
The following definitions as contained in IAS 36.6 form the basis of the impairment approach:
•
The recoverable amount of a PPE item is the higher of its fair value less costs to sell
and its value in use.
•
The value in use of a PPE item is the present value of the future cash flows expected
to be derived from an asset. Fair value less costs to sell is the price that would be
received to sell a PPE item in an orderly transaction between market participants at the
measurement date after deducting costs to sell the PPE item.
•
Carrying amount is the cost price less accumulated depreciation and less accumulated
impairment, if applicable.
455
•
Impairment loss is the amount with which the carrying amount of an asset exceeds its
recoverable amount.
64
If the recoverable amount of an asset is less than the carrying amount thereof, the carrying
amount of the asset must be reduced to the recoverable amount. The impairment loss must
be recognised immediately in profit or loss. (IAS 36.59 and 36.60). In this work the
recoverable amount of an asset, where applicable, will be provided.
65
An impairment loss is recognised as at the reporting date by means of the following journal
entry:
Dr
Cr
Impairment loss (P/L)
Accumulated impairment (SFP)
66
The accumulated impairment account is, just as the accumulated depreciation account, in
essence part of the credit side of the relevant PPE item. An accumulated depreciation and
accumulated impairment account can therefore exist in respect of a specific PPE item.
67
Future depreciation is calculated based on the reviewed carrying amount less the residual
value (if any) and with reference to the remaining useful life. The calculation of the current
reporting period’s depreciation expense is not influenced by an impairment loss that was
recognised in the current year.
68
If an impairment loss is recognised on a PPE item, the depreciation method and the residual
value should be reconsidered and, if necessary, altered. (In this work, the recognition of an
impairment loss will not be combined with a change in useful life, residual value or
depreciation method).
Example 12.13 Impairment
On 1 January 20.7, AC Entity owned inter alia the following machinery item:
Cost price (useful life 5 years and residual value nil)
Accumulated depreciation (on the straight-line method)
R
600 000
120 000
During December 20.7, it was determined that the recoverable amount of the machinery item was
only R200 000. The impairment must be recognised on 31 December 20.7. On the same day, the
remaining useful life of the machinery was confirmed as three years and the depreciation method
was still deemed to be appropriate.
Required:
a)
Recognise the depreciation expense as well as the impairment in the records (general
journal) of AC Entity for the reporting periods ended 31 December 20.7 and 31 December
20.8.
b)
Present and disclose the relevant balances in the financial statements of AC Entity for the
reporting periods ended 31 December 20.7 and 31 December 20.8.
Note: The note to property, plant and equipment is required only for 20.7.
c)
Calculate the amount of the accumulated depreciation and accumulated impairment as at
31 December 20.8.
456
Example 12.13 Solution
a) Journal entries – 31 December 20.7
J1
20.7
31 Dec
J2
20.7
31 Dec
Dr
120 000
Depreciation – machinery (P/L)
Accumulated depreciation – machinery (SFP)
Recognise depreciation on machinery for 20.7
Cr
120 000
Dr
160 000
Impairment loss (P/L)
Accumulated impairment – machinery (SFP)
Recognise impairment on machinery for 20.7
Cr
160 000
Remarks in respect of the above journal
1
Calculation of impairment:
R
Carrying amount of machinery on 31 Dec 20.7
(600 000 – (120 000 + 120 000))
Recoverable amount on 31 December 20.7
Impairment loss
2
360 000
(200 000)
160 000
On 31 December 20.7, the recoverable amount was compared with the carrying
amount on this date. Consequently, as in journal J1 above, the depreciation expense
for 20.7 first has to be recognised after which the impairment loss can be determined.
The impairment loss is included in the statement of profit or loss for 20.7.
a) Journal entries – 31 December 20.8
J1
20.8
31 Dec
Depreciation – machinery (P/L)
Accumulated depreciation – machinery (SFP)
Recognise depreciation on machinery for 20.8
R200 000 ÷ 3 = R66 667
Dr
66 667
Cr
66 667
Remark in respect of the above journal
1
The calculation of the depreciation for 20.8 is based on the remaining useful life. Refer
to paragraph 67 above.
457
b) Presentation and disclosure
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.8
`
///
Gross profit
////
Depreciation
Impairment loss
Profit for the year
Note
20.8
R
20.7
R
xxx
(66 667)
XXX
xxx
(120 000)
(160 000)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.8
Note
ASSETS
Non-current assets
Property, plant and equipment (20.8 dr 200 000 cr 66 667)
5
20.8
R
20.7
R
133 333
200 000
AC ENTITY
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
1
ACCOUNTING POLICY
Property, plant and equipment
Each item of property, plant and equipment is initially recognised as an asset if it is probable
that future economic benefits associated with the item will flow to the entity, and the cost of
the item can be measured reliably. Each item that qualifies for recognition is initially
measured at cost, being the cash equivalent of the purchase price and any costs directly
attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.
Land is shown at cost price. Subsequent to initial recognition, buildings, plant and equipment
are stated at cost less accumulated depreciation and less accumulated impairment losses.
Depreciation is charged so as to allocate the cost of assets less the estimated residual values
thereof over the estimated useful lives to an expense. The following depreciation methods
and annual rates (where applicable) are used to depreciate property, plant and equipment:
Machinery – straight-line method
20%
If there is an indication that there has been a significant change in the useful life, residual
value or in the utilisation pattern of assets, the depreciation is revised prospectively to reflect
the new estimates.
Impairment of property, plant and equipment
At each reporting date property, plant and equipment are reviewed to determine whether
there is any indication that those assets have suffered an impairment loss. If there is an
indication of possible impairment, the recoverable amount of any affected asset is estimated
458
and compared with the carrying amount thereof. If the estimated recoverable amount is
lower, the carrying amount is reduced to the estimated recoverable amount thereof and an
impairment loss is recognised immediately.
5
Property, plant and equipment – 20.7
Machinery
R
480 000
600 000
(120 000)
Total
R
480 000
600 000
(120 000)
Depreciation
(120 000)
(120 000)
Impairment
(160 000)
(160 000)
Gross carrying amount
Accumulated depreciation
Accumulated impairment
Carrying amount end of the year
600 000
(240 000)
(160 000)
200 000
600 000
(240 000)
(160 000)
200 000
Carrying amount beginning of year
Gross carrying amount
Accumulated depreciation
c) Accumulated depreciation and accumulated impairment as at 31 Dec 20.8
R
306 667
160 000
Accumulated depreciation (240 000 + 66 667)
Accumulated impairment loss (160 000 + 0)
Losses and compensation from an insurer
69
An entity can, by means of an insurance contract, hedge the risk of losses caused by events
such as theft, accidents and acts of nature (earth quakes, floods, etc.). The cost associated
with the insurance contract is the monthly insurance premium which is recognised as an
expense in the reporting period to which it relates.
70
Certain PPE items are, due to their specific nature, insured at replacement value, for example
buildings. Other items, in respect of which market values for used items are available, for
example vehicles, are insured at market value. If market values of used items are not
available, the items, for example machinery, are insured at replacement value. The insurer
determines the amount of the claim.
71
The loss suffered in respect of an asset as a result of events such as a fire, theft or acts of
nature, is recognised as soon as the amount arising from the event can be measured reliably.
72
The compensation from the insurer is recognised as soon as the amount from the insurer
becomes receivable, in other words the date on which the insurer notifies the entity of the
extent of the amount that will be paid.
73
The loss suffered and the compensation from the insurer is not off-set against each other, but
is a separate expense and a separate income item (a non-operating income).
459
Example 12.14 Trade-in and compensation for loss
On 1 January 20.7 the following balances, amongst others, appeared in the records of AC Entity:
Delivery vehicles at cost price
Accumulated depreciation – delivery vehicles (on the straight-line method)
R
1 550 000
796 000
The following detail of the delivery vehicles were obtained from the asset register as at
31 December 20.6:
Cost price
Truck A
Truck B
750 000
800 000
1 550 000
Residual value
(excluding VAT)
150 000
160 000
Useful life
5
5
Accumulated Depreciation
31 Dec 20.6
540 000
256 000
796 000
On 1 July 20.7, truck A was traded in on a new vehicle, truck C, with a purchase price of R977 500
(including VAT). The trade-in credit (trade-in value) of truck A was set at R178 250 (including VAT).
The amount due was paid on 1 July 20.7 and on this day, truck C was put into service. The
estimated useful life of truck C is 5 years and the estimated residual value is R170 000.
On 1 December 20.7, truck B was stolen. In this regard, the insurer paid R455 400 to AC Entity on
27 December 20.7. On 4 December 20.7, a replacing vehicle, truck D, was ordered at R1 121 250
(including VAT) and on 31 December 20.7 this truck was put into service and the amount was paid.
Required:
a)
Recognise the abovementioned transactions and events in the records (general journal) of
AC Entity for the reporting period ended 31 December 20.7.
b)
Present and disclose the relevant balances in the financial statements of AC Entity for the
reporting period ended 31 December 20.7.
460
Example 12.14 Solution
Calculations
R
1. Depreciation for 20.7
Truck A
(R750 000 – R150 000) ÷ 5 x 6/12
Truck B
(R800 000 – R160 000) ÷ 5 x 11/12
Truck C
((R977 500 x 100/115) – R170 000) ÷ 5 x 6/12
Truck D
60 000
117 333
68 000
0
245 333
2. Profit or loss with trade-in
Carrying amount of truck A on 1 July 20.7:
R750 000 – (R540 000 + R60 000)
Trade-in credit of truck A on 1 July 20.7
R178 250 x 100/115
Thus: profit with trade-in
Trade-in credit (R155 000) – Carrying amount (R150 000)
150 000
155 000
5 000
3. Amount paid to supplier on 1 July 20.7
Invoice amount in respect of truck C (including VAT)
Less: trade-in credit in respect of truck A (including VAT)
977 500
(178 250)
799 250
4. Carrying amount of truck B on 1 December 20.7
R800 000 – (R256 000 + R117 333)
426 667
5. Insurance compensation received iro truck B on 27 December 20.7
R455 400 x 100/115
396 000
6. Cost price of truck D
R1 121 250 x 100/115
975 000
a) Journal entries
J1
20.7
1 Jul
Depreciation – delivery vehicles (P/L)
Accumulated depreciation – delivery vehicles (SFP)
Recognise depreciation on truck A for 20.7
461
Dr
60 000
Cr
60 000
J2
20.7
1 Jul
Accumulated depreciation – delivery vehicles (SFP)
Delivery vehicles (SFP)
Delivery vehicles (SFP) (977 500 x 100/115)
VAT input (SFP) (977 500 x 15/115)
VAT output (SFP) (178 250 X 15/115)
Bank (SFP) (977 500 – 178 250)
Profit on disposal of PPE item (P/L)
Derecognise cost price and accumulated depreciation of
truck A traded-in and recognise purchase of truck C as well
as profit on trade-in
Dr
600 000
Cr
750 000
850 000
127 500
23 250
799 250
5 000
If the asset derecognition account was used to recognise the trade-in, the journals would have
been as follows:
J2.1
20.7
1 Jul
J2.2
20.7
1 Jul
J2.3
20.7
1 Jul
J3
20.7
1 Dec
Accumulated depreciation – delivery vehicles (SFP)
Delivery vehicles (SFP)
Asset derecognition account (SFP)
Derecognise truck A traded in
Delivery vehicles (SFP) (977 500 x 100/115)
VAT input (SFP) (977 500 x 15/115)
Bank (SFP) (977 500 – 178 250)
Asset derecognition account (SFP) (178 250 x 100/115)
VAT output (SFP) (178 250 x 15/115)
Recognise truck C purchased
Dr
600 000
750 000
150 000
Dr
850 000
127 500
Cr
799 250
155 000
23 250
Dr
5 000
Asset derecognition account (SFP)
Profit on disposal of PPE item (P/L)
Recognise profit on truck traded in
Cr
Cr
5 000
Depreciation – delivery vehicles (P/L)
Accumulated depreciation – delivery vehicles (SFP)
Recognise depreciation on truck B for 20.7
462
Dr
117 333
Cr
117 333
J4
20.7
1 Dec
Loss with theft of delivery vehicle (P/L)
Accumulated depreciation – delivery vehicles (SFP)
Delivery vehicles (SFP)
Derecognise stolen truck B
373 333 = 256 000 + 117 333
J5
20.7
27 Dec Bank (SFP)
VAT output (SFP)
Insurance compensation (P/L)
Recognise compensation received from insurer
J6
20.7
31 Dec Delivery vehicles (SFP)
VAT input (SFP)
Bank (SFP)
Recognise truck D purchased
Dr
426 667
373 333
Cr
800 000
Dr
455 400
Cr
59 400
396 000
Dr
975 000
146 250
Cr
1 121 250
J7
20.7
31 Dec Depreciation – delivery vehicles (P/L)
Accumulated depreciation – delivery vehicles (SFP)
Recognise depreciation on truck C for 20.7
Dr
68 000
Cr
68 000
b) Presentation and Disclosure
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
Note
///
Gross profit
Insurance compensation – theft of delivery vehicle
Profit on disposal of property, plant and equipment
////
Depreciation
Loss due to theft of delivery vehicle
Profit for the year
463
20.7
R
xxx
396 000
5 000
(245 333)
(426 667)
XXX
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
ASSETS
Non-current assets
Property, plant and equipment
5
20.7
R
1 757 000
AC ENTITY
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
1
ACCOUNTING POLICY
Property, plant and equipment
Each item of property, plant and equipment is initially recognised as an asset if it is probable
that future economic benefits associated with the item will flow to the entity, and the cost of
the item can be measured reliably. Each item that qualifies for recognition is initially
measured at cost, being the cash equivalent of the purchase price and any costs directly
attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.
Land is shown at cost price. Subsequent to initial recognition, buildings, plant and equipment
are stated at cost less accumulated depreciation and less accumulated impairment losses.
Depreciation is charged so as to allocate the cost of assets less the estimated residual values
thereof over the estimated useful lives to an expense. The following depreciation methods
and annual rates (where applicable) are used to depreciate property, plant and equipment:
Delivery vehicles
20% per year on the straight-line method
If there is an indication that there has been a significant change in the useful life, residual
value or in the utilisation pattern of assets, the depreciation is revised prospectively to reflect
the new estimates.
Impairment of property, plant and equipment
At each reporting date property, plant and equipment are reviewed to determine whether
there is any indication that those assets have suffered an impairment loss. If there is an
indication of possible impairment, the recoverable amount of any affected asset is estimated
and compared with the carrying amount thereof. If the estimated recoverable amount is
lower, the carrying amount is reduced to the estimated recoverable amount thereof and an
impairment loss is recognised immediately.
464
5
Property, plant and equipment
Carrying amount beginning of year
Gross carrying amount
Accumulated depreciation
Additions – purchased (850 000 + 975 000)
Delivery
vehicles
R
754 000
1 550 000
(796 000)
Total
R
754 000
1 550 000
(796 000)
1 825 000
1 825 000
Disposal at carrying amount
Gross carrying amount
Accumulated depreciation
(150 000)
(750 000)
600 000
(150 000)
(750 000)
600 000
Derecognition at carrying amount
Gross carrying amount
Accumulated depreciation
(426 667)
(800 000)
373 333
(426 667)
(800 000)
373 333
Depreciation
(245 333)
(245 333)
1 825 000
(68 000)
1 825 000
(68 000)
1 757 000
1 757 000
Impairment
Gross carrying amount (1 550 000 + 1 825 000 – 750 000 – 800 000)
Accumulated depreciation (796 000 – 600 000 – 373 333 + 245 333)
Accumulated impairment
Carrying amount end of the year
Miscellaneous aspects
74
Subsequently, attention will be paid to the recognition of costs incurred after the initial
acquisition of the PPE item as well as to the asset register as subsidiary record that supports
the balances of PPE items in the general ledger.
75
The costs associated with the day to day maintenance of a PPE item are recognised as an
expense when the expense is incurred. Or stated differently, the costs associated with the
day to day maintenance of a PPE item are recognised in the profit or loss of the reporting
period in which the costs were incurred.
The component approach
76
The majority of PPE items are recognised as a unit and depreciated as a unit.
77
There are however PPE items that are purchased as a unit, but of which the utilisation of the
economic benefits in respect of important identifiable components, reflect significantly
different patterns. An example is an item such as a blast-furnace which is used to melt iron
ore. On the inside of the blast-furnace is a special lining that protects the rest of the blastfurnace against the heat. The lining is often replaced, say every three years, but the rest of
the blast-furnace has a relatively long useful life. (IAS 16.13)
78
If a PPE item is purchased as a unit, but consists of identifiable components, of which the
pattern of economic utilisation differs significantly, each component must be recognised
465
separately as an appropriate part of the cost of the unit. The different components will then
be appropriately depreciated differently. (IAS 16.43)
Example 12.15 Component approach with initial recognition
On 1 January 20.7 the following balances, amongst others, appeared in the records of AC Entity:
Blast-furnace – cost price
Accumulated depreciation – blast-furnace
Blast-furnace lining – cost price
Accumulated depreciation – blast-furnace lining
Dr
15 000 000
Cr
2 000 000
5 000 000
3 333 333
Additional information
The blast-furnace was put into service on 1 January 20.5 and has a useful life of 15 years with no
residual value. Depreciation is charged in accordance with the straight-line method. The blastfurnace is shut down annually during December for maintenance purposes.
The lining of the blast-furnace (which was also put into service at 1 January 20.5) is replaced every
third year, during December. In the accounting records, the lining is recognised separate from the
blast-furnace and is depreciated over the useful life of 3 years using the straight-line method. No
residual value is accounted for.
An external contractor, KK Entity, replaced the lining during December 20.7 at a cost of R6 210 000
(including VAT). The replacement was completed on 31 December 20.7 and payment occurred on
18 January 20.8. The new lining must also be depreciated over three years using the straight-line
method. No residual value is accounted for.
Required:
a)
Recognise the depreciation expense in the records (general journal) of AC Entity for the
reporting period ended 31 December 20.7.
b)
Derecognise the old blast-furnace lining and recognise the new blast-furnace lining on
31 December 20.7 in the records (general journal) of AC Entity.
c)
Present and disclose the blast-furnace and the blast-furnace lining in the statement of
financial position of AC Entity as at 31 December 20.7.
Example 12.15 Solution
a) Journal entries – depreciation
J1
20.7
31 Dec Depreciation – blast-furnace (P/L)
Accumulated depreciation – blast-furnace (SFP)
Depreciation – blast-furnace lining (P/L)
Accumulated depreciation – blast-furnace lining (SFP)
Recognise depreciation for 20.7
466
Dr
1 000 000
Cr
1 000 000
1 666 667
1 666 667
b) Derecognise old blast-furnace lining and recognise new blast-furnace lining
J2
20.7
31 Dec Accumulated depreciation – blast-furnace lining (SFP)
Blast-furnace lining (SFP)
Derecognise old blast-furnace lining
J3
20.7
31 Dec Blast-furnace lining (SFP) (6 210 000 x 100/115)
VAT input (SFP)
Payable KK (SFP)
Recognise new blast-furnace lining purchased
Dr
5 000 000
Cr
5 000 000
Dr
5 400 000
810 000
Cr
6 210 000
c) Presentation and Disclosure
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
ASSETS
Non-current assets
Property, plant and equipment
Note
20.7
R
5
17 400 000
AC ENTITY
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
1
ACCOUNTING POLICY
Property, plant and equipment
Each item of property, plant and equipment is initially recognised as an asset if it is probable
that future economic benefits associated with the item will flow to the entity, and the cost of
the item can be measured reliably. Each item that qualifies for recognition is initially
measured at cost, being the cash equivalent of the purchase price and any costs directly
attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.
Land is shown at cost price. Subsequent to initial recognition, buildings, plant and equipment
are stated at cost less accumulated depreciation and less accumulated impairment losses.
Depreciation is charged so as to allocate the cost of assets less the estimated residual values
thereof over the estimated useful lives to an expense. The following depreciation methods
and annual rates (where applicable) are used to depreciate property, plant and equipment:
Blast-furnace
over the useful life of 15 years on the straight-line method
Blast furnace lining
over the useful life of 3 years on the straight-line method
If there is an indication that there has been a significant change in the useful life, residual
value or in the utilisation pattern of assets, the depreciation is revised prospectively to reflect
the new estimates.
467
Impairment of property, plant and equipment
At each reporting date property, plant and equipment are reviewed to determine whether
there is any indication that those assets have suffered an impairment loss. If there is an
indication of possible impairment, the recoverable amount of any affected asset is estimated
and compared with the carrying amount thereof. If the estimated recoverable amount is
lower, the carrying amount is reduced to the estimated recoverable amount thereof and an
impairment loss is recognised immediately.
5
Property, plant and equipment
Plant
R
14 666 667
20 000 000
(5 333 333)
Total
R
14 666 667
20 000 000
(5 333 333)
5 400 000
5 400 000
Disposal at carrying amount
Gross carrying amount
Accumulated depreciation
0
(5 000 000)
5 000 000
0
(5 000 000)
5 000 000
Depreciation (1 000 000 + 1 666 667)
(2 666 667)
(2 666 667)
Gross carrying amount
Accumulated depreciation
Carrying amount end of the year
20 400 000
(3 000 000)
17 400 000
20 400 000
(3 000 000)
17 400 000
Carrying amount beginning of year
Gross carrying amount (15 000 000 + 5 000 000)
Accumulated depreciation (2 000 000 + 3 333 333)
Additions – purchased
The asset register
79
For PPE items such as vehicles, purchases are accumulated in the vehicles account in the
general ledger. The portion of the cost price that has already been allocated to the
depreciation expense is accumulated in the accumulated depreciation account in the general
ledger.
80
The vehicles account and the accumulated depreciation account in the general ledger do not
reflect the detail of the number of vehicles, the cost price per vehicle and the accumulated
depreciation per vehicle. The depreciation expense can also not be calculated by only
referring to the amounts in these general ledger accounts. Consequently, an asset register is
maintained per PPE grouping which could contain the following per unit, for example per
vehicle:
•
Non-financial information such as description, technical numbers, the user, where it is
being used, etc.
•
Financial information such as cost price, accumulated depreciation, accumulated
impairment, depreciation per reporting period, impairment per reporting period, useful
life, depreciation method and maintenance costs. An item such as a blast-furnace and
the lining (refer to Example 12.15) can be disclosed as one item in the PPE note, but
468
are recorded (recognised) in the asset register (accounting records) as two separate
items.
81
The asset register is maintained by a subsidiary system of the accounting system. The
accounts (in the general ledger) and the asset register are maintained simultaneously. The
subsidiary system produces the depreciation per PPE grouping for inclusion in the accounts
in the general ledger.
82
The asset register also makes it possible to regularly perform physical individual asset
counts.
Presentation and disclosure of PPE items in the financial
statements
83
Financial statements comprise the following components:
•
the statement of financial position;
•
the statement of profit or loss;
•
the statement of cash flows;
•
the statement of changes in equity; and
•
notes and additional annexures. (refer Chapter 2.10)
84
With reference to the statement of profit or loss and the statement of financial position, focus
was placed in the preceding chapters on the presentation of line items in these financial
statements. In this chapter the important asset component property, plant and equipment was
dealt with on the basis of IAS 16 Property, Plant and Equipment. A number of new line items
were used in the statement of profit or loss and in the statement of financial position the line
item “Property, plant and equipment” was imported. To comply with the main objective of
financial statements, namely to provide information to the users thereof that is useful for
economic decision making, additional information to the financial statements has been
provided in the form of notes as from Example 12.9.
85
Notes to the financial statements consist of notes about the entity’s accounting policy as well
as other notes.
Notes regarding accounting policy
86
Accounting policy is the specific principles, bases, conventions, rules and practices that an
entity uses when preparing financial statements. These principles, bases, conventions, rules
and practices appear (for purposes of this work) in certain parts of the IFRSs.
87
Sometimes an IFRS allows more than one basis and/or practice in respect of the recognition
and measurement of an item. For example, IAS16.29 allows either the cost model or the
revaluation model in respect of the subsequent measurement of PPE items; IAS 16.62 allows
various depreciation methods in accordance with which the depreciation expense can be
calculated. The bases and practices used by the entity are known as the entity’s accounting
policy and must be disclosed in a note to the financial statements. However, accounting
policy notes do not deal only with choices made, but sometimes also contain basic useful
information.
469
Other notes
88
Apart from the detail in respect of the accounting policy, the IFRSs require that additional
information also be disclosed in notes to the financial statements, for example detail of the
cost price, accumulated depreciation and accumulated impairment at the beginning and at
the end of the reporting period per PPE grouping, as well as detail of the movement/changes
during the reporting period.
Example 12.16 Presentation and disclosure of PPE items in the financial statements
The following example indicates how property, plant and equipment should be presented and
disclosed in the financial statements.
AC ENTITY
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20.7
20.7
Note
R
///
Gross profit
xxx
Insurance compensation – theft of delivery vehicle
50 000
Profit on disposal of property, plant and equipment
25 000
////
Depreciation
(432 000)
Impairment loss
(200 000)
Loss due to theft of delivery vehicle
(25 000)
Profit for the year
XXX
Remarks in respect of the statement of profit or loss
1
Suppose a vehicle with a carrying amount of R30 000 was sold at an amount of
R55 000 (excluding VAT), then a profit on the disposal of PPE of R25 000 arises, as
presented above.
2
Suppose one of the other vehicles with a carrying amount of R25 000 was stolen and
that the insurance company paid an amount of R50 000 (excluding VAT). The
compensation received from the insurer is presented separately as other income and
the carrying amount that is derecognised, is presented separately as a loss.
3
The depreciation expense can also be presented per PPE item.
AC ENTITY
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.7
Note
20.7
R
ASSETS
Non-current assets
Property, plant and equipment
5
470
3 626 200
AC ENTITY
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7
1
ACCOUNTING POLICY
Property, plant and equipment
Each item of property, plant and equipment is initially recognised as an asset if it is probable
that future economic benefits associated with the item will flow to the entity, and the cost of
the item can be measured reliably. Each item that qualifies for recognition is initially
measured at cost, being the cash equivalent of the purchase price and any costs directly
attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.
Land is shown at cost price. Subsequent to initial recognition, buildings, plant and equipment
are stated at cost less accumulated depreciation and less accumulated impairment losses.
Depreciation is charged so as to allocate the cost of assets less the estimated residual values
thereof over the estimated useful lives to an expense. The following depreciation methods
and annual rates (where applicable) are used to depreciate property, plant and equipment:
Land
no depreciation is written off on land
Buildings
2% per year on the straight-line method
Machinery
hours used method
Vehicles
32% per year on the diminishing balance method
If there is an indication that there has been a significant change in the useful life, residual
value or in the utilisation pattern of assets, the depreciation is revised prospectively to reflect
the new estimates.
Impairment of property, plant and equipment
At each reporting date property, plant and equipment are reviewed to determine whether
there is any indication that those assets have suffered an impairment loss. If there is an
indication of possible impairment, the recoverable amount of any affected asset is estimated
and compared with the carrying amount thereof. If the estimated recoverable amount is
lower, the carrying amount is reduced to the estimated recoverable amount thereof and an
impairment loss is recognised immediately.
471
5
Property, plant and equipment
Carrying amount beginning of year
Gross carrying amount
Accumulated depreciation
Accumulated impairment
Land
R
450 200
450 200
Buildings Machinery Vehicles
Total
R
R
R
R
1 620 000 1 200 000
768 000 4 038 200
1 800 000 1 500 000 1 085 000 4 835 200
(180 000) (300 000) (317 000) (797 000)
0
0
0
0
Additions – purchased
275 000
275 000
Disposal at carrying amount
Gross carrying amount
Accumulated depreciation
(30 000)
(150 000)
120 000
(30 000)
(150 000)
120 000
Derecognition at carrying amount
Gross carrying amount
Accumulated depreciation
(25 000)
(300 000)
275 000
Depreciation
(90 000)
Impairment
Gross carrying amount
Accumulated depreciation
Accumulated impairment
Carrying amount end of year
24
450 200
450 200
(150 000)
(192 000)
(432 000)
(200 000)
(200 000)
1 800 000 1 500 000
(270 000) (450 000)
(200 000)
1 530 000
850 000
910 000 4 660 200
(114 000) (834 000)
(200 000)
796 000 3 626 200
Change in estimate
During the year, the estimated remaining useful life of machinery was extended from 3 years
to 4 years. The effect of the change in estimate was to decrease the depreciation expense
with R36 000.
472
Chapter 13 Inventories
Contents
Introduction
Systems to account for trade inventories in the accounting records
The perpetual inventory system
The periodic inventory system
Initial measurement and recognition of trade inventories
Measurement: Elements of the cost of trade inventories
Trade inventories purchased with a loan
Recognition of the purchase of trade inventories
Cost formulas
Specifically identifiable inventory items
Uniform interchangeable units per inventory item
FIFO cost formula
Weighted average cost formula
Retail method
Returns (out) and returns (in): the cost formulas and inventory systems
Returns (out) and the perpetual inventory system
Returns (out) and the periodic inventory system
Returns (in) and the perpetual inventory system
Returns (in) and the periodic inventory system
Inventory shortages, cost formulas and inventory systems
Inventory shortages and the perpetual inventory system
Inventory shortages and the periodic inventory system
Determination of the sales price
Insurance claim and inventory loss due to an event
Insurance of trade inventories against an event
The average clause
Trade inventories on hand on the reporting date
Definition of inventories
Measurement of trade inventories on the reporting date
Presentation and disclosure of inventories items in the financial statements
473
Paragraph
1
4
7
8
19
19
23
24
26
28
30
35
36
37
40
42
43
44
46
47
47
50
51
58
58
68
70
70
73
79
Examples
Example
13.1
13.2
13.3
13.4
13.5
13.6
13.7
13.8
13.9
13.10
13.11
13.12
13.13
13.14
13.15
Perpetual inventory system
Periodic inventory system
Elements of the cost of trade inventories
Trade inventories purchased with a loan
FIFO cost formula and inventory systems
Weighted average cost formula and inventory systems
Determination of sales, cost of sales and gross profit
The retail method
Returns (out), returns (in) and inventory shortages
Gross profit percentage
Loss due to fire and compensation by an insurer under the perpetual inventory
system
Loss due to fire and compensation by an insurer under the periodic inventory
system
Net realisable value per item or per group
Recognition of the write-down of trade inventories to net realisable value under the
periodic inventory system
Presentation and disclosure of PPE and trade inventories in the financial
statements
474
Chapter 13 Inventories
Introduction
1
In this chapter the inventories of a trading entity will mainly be dealt with. The inventories of a
manufacturing entity will be dealt with separately in Chapter 22. In this chapter, various
aspects in respect of inventories will be dealt with, with reference to IAS 2 Inventories.
2
As previously indicated there are, besides the Conceptual Framework 2010, 17 International
Financial Reporting Standards (IFRSs) as well as 28 International Accounting Standards
(IASs). Each of these standards deals with a specific accounting aspect (for example,
inventories) and indicates the recording, presentation and disclosure requirements that have
to be adhered to. It is recommended that the reader of this work also consults IAS 2.
3
It has already been noted in Chapter 6 paragraph 96 that there are two systems in
accordance with which trade inventories can be recognised in the accounting records,
namely the perpetual inventory system and the periodic inventory system. The manner in
which trade inventories are recognised in the records of an entity is determined by the entity’s
choice of inventory system. IAS 2 does not deal with the two inventory systems, but is
structured in such a way that the guidelines are applicable under both inventory systems.
Systems to account for trade inventories in the accounting
records
4
5
6
The following two systems exist whereby trade inventories can be recognised in the
accounting records:
•
The perpetual inventory system that provides correct detail about the status of trade
inventories on a perpetual, up-to-date basis. Purchases of trade inventories are initially
debited against an asset account “Trade inventories”; and
•
The periodic inventory system that reflects the correct status of trade inventories at
the end of each reporting period and not during the reporting period. Purchases of trade
inventories are initially debited against an expense account “Purchases”.
The choice between the two systems is mostly made based on practical considerations,
namely:
•
The size of the entity; and
•
The sophistication of the entity’s computer system.
The two systems produce, under specific circumstances, identical reporting results, namely
the same amount for trade inventories in the statement of financial position and the same
amount for cost of sales in the statement of profit or loss at the reporting date.
475
The perpetual inventory system
7
In accordance with the perpetual inventory system:
•
Trade inventories purchased are recognised as an asset by debiting the trade
inventories account and crediting either trade payables or bank. If the purchaser is a
registered VAT vendor, VAT input is recognised as a separate asset and is not included
in the cost price of trade inventories.
•
The cost of trade inventories sold is recognised as an expense by debiting the cost of
sales account and crediting the trade inventories account. When the sale occurred, the
cost of sales amount of each sales transaction is immediately determined by the
system.
•
The number of items that should be on hand in respect of each inventory item, as well
as the cost of the specific inventory item, is indicated on a perpetual, up-to-date basis.
•
Physical inventory counts are perpetually performed and compared with the number of
inventory items that, according to the system, should be on hand. In this way, inventory
shortages and the cost thereof are isolated.
•
Inventory items in respect of which the cost is more than the amount that would be
realised should these items be sold (net realisable value), are identified.
Example 13.1 Perpetual inventory system
AC Entity uses the perpetual inventory system.
1.
Trade inventories on hand on 1 January 20.7 amount to 1 400 units at R80 each.
2.
Credit purchases from suppliers during 20.7 amount to 12 000 units at R80 each.
3.
Returns to suppliers during 20.7 amount to 400 units at R80 each.
4.
Credit sales during 20.7 amount to 10 200 units at R140 per unit.
5.
Returns by customers during 20.7 amount to 200 units.
6.
The system indicates that there should be 3 000 units on hand on 31 December 20.7.
7.
Trade inventories on hand on 31 December 20.7, as determined through a physical
inventories count, amount to 2 750 units at R80 each.
Remark in respect of the set of facts to Example 13.1
1
The example is highly simplified since it deals with one inventory item with a constant
purchase price.
Required:
a)
Recognise the abovementioned transactions and events in the records (general journal) of
AC Entity for the reporting period ended 31 December 20.7.
b)
Show the cost of sales account as well as the trade inventories account in the general ledger
of AC Entity for the reporting period ended 31 December 20.7.
Note: Ignore VAT.
476
Example 13.1 Solution
a) Journal entries
J1
20.7
1 Jan to Trade inventories (12 000 x 80) (SFP)
31 Dec
Trade payables (SFP)
Recognise purchase of inventories during 20.7 in terms of the
perpetual inventory system
J2
20.7
1 Jan to Trade payables (400 x 80) (SFP)
31 Dec
Trade inventories (SFP)
Recognise returns (out) of inventories during 20.7 in terms of
the perpetual inventory system
J3
20.7
1 Jan to Trade receivables (10 200 x 140) (SFP)
31 Dec
Sales (P/L)
Recognise sale of inventories during 20.7
J4
20.7
1 Jan to Cost of sales (10 200 x 80) (P/L)
31 Dec
Trade inventories SFP)
Recognise the cost of the sale of inventories during 20.7 as
an expense
J5
20.7
1 Jan to Returns (in) (200 x 140) (P/L)
31 Dec
Trade receivables (SFP)
Recognise returns by customers during 20.7
Dr
960 000
Cr
960 000
Dr
32 000
Cr
32 000
Dr
1 428 000
Cr
1 428 000
Dr
816 000
Cr
816 000
Dr
28 000
Cr
28 000
Remark
1
At the end of the recording period returns (in) are closed off against the sales account.
477
J6
20.7
1 Jan to Trade inventories (200 x 80) (SFP)
31 Dec
Cost of sales (P/L)
Recognise returns by customers during 20.7
J7
20.7
31 Dec
Dr
16 000
Cr
16 000
Loss due to inventory shortages (3 000 – 2 750) x 80 (P/L)
Trade inventories (SFP)
Recognise inventory shortage as an expense
Dr
20 000
Cr
20 000
Remarks in respect of journal J7
1
The perpetual inventory system reflects in the trade inventories account that on
31 December 20.7 there should be 3 000 units (1 400 + 12 000 – 400 – 10 200 + 200)
on hand. The inventories count indicates that there are however only 2 750 units.
Consequently there is a shortage of 250 units which has to be isolated by the system
and, after approval, closed off against cost of sales.
2
The loss due to inventory shortages is closed off against cost of sales on the reporting
date.
b) Cost of sales and trade inventories account
Dr
Date
20.7
1 Jan –
31 Dec
31 Dec
Cost of sales
Contra account
Trade inventories
Loss due to inventory
shortages
Amount
Date
20.7
816 000 1 Jan –
31 Dec
20 000 31 Dec
Cr
Contra account
Trade inventories
16 000
Retained earnings
820 000
836 000
Dr
Date
20.7
1 Jan
836 000
Trade inventories
Contra account
Balance bd
1 Jan –
31 Dec
1 Jan –
31 Dec
Trade payables
(for purchases)
Cost of sales
(for returns (in))
20.8
1 Jan
Balance bd
Amount
Amount
Date
20.7
112 000 1 Jan –
31 Dec
1 Jan –
960 000 31 Dec
1 Jan –
16 000 31 Dec
31 Dec
1 088 000
220 000
478
Cr
Contra account
Trade payables
(for returns (out))
Cost of sales
(for sales)
Loss due to inventory
shortages
Balance cf
Amount
32 000
816 000
20 000
220 000
1 088 000
The periodic inventory system
8
The periodic inventory system is less sophisticated than the perpetual inventory system. Prior
to 1980, this was basically the only system used to account for trade inventories. With the
development in computer technology and software, the perpetual inventory system
developed as a system that is, apart from the periodic inventory system, used to account for
trade inventories. Most of the small and medium entities however still use the periodic
inventory system.
9
The periodic inventory system shows strong similarities with the manner in which office
supplies are accounted for. Refer to Chapter 6 paragraphs 56 to 61 as well as Example 6.1.
10
During the reporting period, the periodic inventory system accumulates purchase costs of
trade inventories, as well as other costs incurred in bringing the trade inventories to its
present location, in the following expense accounts:
11
•
The purchases account is debited with the purchase price (excluding VAT, if applicable)
and the VAT input account is, if applicable, debited with the VAT. Either the relevant
trade payable’s account or the bank account is credited with the invoice amount
(including VAT, if applicable). The invoice price is net of trade discount, cash discount
and settlement discount.
•
The import duties account is debited with the (customs and excise) amount, as charged
by the authorities, and bank is usually credited directly. Import duties are not subject to
VAT.
•
The delivery costs account is debited with the delivery costs (excluding VAT, if
applicable) incurred by the purchaser and the VAT input account is, if applicable,
debited with the VAT. Either the relevant payable’s account or the bank account is
credited with the invoice amount (including VAT, if applicable).
•
If the purchaser is responsible for the legal costs associated with the purchase contract,
the legal costs account is debited with the legal costs (excluding VAT, if applicable) and
the VAT input account is, if applicable, debited with the VAT. Either the relevant
payable’s account or the bank account is credited with the invoice amount (including
VAT, if applicable).
On the reporting date, the expense accounts that relate to the purchase of trade inventories,
are closed off against the cost of sales account by means of the following journal entries:
Dr
Purchases
Cr
Each of the relevant expense accounts (e.g. import duties, delivery costs, etc.)
The journal above capitalises all the costs incurred to bring the inventory to its present
location in accordance with IAS 2.10 (see paragraph 20 below). Subsequently the purchases
account is closed off to cost of sales.
Dr
Cost of sales
Cr
12
Purchases
The trade inventories on hand on the reporting date are determined only at the end of the
year by performing a physical inventories count. After the inventories count, the cost of the
inventories on hand is calculated by applying a cost formula (FIFO or weighted average
method).
479
13
The trade inventories on hand at the end of the year is recognised through the following
journal entry:
Dr
Trade inventories
Cr
Cost of sales
with the cost of the trade inventories, as calculated.
Trade inventories are therefore recognised by reclassifying an appropriate portion of
the expense, cost of sales, as an asset.
14
Just as trade inventories on hand were recognised as an asset at the end of the current year,
trade inventories on hand at the end of the previous year were also recognised as an asset.
The balance of the trade inventories account at the end of the previous year is the balance of
the trade inventories account at the beginning of the current year.
15
The inventories on hand at the beginning of the current year are closed off against the current
year’s cost of sales as at the beginning of the current year through the following journal entry:
Dr
Cost of sales
Cr
Trade inventories
with the amount of the trade inventories as at the beginning of the current reporting period.
16
Recording of trade inventories in the periodic inventory system does take place, but is not at
such a sophisticated level. The purpose is to assist in calculating the cost price of trade
inventories on hand, and not to give an indication of the trade inventories that should
physically be on hand.
17
Review Chapter 6 paragraphs 108 to 110 as well as Example 6.8.
18
Subsequently, the same set of facts will be used as for Example 13.1, with the exception that
the entity uses the periodic inventory system. The purpose is to illustrate the difference
between the periodic and the perpetual inventory system.
Example 13.2 Periodic inventory system
AC Entity uses the periodic inventory system.
1.
Trade inventories on hand on 1 January 20.7 amount to 1 400 units at R80 each.
2.
Credit purchases from suppliers during 20.7 amount to 12 000 units at R80 each.
3.
Returns to suppliers during 20.7 amount to 400 units at R80 each.
4.
Credit sales during 20.7 amount to 10 200 units at R140 per unit.
5.
Returns by customers during 20.7 amount to 200 units.
6.
Trade inventories on hand on 31 December 20.7, as determined through a physical
inventories count, amount to 2 750 units at R80 each.
Remark in respect of the set of facts to Example 13.2
1
The example is highly simplified since it deals with one inventory item with a constant
purchase price.
480
Required:
a)
Recognise the abovementioned transactions (2 to 5) in the records (general journal) of
AC Entity for the reporting period ended 31 December 20.7.
b)
Show the list of balances in the records of AC Entity as at 31 December 20.7, before any
closing entries and adjustments.
c)
Provide journal entries to close off the applicable accounts against sales and cost of sales.
d)
Provide the journal entry to recognise trade inventories at 31 December 20.7 in the records of
AC Entity.
e)
Show the cost of sales account in the general ledger of AC Entity for the reporting period
ended 31 December 20.7.
f)
Show the trade inventories account in the general ledger of AC Entity for the reporting period
ended 31 December 20.7.
g)
Calculate the following for the reporting period ended 31 December 20.7:
i)
the gross profit;
ii)
the gross profit percentage on cost of sales; and
iii)
express the profit margin as a percentage of sales.
Refer to paragraphs 51 to 57 for a discussion on gross profit.
Note: Ignore VAT.
Example 13.2 Solution
a) Journal entries
J1
20.7
1 Jan to Purchases (12 000 x 80) (P/L)
31 Dec
Trade payables (SFP)
Recognise purchase of inventories during 20.7 in terms of the
periodic inventory system
J2
20.7
1 Jan to Trade payables (400 x 80) (SFP)
31 Dec
Returns (out) (P/L)
Recognise returns (out) of inventories during 20.7 in terms of
the periodic inventory system
Dr
960 000
Cr
960 000
Dr
32 000
Cr
32 000
Remark in respect of journal J2
1
With a periodic inventory system, returns (out) is indirectly part of the purchases
account. At the end of the reporting period, the returns (out) account is closed off
against the purchases account.
481
J3
20.7
1 Jan to Trade receivables (10 200 x 140) (SFP)
31 Dec
Sales (P/L)
Recognise sale of inventories during 20.7
Dr
1 428 000
Cr
1 428 000
Remark in respect of journal J3
1
With the periodic inventory system, cost of sales is not known when the sales
transaction takes place and is consequently not recognised when the sales transaction
occurs.
J4
20.7
1 Jan to Returns (in) (200 x 140) (P/L)
31 Dec
Trade receivables (SFP)
Recognise returns by customers during 20.7
Dr
28 000
Cr
28 000
Remark
1
At the end of the recording period, the returns (in) account is closed off against the
sales account.
b) List of balances on 31 December 20.7 – before closing entries and adjustments
Trade inventories (1 Jan 20.7)
Trade receivables
Trade payables
Sales
Purchases
Returns (out)
Returns (in)
Dr
112 000
1 400 000
Cr
928 000
1 428 000
960 000
32 000
28 000
Remarks in respect of the above list of balances
1
Returns (out) are in essence part of the credit side of the purchases account.
2.
Returns (in) are in essence part of the debit side of the sales account.
c) Closing off of accounts against cost of sales
J5
20.7
31 Dec
Returns (out) (P/L)
Purchases (P/L)
Close-off returns (out) against the purchases account
482
Dr
32 000
Cr
32 000
J6
20.7
31 Dec
J7
20.7
31 Dec
Dr
28 000
Sales (P/L)
Returns (in) (P/L)
Close returns (in) off against the sales account
Cr
28 000
Dr
1 040 000
Cost of sales (P/L)
Purchases (960 000 – 32 000) (P/L)
Trade inventories (1 Jan 20.7) (SFP)
Close-off of accounts against cost of sales
Cr
928 000
112 000
Remark in respect of journal J7
1
The closing off of relevant accounts against cost of sales is performed as part of the
adjustment process and not as part of the process of closing off.
d) Journal entry to recognise trade inventories on 31 December 20.7
J8
20.7
31 Dec
Trade inventories (SFP) (2 750 x 80)
Cost of sales (P/L)
Recognise closing inventories on 31 December 20.7 by
transferring a portion of the expense cost of sales to the
asset trade inventories
Dr
220 000
Cr
220 000
Remarks in respect of journal J8
1
With the periodic inventory system, the recognition of trade inventories on hand on the
reporting date is part of the adjustment process.
2
After determining the physical quantity of trade inventories on hand by performing an
inventories count, the cost of the trade inventories on hand is calculated. Since the unit
price in this example is constant, the cost per unit will be R80.
e) Cost of sales account
Dr
Cost of sales
Date
Contra account
20.7
31 Dec Trade inventories
31 Dec Purchases
Amount
Date
Cr
Contra account
20.7
112 000 31 Dec Trade inventories
928 000 31 Dec Retained earnings
1 040 000
Amount
220 000
820 000
1 040 000
Remarks in respect of the above account
1
During the process of closing off, cost of sales is closed off against retained earnings
together with all the other temporary accounts.
483
2
Due to the fact that this example is so simplified, it can easily be noted that a shortage
of 250 units arose during 20.7 (1 400 + 12 000 – 400 – 10 200 + 200 – 2 750 = 250).
The periodic inventory system does not isolate inventory shortages. The value/amount
of inventory shortages is automatically included in cost of sales. The cost of sales is
R820 000, which can be reconciled as follows:
Cost of units actually sold (10 000 x R80)
R800 000
Plus: the cost of the “missing” units (250 X R80)
R20 000
f) Trade inventories account
Dr
Trade inventories
Date
Contra account
20.7
1 Jan Balance bd
31 Dec Cost of sales
20.8
1 Jan
Balance bd
Amount
Date
Cr
Contra account
20.7
112 000 31 Dec Cost of sales
220 000 31 Dec Balance cf
332 000
Amount
112 000
220 000
332 000
220 000
g) Calculations
i) Gross profit
Sales (1 428 000 – 28 000)
Less: Cost of sales
Gross profit
1 400 000
(820 000)
580 000
ii) Gross profit % on cost price
(580 000/820 000) x 100
70.73%
iii) Gross profit % on sales price
(70.73/170.73) x 100
or
(580 000/1 400 000) x 100
41.43%
41.43%
Initial measurement and recognition of trade inventories
Measurement: Elements of the cost of trade inventories
19
The cost of trade inventories comprises the purchase price as well as other costs incurred in
bringing the trade inventories to its present location. (IAS 2.10)
20
Purchase costs of trade inventories comprise:
•
the purchase price excluding VAT, if the purchaser and the seller are both registered
VAT vendors. Trade discount, cash discount and settlement discount do not form part
of the cost price;
•
import duties;
484
21
22
•
delivery costs (excluding VAT);
•
handling costs (excluding VAT); and
•
other direct costs of acquisition, for example legal fees under specific circumstances
(excluding VAT).
The following costs do not form part of the cost of trade inventories:
•
Storage costs; and
•
Finance costs on a loan utilised for the purchase of trade inventories.
The accounting treatment of trade inventories that are purchased is determined by the
inventory system (perpetual or periodic) used by the purchasing entity.
Trade inventories purchased with a loan
23
Credit purchases of trade inventories, in accordance with normal credit terms, are measured
at the cash price equivalent (invoice price) on the acquisition date. If the initial payment is
deferred beyond normal credit terms, the cost price is the present value of the future
payments. (IAS 2.18) The interest accrued is not part of the cost price of the trade
inventories, but is recognised as an interest expense in the appropriate reporting period.
Recognition of the purchase of trade inventories
24
In accordance with the perpetual inventory system trade inventories purchased are
recognised as an asset by debiting the trade inventories account and crediting either trade
payables or bank. If the purchasing entity is a registered VAT vendor, VAT input is
recognised as a separate asset and is not included in the cost price of trade inventories.
25
During the reporting period, the periodic inventory system accumulates purchase costs of
trade inventories, as well as other costs incurred in bringing the trade inventories to its
present location, in the following expense accounts: purchases, import duties, transport
costs and legal costs (if applicable). The expense account is appropriately debited and either
trade payables or bank is credited. If the purchasing entity is a registered VAT vendor, VAT
input is recognised as a separate asset and does not form part of the expense in respect of
the purchase of trade inventories. The accounts that relate to the purchase of trade
inventories are closed off against the purchases account as at the reporting date. The
purchases account is then closed off against the cost of sales account.
Example 13.3 Elements of the cost of trade inventories
The current reporting date of AC Entity, a registered VAT vendor, is 31 December 20.7.
On 1 April 20.7, 60 generators to the amount of R1 437 500 (including VAT) were ordered from
K Entity, for purposes of re-sale. AC Entity is responsible for the delivery costs in respect of the
generators from the premises of K Entity to the premises of AC Entity. AC Entity acquired the
services of an external transport contractor to deliver the generators to the premises of AC Entity.
On 15 April 20.7, the generators were loaded by the contractor. At this point in time, the right of
ownership was transferred to AC Entity.
On 17 April 20.7, the generators were delivered to the premises of AC Entity and an amount of
R51 750 (including VAT) was paid to the contractor by means of a cheque.
485
The invoice, to the amount of R1 437 500, was received together with the goods and contains an
indication that, if the invoice is paid before 30 April 20.7, a settlement discount of 5% will be
granted. AC Entity’s payment history indicates that the entity has always made use of the
settlement discount.
On 28 April 20.7, AC Entity paid the invoice by means of an electronic fund transfer.
Required:
a)
Recognise the abovementioned transactions in the records (general journal) of AC Entity for
the reporting period ended 31 December 20.7 if it is accepted that AC Entity uses the
perpetual inventory system.
b)
Recognise the abovementioned transactions in the records (general journal) of AC Entity for
the reporting period ended 31 December 20.7 if it is accepted that AC Entity uses the periodic
inventory system.
Example 13.3 Solution
a) Journal entries – perpetual inventory system
J1
20.7
15 Apr
J2
20.7
17 Apr
J3
20.7
28 Apr
Trade inventories (SFP) (1 437 500 x 100/115 x 95%)
VAT input (SFP) (1 437 500 x 15/115 x 95%)
Payable K (SFP) (1 437 500 x 95%)
Recognise inventories purchased on credit – perpetual
inventory system
Trade inventories (SFP) (51 750 x 100/115)
VAT input (SFP) (51 750 x 15/115)
Bank (SFP)
Recognise delivery costs in respect of inventories purchased
– perpetual inventory system
Payable K (SFP)
Bank (SFP)
Derecognise Payable K due to settlement
486
Dr
1 187 500
178 125
Cr
1 365 625
Dr
45 000
6 750
Cr
51 750
Dr
1 365 625
Cr
1 365 625
b) Journal entries – periodic inventory system
J1
20.7
15 Apr
J2
20.7
17 Apr
J3
20.7
28 Apr
Purchases (P/L) (1 437 500 x 100/115 x 95%)
VAT input (SFP) (1 437 500 x 15/115 x 95%)
Payable K (SFP) (1 437 500 x 95%)
Recognise inventories purchased on credit – periodic
inventory system
Delivery costs (P/L) (51 750 x 100/115)
VAT input (SFP) (51 750 x 15/115)
Bank (SFP)
Recognise transport costs in respect
purchased – periodic inventory system
Dr
1 187 500
178 125
Cr
1 365 625
Dr
45 000
6 750
Cr
51 750
of
Payable K (SFP)
Bank (SFP)
Derecognise Payable K due to settlement
inventories
Dr
1 365 625
Cr
1 365 625
Remark
1
As at the reporting date, the delivery costs will be closed off against the purchases
account and the purchases account will be closed off against the cost of sales account.
Example 13.4 Trade inventories purchased with a loan
The current reporting date of AC Entity, a registered VAT vendor, is 31 December 20.7.
On 1 June 20.7, trade inventories that were purchased on credit from K Entity, were received.
The invoice price is R517 500 (including VAT) and is payable as follows: R67 500 is payable in
accordance with normal credit terms on or before 30 June 20.7 and R481 184, which includes an
amount for interest, is payable on 30 November 20.7.
Required:
a)
Recognise the abovementioned transactions in the records (general journal) of AC Entity for
the reporting period ended 31 December 20.7 if it is accepted that AC Entity uses the
perpetual inventory system.
b)
Recognise the abovementioned transactions in the records (general journal) of AC Entity for
the reporting period ended 31 December 20.7 if it is accepted that AC Entity uses the periodic
inventory system.
487
Example 13.4 Solution
a) Journal entries – perpetual inventory system
J1
20.7
1 Jun
J2
20.7
30 Jun
J3
20.7
30 Nov
J4
20.7
30 Nov
Trade inventories (SFP) (517 500 x 100/115)
VAT input (SFP) (517 500 x 15/115)
Payable K (SFP)
Loan from K Entity (SFP) (517 500 – 67 500)
Recognise inventories purchased on credit – perpetual
inventory system.
Payable K (SFP)
Bank (SFP)
Derecognise payable due to settlement
Interest expense (P/L) (481 184 – (517 500 – 67 500))
Loan from K Entity (SFP)
Recognise accrued interest (1 Jun – 30 Nov 20.7)
Dr
450 000
67 500
67 500
450 000
Dr
67 500
Cr
67 500
Dr
31 184
Cr
31 184
Dr
481 184
Loan from K Entity (SFP)
Bank (SFP)
Derecognise loan due to settlement
Cr
Cr
481 184
b) Journal entries – periodic inventory system
J1
20.7
1 Jun
Purchases (P/L) (517 500 x 100/115)
VAT input (SFP) (517 500 x 15/115)
Payable K (SFP)
Loan from K Entity (SFP) (517 500 – 67 500)
Recognise inventories purchased on credit – periodic
inventory system.
For the remaining journals, refer to journals J2 to J4 under (a) above.
488
D
450 000
67 500
Cr
67 500
450 000
Cost formulas
26
27
The main objective with the way in which trade inventories are recorded in the accounting
records, is to provide the following amounts in respect of trade inventories for inclusion in the
financial statements:
•
the cost of trade inventories on hand on the reporting date; and
•
the cost of sales for the current reporting period.
Inventories can, with reference to the specific nature thereof, be divided into two categories,
namely:
•
Unique, specifically identifiable items such as art works at an art dealer or vehicles at a
motor dealer. These items are usually not interchangeable (identical); and
•
Uniform, interchangeable units per inventory item.
Specifically identifiable inventory items
28
Some entity’s inventories comprise specific identifiable items, for example paintings at an art
dealer or vehicles at a motor dealer. The recordkeeping of the purchase price and other costs
incurred in bringing the trade inventories to its present location, occur in accordance with the
specific identification method. This method entails that specific costs (purchase price and
other costs incurred in bringing the item to its present location) are allotted as cost of the
identified item. Each item has a specific purchase price as well as a specific selling price. A
separate subsidiary inventory record exists for each item, which indicates the specific cost of
the item.
29
Such trade inventories are usually accounted for by means of the perpetual inventory system.
With the purchase of a trade inventory item on credit, the trade inventories account as well as
the VAT input account (where applicable) are debited and the account of the trade payable is
credited. Other costs incurred in bringing the item to its present location are recognised in a
similar way. With the sale of the item, the cost of sales account is debited and the trade
inventories account is credited with the cost price of the item, which is known. The perpetual
inventory system is fairly simple in this specific case.
Uniform interchangeable units per inventory item
30
Most of the trading entities’ trade inventories comprise a variety of different items, for
example items A, B, C, etc. In respect of each inventory item, there are numerous units of the
product on the display shelves as well as in the entity’s storeroom. The units per inventory
item are physically identical and consequently interchangeable, for example 200 1 litre tins of
a particular brand of paint. If the units were not purchased at the same time, the cost price
will however not be the same for all the units.
489
31
Consider the following example: AC Entity, a retailer, sells a variety of different inventory
items (items A, B, C, etc.) that are purchased from wholesalers. AC Entity’s current reporting
period ends on 31 December 20.7. The following is applicable to item A:
•
Units on hand on 1 January 20.7: 200 units with a unit cost price of R50;
•
On 1 May 20.7, 280 units of item A were purchased at a unit cost price of R55;
•
On 1 December 20.7, 350 units of item A were sold.
(This example is simplified for educational purposes. Purchases and sales usually occur
more frequently.)
32
The problem illustrated by the example is how to calculate the cost of sales and the cost of
trade inventories on hand. In Accounting, there are two acceptable cost formulas in respect
of uniform, interchangeable units per inventory item, namely:
•
The FIFO cost formula (FIFO is the acronym for first-in-first-out). This formula makes an
assumption regarding the flow of the units. The units that were purchased first are sold
first.
•
The weighted average cost formula, which is also known as the moving average
method. (The weighted average also accounts for volumes and is not merely the
average of the respective unit prices.)
33
If an entity’s trade inventories consist of specifically identifiable items, the entity must use the
specific identification method to calculate the cost of sales and trade inventories on hand.
If an entity’s trade inventories do not consist of specifically identifiable items, but rather of
uniform, interchangeable units per inventory items, the entity must choose between the
abovementioned two cost formulas. Should an entity, which uses the perpetual inventory
system, elect the FIFO cost formula, the inventory system is set up in such a way that both
the cost of sales and trade inventories on hand is calculated by using the FIFO cost formula.
If the entity chooses the weighted average formula, the inventory system is set up in such a
way that both the cost of sales and trade inventories on hand is calculated by using the
weighted average cost formula. Should an entity, which uses the periodic inventory
system, decide to use the FIFO cost formula, the cost of trade inventories on hand is
calculated by applying the FIFO cost formula and the cost of sales is arrived at as the
balancing figure on the cost of sales account. If the entity chooses the weighted average cost
formula, the cost of trade inventories on hand is calculated by applying the weighted average
cost formula and the cost of sales is arrived at as the balancing figure on the cost of sales
account
34
The cost formula elected by the entity is, as in the case of the depreciation method chosen
by the entity, part of the entity’s accounting policy. The accounting policy is disclosed in a
note to the financial statements. Refer to Example 13.14.
FIFO cost formula
35
In accordance with the FIFO cost formula, the cost of trade inventories sold and the cost of
trade inventories on hand are calculated based on the assumption that units that were
purchased first are sold first. The FIFO cost formula is the method that is applied most by the
listed companies in South Africa.
490
Weighted average cost formula
36
In accordance with this cost formula, the cost of trade inventories sold and the cost of trade
inventories on hand are calculated at the weighted average cost price per unit at the time of
the sale and the weighted average cost price per unit on the reporting date respectively.
Example 13.5 FIFO cost formula and inventory systems
AC Entity is a registered VAT vendor. AC Entity’s current reporting date is 31 December 20.7.
AC Entity incurred the following transactions during 20.7 in respect of inventory item A:
Date
1 Jan
2 Feb
5 Apr
15 Jun
20 Sep
21 Dec
Detail
Units
Opening balance
Sales
Purchases
Sales
Purchases
Sales
R/unit
(excl VAT)
200
2 000
(1 200)
3 000
(2 000)
1 500
(1 500)
240
300
AC Entity calculates the cost of trade inventories by using the FIFO cost formula.
The trade inventories on hand, as physically counted on 31 December 20.7, amount to 1 700 units.
Required:
a)
Assume AC Entity accounts for trade inventories by using the perpetual inventory system.
Calculate the cost of sales for each transaction, the cost of the inventory shortage and the
cost of trade inventories on hand on 31 December 20.7.
b)
Assume AC Entity accounts for trade inventories by using the periodic inventory system.
Calculate the cost of trade inventories on hand on 31 December 20.7 and calculate the cost
of sales for the year ended 31 December 20.7.
Remark in respect of the set of facts of Example 13.5
1
The set of facts is simplified on purpose. It deals with only one inventory item whilst an
entity usually purchases and sells a wide variety of inventory items. Purchase and sales
transactions also occur more frequently.
Example 13.5 Solution
a) FIFO cost formula and the perpetual inventory system
Date
Detail
N
1 Jan
2 Feb
5 Apr
15 Jun
20 Sep
21 Dec
Opening balance
Sales
Purchases
Sales
Purchases
Sales
2 000
(1 200)
3 000
(2 000)
1 500
(1 500)
1 800
R/u
Calculation
R
Cost of sales
200
1 200 x 200
240 000
(800 x 200)+(1 200 x 240)
448 000
(1 500 x 240)
360 000
1 048 000
240
300
491
31 Dec
31 Dec
Shortage
On hand
(100)
1 700
(1 800 – 1 700) x 240
Cost of inventory
shortage
24 000
Cost of trade
inventories on hand on
31 Dec 20.7
(200 x 240) + (1 500 x 300)
498 000
Remarks
1
The calculation executes the presumption of the FIFO cost formula, namely that trade
inventories will be sold more or less in the order in which it were purchased.
The cost of sales of 2 February 20.7 (1 200 units) are all from the opening inventories
and are therefore calculated at R200 per unit.
Regarding the cost of sales of 15 June 20.7 (2 000 units) 800 units are from the
1 January 20.7 inventories (the opening inventories) and are therefore calculated at
R200 per unit and 1 200 units are from the purchase of 5 April 20.7 and are therefore
calculated at R240 per unit. The cost of sales of 21 December 20.7 (1 500 units) are
from the purchase of 5 April 20.7 and are therefore calculated at R240 per unit.
According to the subsidiary record for inventory item A, 1 800 units should have been
on hand on 31 December 20.7. A physical count of 1 700 reveals that an inventory
shortage of 100 units arose. In terms of the FIFO presumption, the shortage relates to
the items purchased on 5 April 20.7 and consequently results in an inventory shortage
of R24 000 (100 x R240).
In respect of the trade inventories on 31 December 20.7 (1 700 units), 200 units are
from the purchase of 5 April 20.7 and 1 500 units are from the purchase of
20 September 20.7 and are therefore calculated at R240 and R300 per unit
respectively.
2
The software of the inventory programme is set up to calculate the cost of sales of each
transaction in time. The cost of sales of all transactions for each day is accumulated by
the system and is posted in total on a daily basis by debiting cost of sales and crediting
trade inventories.
3
The system indicates the number of units that should be on hand. If a physical count
indicates that there are inventory shortages, the cost of the inventory shortages is
calculated and, upon approval, the “Loss due to inventory shortages” account is debited
and trade inventories is credited. At the end of the reporting period, the “Loss due to
inventory shortages” account is closed off against the cost of sales account. The cost of
sales for 20.7 is therefore R1 072 000 (R1 048 000 + R24 000).
b) FIFO cost formula and the periodic inventories system
Cost of the trade inventories on hand at 31 December 20.7
The trade inventories on hand on the reporting date (1 700 units), are determined only at the end of
the year by performing a physical inventories count. After the inventories count, the cost of the
trade inventories on hand is calculated by applying the cost formula used by the entity, namely the
FIFO cost formula in this case.
492
The FIFO cost formula produces the following cost in respect of the trade inventories on hand:
(1 500 x R300) + (200 x R240) = R498 000
Note that the FIFO cost formula produces the same cost for trade inventories on hand on
31 December 20.7 under the perpetual and the periodic inventory system, namely R498 000.
Cost of sales for 20.7
Cost of sales is calculated by preparing the cost of sales account.
Dr
Cost of sales
Date
Contra account
20.7
1 Jan Trade inventories
Dec 31 Purchases*
*(3 000 x 240 = 720 000) +
Amount
Date
Cr
Contra account
20.7
400 000 31 Dec Trade inventories
1 170 000 31 Dec Retained earnings
1 570 000
Amount
498 000
1 072 000
1 570 000
(1 500 x 300 = 450 000)
Remarks
1
Trade inventories that were recognised as an asset as at 31 December 20.6, are closed
off against the cost of sales account as at 1 January 20.7 by debiting cost of sales and
crediting trade inventories.
2
As at 31 December 20.7, the purchases account is closed off against the cost of sales
account by debiting cost of sales and crediting purchases. Other applicable accounts,
such as transport costs (in), would be treated similarly.
3
As at 31 December 20.7, a portion of the expense cost of sales is reclassified as an
asset by debiting trade inventories and crediting cost of sales.
4
Following the above, the balance of the cost of sales account is R1 072 000 and is
closed off against retained earnings through the process of closing off.
5
Note that, under the perpetual and periodic inventory system, the FIFO cost formula
produces the same cost of sales for 20.7, namely R1 072 000. The periodic inventory
system is unable to isolate inventories shortages, but does account for them.
Example 13.6 Weighted average cost formula and inventory systems
AC Entity is a registered VAT vendor. AC Entity’s current reporting date is 31 December 20.7.
AC Entity had the following transactions during 20.7 in respect of inventory item A:
Date
1 Jan
2 Feb
5 Apr
15 Jun
20 Sep
21 Dec
Detail
Opening balance
Sales
Purchases
Sales
Purchases
Sales
Units
2 000
(1 200)
3 000
(2 000)
1 500
(1 500)
R/unit
(excl VAT)
200
240
300
AC Entity calculates the cost of trade inventories by using the weighted average cost formula.
493
The trade inventories on hand, as physically counted on 31 December 20.7, amount to 1 700 units.
Required:
a)
Assume AC Entity accounts for trade inventories by using the perpetual inventory system.
Calculate the cost of sales for each transaction, the cost of the inventory shortage and the
cost of trade inventories on hand on 31 December 20.7.
b)
Assume AC Entity accounts for trade inventories by using the periodic inventory system.
Calculate the cost of trade inventories on hand on 31 December 20.7 and calculate the cost
of sales for the year ended 31 December 20.7.
Example 13.6 Solution
a) Weighted average cost formula and the perpetual inventories system
Date
Detail
N
1 Jan
2 Feb
5 Apr
15 Jun
Opening balance
Sales
Purchases
Sales
2 000
(1 200)
3 000
(2 000)
200
20 Sep
21 Dec
Purchases
Sales
1 500
(1 500)
300
31 Dec
31 Dec
Shortage
On hand
R/u
Calculation
R
Cost of sales
1 200 x 200
240 000
((800 x 200) + (3 000 x 240)) ÷
3800 = 231.58 x 2 000
463 160
((1 800 x 231.58) + (1 500 x 300)) ÷
3300 = 262.68 x 1 500
394 020
240
1 800
1 097 180
(100)
Cost of inventory
shortage
26 268
(1 800 – 1 700) x 262.68
Cost of trade
inventories on hand
on 31 Dec 20.7
1 700 x 262.68
446 556
1 700
Remarks
1
The calculation executes the approach of the weighted average cost formula, namely
that the cost of trade inventories sold is calculated at the weighted average cost price
per unit on the day of the sale. The average is weighted because volumes and prices
are accounted for and the average is variable because it is calculated time and again
on the day of the sale.
2
The software of the inventory programme is set up to calculate the cost of sales of each
transaction in time. The cost of sales of all transactions for each day is accumulated by
the system and is posted in total on a daily basis by debiting cost of sales and crediting
trade inventories.
3
The system indicates the number of units that should be on hand. If a physical count
indicates that there are inventory shortages, the cost of the inventory shortages is
calculated and, upon approval, the “Loss due to inventory shortages” account is debited
and trade inventories is credited. At the end of the reporting period, the “Loss due to
494
inventory shortages” account is closed off against the cost of sales account. The cost of
sales for 20.7 is therefore R1 123 448 (R1 097 180 + R26 268).
4
Note that, with reference to Example 13.5, the FIFO cost formula during periods of
rising costs, will produce a higher cost of closing inventories and therefore a lower cost
of sales than the weighted average cost formula.
b) Weighted average cost formula and the periodic inventory system
Cost of the trade inventories on hand on 31 December 20.7
The trade inventories on hand on the reporting date (1 700 units), are determined only at the end of
the year by performing a physical inventories count. After the inventories count, the cost of the
trade inventories on hand is calculated by applying the cost formula used by the entity, namely the
weighted average cost formula in this case.
The weighted average cost of sales for 20.7 is:
(400 000 + 720 000 + 450 000) ÷ 6 500 = R241.54 per unit
The cost of trade inventories on hand on 31 December 20.7 is therefore R410 618.
Note that the weighted average cost formula under the perpetual inventory system produces a cost
for trade inventories on hand on 31 December 20.7 of R446 556 as against a cost for trade
inventories on hand of R410 618 under the periodic inventory system. The reason for the difference
is that the variable weighted average under the perpetual inventory system is R262.68 on
31 December 20.7 as against the weighted average for 20.7 under the periodic inventory system of
R241.54.
Cost of sales for 20.7
Cost of sales are calculated from the cost of sales account
Dr
Cost of Sales
Date
Contra account
20.7
1 Jan Trade inventories
31 Dec Purchases
Amount
400 000
1 170 000
1 570 000
Date
Cr
Contra account
20.7
31 Des Trade inventories
31 Dec Retained earnings
Amount
410 618
1 159 382
1 570 000
Retail method
37
Some retail groups do not use a cost formula (e.g. FIFO or weighted average) to determine
the cost of trade inventories, but use a technique known as the retail method. (IAS 2.21 and
.22) The retail method is only suitable for use by entities that maintain a fairly constant gross
profit margin (for the entity or for each of the entity’s divisions).
38
The technique entails that the cost of trade inventories on hand is calculated by reducing the
sales price of the trade inventories on hand with the gross profit, as appropriately calculated.
If the sales prices of some of the trade inventories on hand have been marked down, it must
be appropriately accounted for. The retail method is only used if the cost of trade inventories,
as calculated with the technique, approximates the actual cost of the trade inventories.
(IAS2.21) The retail method is also applied to determine the cost of trade inventories
destroyed in an event, where the relevant entity uses the periodic inventory system. Refer to
Example 13.12
495
39
It is important to understand the relationship between sales, cost of sales and gross profit in
order to understand the mechanics of the retail method. (A detailed discussion on the
determination of sales follows in paragraphs 51 to 57 below.) By definition, sales is the sum
of cost of sales and the gross profit. In the retail method (where the gross profit margin is
assumed to be fairly constant), the gross profit percentage is expressed as a percentage of
either sales or cost of sales.
Example 13.7 Determination of sales, cost of sales and gross profit
AC Entity applies a constant gross profit percentage of 30% on its inventories.
Required:
a)
Assuming a gross profit of R900 000 and that the gross profit is expressed as a percentage
of sales, calculate the sales and cost of sales for the reporting period ended 31 December
20.7.
b)
Assuming a gross profit of R900 000 and that the gross profit is expressed as a percentage
of cost of sales, calculate the sales and cost of sales for the reporting period ended 31
December 20.7.
c)
Assuming the sales for the reporting period amounted to R3 500 000, the gross profit is
expressed as a percentage of sales and 50% of the sales were sold at a discount of 25% on
the normal sales price, calculate the cost of sales for the reporting period ended 31
December 20.7.
Example 13.7 Solution
a) Gross profit expressed as a percentage of sales
Where the gross profit is expressed as a percentage of sales, the sales factor is 100, the gross
profit factor is 30 (as given) and therefore the cost of sales factor is 70, which is the difference
between sales and the gross profit. This can be depicted as follows:
Cost of sales
70
Gross profit
30
Sales
100
The calculation to determine sales therefore will be as follows:
Sales = (100/30 * R900 000) R3 000 000.
The formula to determine cost of sales therefore will be as follows:
Cost of sales = (70/30 * R900 000) R2 100 000.
b) Gross profit expressed as a percentage of cost of sales
Where the gross profit is expressed as a percentage of cost of sales, the cost of sales factor is
100, the gross profit factor is 30 (as given) and therefore the sales factor is 130, which is the
difference between sales and the gross profit. This can be depicted as follows:
Cost of sales
100
Gross profit
30
Sales
130
The formula to determine sales therefore will be as follows:
Sales = (130/30 * R900 000) R3 900 000.
The formula to determine cost of sales therefore will be as follows:
Cost of sales = (100/30 * R900 000) R3 000 000.
496
c) Gross profit expressed as a percentage of sales with discounted sales
Where the gross profit is expressed as a percentage of sales, the sales factor is 100, the gross
profit factor is 30 (as given) and therefore cost of sales factor is 70. However in this case as some
of the sales were discounted, it would not be correct to use the gross profit percentage on the total
sales. The first step would be to “normalise” or “gross up” the discounted sales as though they had
been sold at the normal price and not the discounted price. In this case the normalised sales would
be a factor of 100, the discount a factor of 25 and the discounted sales a factor 75. This can be
depicted as follows:
Discounted sales
75
Discount
25
Normalised sales
100
The formula to determine the normalised sales on the discounted sales therefore will be as follows:
Normalised sales = (100/75 * (R3 500 000*50%)) R2 333 333.
Put differently, half of the sales (R1 750 000) would have been normally sold for R2 333 333 had
there not been a 25% discount. Since the other half was sold for the normal profit, the total
normalised sales is the sum of R2 333 333 and R1 750 000, that is R4 083 333.
With the normalised sales determined, the relationship between sales, cost of sales and gross
profit can be used as follows to determine cost of sales:
Cost of sales
100
Gross profit
30
Sales
130
The formula to determine cost of sales therefore will be as follows:
Cost of sales = (100/130 * R4 083 333) R3 141 025. Note: In this case, sales is known and gross
profit is unknown, and it is for this reason that cost of sales is determined on the basis of the sales.
Example 13.8 The retail method
AC Entity conducts business in the retail sector and sells clothing in three categories, namely men,
women and children. AC Entity does not use a cost formula to determine the cost of trade
inventories on hand, but uses the retail method cost technique. The clothes sold by AC Entity focus
on autumn/winter and spring/summer. Sales are held annually during February and August.
AC Entity’s current reporting period ends on 31 December 20.7 and the following information is
relevant:
Total
R
Trade inventories on hand:
- at normal sales prices
- at marked down sales prices
Average gross profit margin on sales
30 790 000
Men’s
clothing
R
Women’s
clothing
R
9 800 000
520 000
40%
12 450 000
780 000
50%
Children’s
clothing
R
8 540 000
585 000
60%
The marked down sales prices constitute 65% of the normal sales prices.
Required:
Apply the retail method to determine the cost of trade inventories on 31 December 20.7. (Refer to
paragraphs 51 to 57 for a discussion on gross profit.)
497
Example 13.8 Solution
Total
R
Trade inventories on hand:
- at normal sales prices
Average gross profit margin on
sales
Cost of sales expressed as a
percentage of sales
Cost of the relevant trade
inventories
Trade inventories on hand:
- at marked-down sales prices
Discounted price
Normal price
- at normalised sales prices
Cost of sales expressed as a
percentage of sales
Cost of the affected trade
inventories
Cost of trade inventories on
hand
A
30 790 000
B
C=
(100% -B)
D = A*C
15 521 000
E
F
G
H = E*G/F
C (above)
Men’s
clothing
R
Women’s
clothing
R
Children’s
clothing
R
9 800 000
40%
12 450 000
50%
8 540 000
60%
60%
50%
40%
5 880 000
6 225 000
3 416 000
520 000
65%
100%
800 000
60%
780 000
65%
100%
1 200 000
50%
585 000
65%
100%
900 000
40%
I = H*C
1 440 000
480 000
600 000
360 000
J = D+I
16 961 000
6 360 000
6 825 000
3 776 000
Returns (out) and returns (in): the cost formulas and inventory
systems
40
Subsequently, attention is given to the treatment of returns of purchased trade inventories to
the supplier and returns of sold trade inventories by the trade receivable.
41
Returns of trade inventories to a supplier (returns (out)) and returns of trade inventories by a
trade receivable (returns (in)) have already been dealt with in Chapter 9 paragraphs 18 to 20,
including Example 9.2, and should be thoroughly revised.
Returns (out) and the perpetual inventory system
42
Under the perpetual inventory system returns to a payable (supplier) are recognised by the
following journal entry:
20.7
Date of Payable (amount including VAT) (SFP)
credit
VAT input (SFP)
note
Trade inventories (original cost price) (SFP)
Recognise returns out in terms of the perpetual
inventory system
498
Dr
Cr
115
15
100
Remark in respect of the above journal
1
The journal represents a reversal of the original purchase of the trade inventories (or
a proportional reversal if only a portion of the relevant trade inventories purchased is
returned).
Returns (out) and the periodic inventory system
43
Under the periodic inventory system, returns to a payable (supplier) are recognised by means
of the following journal entry:
20.7
Date of Payable (amount including VAT) (SFP)
credit
VAT input (SFP)
note
Returns (out) (amount excluding VAT) (P/L)
Recognise returns out in terms of the periodic inventory
system
Dr
Cr
115
15
100
Remarks in respect of the above journal
1
At the end of the reporting period, the returns (out) account is closed off against the
purchases account.
2
Under the periodic inventory system no entries are made in respect of the cost of the
physical trade inventories that are returned. In other words, there is no entry where the
trade inventories account is debited and the cost of sales account is credited.
Returns (in) and the perpetual inventory system
44
Under the perpetual inventory system returns by a receivable (customer) are recognised by
the following journal entry:
20.7
Date of Returns (in) (amount excluding VAT) (P/L)
credit
VAT output (SFP)
note
Trade receivable (amount including VAT) (SFP)
Recognise returns in under the perpetual inventory
system
Dr
Cr
100
15
115
Remark in respect of the above journal
1
45
At the end of the reporting period the returns (in) account is closed off against the sales
account.
Subsequently, trade inventories that were physically returned are recognised by means of the
following journal entry:
20.7
Date of Trade inventories (cost of inventories returned) (SFP)
credit
Cost of sales (P/L)
note
Recognise returns in under the perpetual inventory
system
499
Dr
Cr
100
100
Remarks in respect of the above journal
1
The journal represents a reversal of the initial transaction that was recognised at the
delivery of the sold trade inventories (or a proportional reversal if only a portion of the
relevant trade inventories sold is returned).
2
The trade inventories that were returned are therefore recognised at the same unit price
as that with which the trade inventories account was credited at the time of delivery of
the sale.
Returns (in) and the periodic inventory system
46
Under the periodic inventory system, returns by a receivable (customer) are recognised by
means of the following journal entry:
20.7
Date of Returns (in) (amount excluding VAT) (P/L)
credit
VAT output (SFP)
note
Trade receivable (amount including VAT) (SFP)
Recognise returns in under the periodic inventory
system
Dr
Cr
100
15
115
Remark in respect of returns (in) and the abovementioned journal
1
At the end of the reporting period, the returns (in) account is closed off against the sales
account.
2
Under the periodic inventory system, no entry is made in respect of the cost of the
physical trade inventories returned by a receivable.
Inventory shortages, cost formulas and inventory systems
Inventory shortages and the perpetual inventory system
47
The perpetual inventory system reflects, in respect of each inventory item, the number of
items that should be on hand as well as the cost of each inventory item. The cost will be
calculated using either the FIFO cost formula or the weighted average cost formula. During
the year as well as on the reporting date, on a sample basis, the physical units on hand are
compared with the number of units, as indicated by the system. The comparison will identify
the shortages that arose. The shortages can occur as a result of theft of items or because of
damaged items. The perpetual inventory system will indicate the cost of the inventory
shortages. The cost is calculated using either the FIFO cost formula or the weighted average
cost formula. Inventory shortages must be recognised as an expense.
48
The recognition of inventory shortages as an expense, is as follows:
Dr
Loss due to inventory shortages (expense that increases)
Cr
Trade inventories (asset that decreases)
500
49
This loss is closed off to the cost of sales account, either during the adjustment process or
immediately. The direct debiting of the loss against cost of sales should be avoided. The
write-off of inventory shortages has to be authorised by the owner or his/her proxy. Also refer
to Examples 13.1 and 13.9.
Inventory shortages and the periodic inventory system
50
The periodic inventory system cannot identify inventory shortages. Inventory shortages that
occur during the reporting period cause the physical trade inventories on hand (according to
an inventory count that usually occurs at the end of the reporting period) to be lower. The
cost of the trade inventories on hand, as calculated by applying the cost formula (FIFO or
weighted average), will therefore also be lower. The lower cost of trade inventories on hand
results in a higher cost of sales. The cost of inventory shortages is automatically included as
part of the cost of sales (as calculated at the end of the reporting period). Refer to
Example 13.2.
Example 13.9 Returns (out), returns (in) and inventory shortages
The current reporting date of AC Entity, a registered VAT vendor, is 31 December 20.7.
AC Entity accounts for trade inventories in the accounting records by means of a perpetual
inventory system and uses the FIFO cost formula to determine the cost price of trade inventories.
K Entity, a registered VAT vendor, is as wholesaler one of the suppliers of a specific product (Tx) to
AC Entity.
Transactions
01 Dec Trade inventories on hand amount to 2 000 Tx units at a total cost price of R84 000.
08 Dec Receive 4 000 Tx units which were purchased from K Entity. The invoice price of
R207 000 (including VAT) is payable on 7 January 20.8.
14 Dec 10% of the trade inventories which were received on 8 December 20.7, were returned to
K Entity. The amount on the debit note is R20 700 (including VAT) and the reason was
reflected as “latent defects”.
17 Dec Receive a credit note from K Entity (dated 17 December 20.7) to the amount of R20 700
(including VAT) in respect of goods returned on 14 December 20.7 to K Entity.
18 Dec Sell and deliver 2 800 Tx units on credit to Receivable DH for R217 350 (including VAT).
Payment must take place on or before 15 January 20.8.
21 Dec Receive 1 000 Tx units which were purchased from K Entity. The invoice amount of
R52 900 (including VAT) is payable on 18 January 20.8.
23 Dec Receive 400 Tx units which were returned by Receivable D due to the fact that the items
are damaged. These units were sold to Receivable D on 18 December 20.7. The units
were received by the head of AC Entity’s warehouse and marked for destruction since it
can no longer be used. The units were immediately replaced with 400 other Tx units,
which were sent to Receivable D on the same day.
31 Dec An inventory count indicates that, on 31 December 20.7, there are 3 250 Tx units on
hand. The write-off of the inventory shortage was authorised by the owner.
501
Required:
Recognise the abovementioned transactions directly in the trade inventories account in the general
ledger of AC Entity for the reporting period ended 31 December 20.7.
Example 13.9 Solution
Date
20.7
01 Dec
08 Dec
17 Dec
18 Dec
21 Dec
23 Dec
31 Dec
31 Dec
Trade inventories
Contra account
Balance bd
Payable K ((207 000 x 100/115) ÷ 4 000)
Payable K (20 700 x 100/115)
Cost of sales
Payable K ((52 900 x 100/115) ÷ 1 000)
Loss due to inventory shortages
Loss due to inventory shortages (3 400 – 3 250)
Balance cf (4 000 – 400 – 800 – 400 – 150)
N
2 000
4 000
(400)
(2 000)
(800)
1 000
(400)
(150)
2 250
1 000
R/u
42
45
45
42
45
46
45
45
45
46
Dr
84 000
180 000
18 000
84 000
36 000
46 000
310 000
20.8
01 Jan Balance bd
2 250 45
1 000 46
Cr
18 000
6 750
101 250
46 000
310 000
101 250
46 000
Remarks in respect of the above solution
1
The number of units (N) and Rand per unit (R/u) are reflected merely to illustrate the
way in which the FIFO cost formula works.
2
The journal entry for returns (out) on 17 December 20.7, is as follows:
20.7
17 Dec
Payable K (SFP)
VAT input (20 700 x 15/115) (SFP)
Trade inventories (SFP)
Recognise returns out
18 000 = (400 x 45) / (20 700 x 100/115)
Dr
20 700
Cr
2 700
18 000
3
If the trade inventories that are returned to the payable are immediately (at receipt
thereof) replaced by the payable, no entry is recorded in the purchaser’s (AC Entity)
records. In this case, the units that were returned were however not replaced by the
payable and consequently the abovementioned journal had to be recognised.
4
The trade inventories account is, in respect of returns (out), credited with the unit price
at which the trade inventories were initially purchased.
5
On 23 December 20.7, 400 units were returned by Receivable D. These units were
immediately replaced by AC Entity with new units. The trade inventories returned were
authorised for destruction. The only entry required in AC Entity’s records is that a
further 400 units be credited against the trade inventories account and debited against
502
the “Loss due to inventory shortages” account. This loss is closed off against the cost of
sales account, either immediately or during the adjustment process. The direct debiting
of the loss against cost of sales should be avoided.
6
The perpetual inventory system makes it possible to isolate and recognise inventory
shortages. The perpetual inventory system indicates that 3 400 Tx units should be on
hand. A physical count on 31 December 20.7 however indicates that there are only
3 250 Tx units on hand. An inventory shortage of 150 Tx units therefore has to be
recognised by crediting the trade inventories account and debiting the account “Loss
due to inventory shortages”. The cost of the expense is measured by using the FIFO
cost formula. This loss is closed off against the cost of sales account, either during the
adjustment process or immediately. The direct debiting of the loss against cost of sales
should be avoided.
Determination of the sales price
51
The price of a product is in principle determined by demand and supply. Over a period of time
the owner or the sales manager of an entity develops a particular feeling for determining the
sales prices.
52
The difference between sales and cost of sales is known as gross profit. The gross profit
percentage is usually determined with reference to the cost of the trade inventories. The
gross profit percentage, applied to the cost per unit of the inventory item, determines the
sales price per unit. The determination of the gross profit requires judgement and knowledge
of a specific sector.
53
Sales less cost of sales during a reporting period gives the gross profit for the relevant
reporting period. The sales price per unit must be determined within the context of demand
and supply in such a way that a gross profit which is sufficient to produce a profit for the year
(gross profit less other operating costs), is generated. Furthermore, the profit for the year
must be sufficient to ensure more retained earnings, after distributions to the owner. It is
impossible for an entity to continue to exist if retained earnings are not annually carried
forward to the following year.
54
A characteristic of the modern economy is the rising trend of prices. This means that an entity
cannot set a sales price per unit for the year at the beginning of the year. It can even happen
that, within a month, an entity increases sales prices more than once. Refer to the set of facts
of Example 13.5. The cost price per unit reflects a rising trend for the month and therefore the
sales price per unit also reflects such a trend. The price movements in Example 13.5 are for
illustrative purposes deliberately fairly sharp.
55
Demand should place a damper on the extent and the regularity of price increases. Sales
price per unit is determined as:
Cost price per unit + the gross profit.
The gross profit is determined as:
Cost price per unit x gross profit % on cost price.
56
The cost price per unit is determined by applying the elected cost formula (FIFO, weighted
average or specific identification).
503
57
Time will usually pass between the increase in the cost price of inventories and the resulting
increase in sales prices. Legislation requires that prices of products be visibly displayed in
salesrooms. Some shops display the sales price on each individual item. Market forces can
also prevent an entity to transfer an increase in input costs immediately to customers. Sales
prices will mostly increase due to an increase in the cost of the inventories, but can also
increase because of a decision by the entity to increase the entity’s gross profit percentage.
Example 13.10 Gross profit percentage
AC Entity uses the FIFO cost formula to determine the cost of sales as well as the cost of trade
inventories. Sales prices are set to obtain a gross profit of 45% on cost price.
The records of AC Entity reflect the following amounts, amongst others, for the reporting period
ended 31 December 20.7:
R
7 008 645
(4 901 150)
2 107 495
Sales
Cost of sales
Gross profit
Required:
a)
Calculate the gross profit percentage on sales by using the gross profit percentage of 45%,
which was calculated on cost price.
b)
Calculate the actual gross profit percentage on cost price of AC Entity for the reporting period
ended 31 December 20.7.
c)
Provide possible reasons as to why your answer in b) above differs from the gross profit
percentage of 45% used by AC Entity to determine sales prices.
d)
Assume AC Entity sold various items for R870 (excluding VAT). Calculate the cost of sales if
the gross profit percentage is set at 45% on cost price.
e)
Assume AC Entity sold various items for R870 (excluding VAT). Calculate the cost of sales if
the gross profit percentage is set at 31.03% on the sales price.
Example 13.10 Solution
a) Gross profit expressed as a percentage of sales
45/145 x 100 = 31.03%
The abovementioned calculation follows from the relationship between Cost price, Gross profit and
Sales price:
Cost of sales
100
Gross profit
45
Sales
145
b) Actual gross profit percentage
R2 107 495/R4 901 150 x 100/1 = 43%
504
c) Possible reasons for the lower gross profit percentage
•
Inventory shortages;
•
Trade inventories sold at lower prices during clearance sales; or
•
The passage of time between the increase in the cost and the increase in the sales price.
d) Calculation of cost of sales
If the gross profit % on cost price is known, the relationship is written with Cost price = 100.
Cost of sales
100
X
+ Gross profit
45
=
Sales
145
R870
X = 100/145 x R870 = R600
e) Calculation of cost of sales
If the gross profit % on sales price is known, the relationship is written with Sales price = 100.
Cost of sales
68.97
X
+ Gross profit
31.03
=
Sales
100
R870
X = 68.97/100 x 870 = R600
Insurance claim and inventory loss due to an event
Insurance of trade inventories against an event
58
In the case of a trading entity, the risk exists that trade inventories can be destroyed or
damaged during an event (fire, floods, etc.). Trade inventories can also be stolen. An entity
can, by means of an insurance contract, hedge the risk of losses caused by events such as
theft, accidents and acts of nature (earth quakes, fires, floods, etc.). The cost associated with
the insurance contract is the monthly insurance premium which is recognised as an expense
in the reporting period to which it relates.
59
In Accounting, the loss of trade inventories due to such an event and the compensation
received from the insurer are two separate transactions and are consequently not offset
against eac