FINANCIAL REPORTING AND ANALYSIS
Module Guide
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MANAGEMENT COLLEGE OF SOUTHERN AFRICA
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This Guide
Financial Reporting and Analysis (NQF level 5)
module guide will be used across the following programmes:
x
Bachelor of Business Administration
x
Bachelor of Commerce in Financial Management
x
Bachelor of Public Administration
x
Bachelor of Commerce in Human Resource Management
x
Bachelor of Commerce in Supply Chain Management
x
Bachelor of Commerce in Information Technology Management
x
Bachelor of Commerce in Marketing Management
x
Bachelor of Commerce in Project Management
x
Bachelor of Commerce in International Business Management
Financial Reporting and Analysis
Preface.................................................................................................................................................................... 1
Unit 1: Understanding Financial Statements ........................................................................................................... 7
Unit 2: Statements of a Sole Proprietorship .......................................................................................................... 27
Unit 3: Financial Statements of a Partnership ....................................................................................................... 50
Unit 4: Financial Statements of a Company .......................................................................................................... 78
Unit 5: Analysis of Financial Statements ............................................................................................................. 113
Bibliography ........................................................................................................................................................ 145
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Financial Reporting and Analysis
List of Content
List of Figures
Figure 1-1 Financial Statements ..................................................................................................................... 10
Figure 1-2 The flow of information through the accounting system .................................................................. 16
Figure 1 Pre-Adjustment Trial Balance ............................................................................................................. 30
Figure 5-1 Financial ratios ............................................................................................................................ 115
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Financial Reporting and Analysis
Preface
A.
Welcome
Dear Student
It is a great pleasure to welcome you to Financial Reporting and Analysis (FRA5). To make sure that you share
our passion about this area of study, we encourage you to read this overview thoroughly. Refer to it as often as
you need to, since it will certainly make studying this module a lot easier. The intention of this module is to develop
both your confidence and proficiency in this module.
The field of Financial Management is extremely dynamic and challenging. The learning content, activities and
self- study questions contained in this guide will therefore provide you with opportunities to explore the latest
developments in this field and help you to discover the field of Financial Management as it is practiced today.
This is a distance-learning module. Since you do not have a tutor standing next to you while you study, you need
to apply self-discipline. You will have the opportunity to collaborate with each other via social media tools. Your
study skills will include self-direction and responsibility. However, you will gain a lot from the experience! These
study skills will contribute to your life skills, which will help you to succeed in all areas of life.
We hope you enjoy the module.
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Financial Reporting and Analysis
B.
x
Module Overview
The module is a 15 credit module at NQF level 5
AIM OF THE MODULE
This module aims to introduce students to financial statements and techniques involved in the preparation, analysis
and interpretation of financial statements
C.
Learning Outcomes and Associated Assessment Criteria of the Module
LEARNING OUTCOMES OF THE MODULE
ASSOCIATED ASSESSMENT CRITERIA OF THE
MODULE
x
x
explain the role of financial statements in x
Student should be able to complete all Think
businesses.
Points within each section. Students must stop and
think
understand and apply the regulations of both the
x
x
x
Think
Students should possess the ability to work through
students to carry out specific tasks or answer some
discuss the strengths and weaknesses of basic
questions. The aim of these activities is to give
financial statements.
students an opportunity to apply what you have
understand the concepts and procedures
learnt.
underlying
Students are required to work through the Self-
the
preparation
of
financial x
statements.
Test Questions/Revision Questions, which will
prepare financial statements for a sole
test the students understanding of what they have
proprietorship, partnership and company.
learnt up to that point,
analyse and interpret information that can be x
Students understanding is assessed through their
obtained
ability to successfully complete and achieve a pass
from
financial
statements
and
accounting reports.
x
the
the Self-Assessment Activities, which ask
content of financial statements.
x
at
example.
financial statements.
x
issue
concept to their own experience or to think of an
Reporting Standards in the preparation of
be familiar with the composition, structure and
an
Points. Sometimes students are asked to apply a
Companies Act and International Financial
x
about
mark of 50% in the:
prepare projected financial statements for a
The Main Assignment
business and explain their usefulness for
The Examination
decision-making purposes.
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Financial Reporting and Analysis
D.
Learning Outcomes and the Associated Assessment Criteria of the Units
You will find the Unit Learning Outcomes and the Associated Assessment Criteria on the introductory pages of
each Unit in the Module Guide. The Unit Learning Outcomes and Associated Assessment Criteria lists an overview
of the areas you must demonstrate knowledge in and the practical skills you must be able to achieve at the end of
each Unit lesson in the Module Guide.
E.
How to Use this Module
This Module Guide was compiled to help you work through your units and textbook for this module, by breaking
your studies into manageable parts. The Module Guide gives you extra theory and explanations where necessary,
and so enables you to get the most from your module.
The purpose of the Module Guide is to allow you the opportunity to integrate the theoretical concepts from the
prescribed textbook and recommended readings. We suggest that you briefly skim read through the entire guide
to get an overview of its contents. At the beginning of each Unit, you will find a list of Learning Outcomes and
Associated Assessment Criteria. This outlines the main points that you should understand when you have
completed the Unit/s. Do not attempt to read and study everything at once. Each study session should be 90
minutes without a break
This module should be studied using the prescribed and recommended textbooks/readings and the relevant
sections of this Module Guide. You must read about the topic that you intend to study in the appropriate section
before you start reading the textbook in detail. Ensure that you make your own notes as you work through both the
textbook and this module. In the event that you do not have the prescribed and recommended textbooks/readings,
you must make use of any other source that deals with the sections in this module. If you want to do further reading,
and want to obtain publications that were used as source documents when we wrote this guide, you should look
at the reference list and the bibliography at the end of the Module Guide. In addition, at the end of each Unit there
may be link to the PowerPoint presentation and other useful reading.
F.
Study Material
The study material for this module includes tutorial letters, programme handbook, this Module Guide, a list of
prescribed and recommended textbooks/readings which may be supplemented by additional readings.
G.
Prescribed and Recommended Textbook/Readings
There is at least one prescribed and recommended textbooks/readings allocated for the module.
The prescribed and recommended readings/textbooks presents a tremendous amount of material in a simple,
easy-to-learn format. You should read ahead during your course. Make a point of it to re-read the learning content
in your module textbook. This will increase your retention of important concepts and skills. You may wish to read
more widely than just the Module Guide and the prescribed and recommended textbooks/readings, the
Bibliography and Reference list provides you with additional reading.
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Financial Reporting and Analysis
The prescribed and recommended textbooks/readings for this module is:
x
Bartlett, G., Beech, G., de Hart, F., de Jager, P., de Lange, J., Erasmus, P., Hefer, J., Madiba, T., Middelberg,
S., Plant, G., Streng, J., Thayser, D. and van Rooyen, S. (2014) Financial Management: Turning theory into
practice. 1st Edition. Cape Town: Oxford University Press.
x
H.
Conradie, W.M. and Fourie, C.M.W. (2013) Basic Financial Management. 1st Edition. Cape Town: Juta & Co.
Special Features
In the Module Guide, you will find the following icons together with a description. These are designed to help you
study. It is imperative that you work through them as they also provide guidelines for examination purposes.
Special Feature
Icon
Explanation
LEARNING
The Learning Outcomes indicate what aspects of the particular
OUTCOMES
Unit you have to master and demonstrate that you have mastered
them.
ASSOCIATED
The Associated Assessment Criteria is the evaluation of student
ASSESSMENT
understanding with respect to agreed-upon outcomes. The
CRITERIA
Criteria set the standard for the successful demonstration of the
understanding of a concept or skill.
THINK POINT
A think point asks you to stop and think about an issue.
Sometimes you are asked to apply a concept to your own
experience or to think of an example.
ACTIVITY
You may come across activities that ask you to carry out specific
tasks. In most cases, there are no right or wrong answers to
these activities. The aim of the activities is to give you an
opportunity to apply what you have learned.
READINGS
At this point, you should read the reference supplied. If you are
unable to acquire the suggested readings, then you are welcome
to consult any current source that deals with the subject. This
constitutes research.
PRACTICAL
Real examples or cases will be discussed to enhance
APPLICATION
understanding of this Module Guide.
OR EXAMPLES
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Financial Reporting and Analysis
SELF-TEST
You may come across self-test questions at the end of each Unit
QUESTIONS
that will test your knowledge. You should refer to the module for
the answers or your textbook(s).
REVISION
You may come across self-assessment questions that test your
QUESTIONS
understanding of what you have learned so far. These may be
attempted with the aid of your textbooks, journal articles and
Module Guide.
CASE STUDY
Case studies are included in different sections in this module
guide. This activity provides students with the opportunity to
apply theory to practice.
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Financial Reporting and Analysis
Unit
1:
7
Understanding Financial
Statements
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Financial Reporting and Analysis
Unit Learning Outcomes and Associated Assessment Criteria
ARNING OUTCOMES OF THIS UNIT:
x
x
ASSOCIATED ASSESSMENT CRITERIA OF THIS UNIT:
understand the role played by each of x
Complete relevant think point, activity or self-assessment
the financial statements.
question to explain the usefulness of statements of
comprehensive income, financial position and cash flow
identify the various users of financial
statements and describe the value of the x
statements to them
x
explain the key concepts of GAAP.
x
discuss the uses and limitations of
financial statements.
x
x
x
Complete relevant think point, activity or self-assessment
question to tabulate the users of financial statements and the
information that is most relevant to them
x
Complete self-assessment activities 1.9.1
identify the characteristics of good x
Complete relevant think point, activity or self-assessment
financial statements.
question to list the key concepts of GAAP to be considered
when compiling financial statements
classify financial information into five
types of accounts.
x
x
Self-assessment activity 1.9.5
x
Complete self-assessment activities 1.9.2
explain the terminology applicable to x
Complete relevant think point, activity or self-assessment
financial statements
question to explain how the limitations of financial statements
can negatively affect users
summarise financial information in the
financial statements.
x
Complete think point 1
x
Complete self-assessment activities 1.9.3
x
Complete relevant think point, activity or self-assessment
question to analyse financial statement and identify what
makes them good
x
Complete relevant think point, activity or self-assessment
question to correctly classify financial information
x
self-assessment activity 1.9.4
x
Complete relevant think point, activity or self-assessment
question to prepare a summary of financial information
x
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Complete self-assessment activities 1.9.4, 1.9.5
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Financial Reporting and Analysis
1.1 Introduction
1.2 Role of Financial Statements
1.3 Users of Financial Statements
1.4 Generally Accepted Accounting Practice
1.5 Value and Limitations of Financial Statements
1.6 Characteristics of Good Financial Statements
1.7 Classification of Financial Information
1.8 Summarising Financial Information in the Financial Statements
Prescribed / Recommended Readings
x Bartlett, G., Beech, G., de Hart, F., de Jager, P., de Lange, J., Erasmus, P.,
Hefer, J., Madiba, T., Middelberg, S., Plant, G., Streng, J., Thayser, D. and
van Rooyen, S. (2014) Financial Management: Turning theory into practice.
1st Edition. Cape Town: Oxford University Press.
x Lodewyckx, E., Lötter, W., Rhodes, N. and Seedat, C. (2013) Introduction
to Financial Accounting: Fresh Perspectives. 2nd edition. Cape Town:
Pearson.
x Marx, J., de Swardt, C., Smith, M.B. and Erasmus, P. (2014) Financial
Management in Southern Africa. 4th Edition. Cape Town: Pearson
Education.:
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Financial Reporting and Analysis
1.1 INTRODUCTION
A financial statement may be defined as a formal record of the financial activities of a business
(www.studymode.com). Relevant financial information is presented in a structured manner and in a form that is
easy to understand. Stated simply, a financial statement is a declaration of what is believed to be true about a
company, communicated in terms of a monetary unit, such as the Rand.
1.2 ROLE OF FINANCIAL STATEMENTS
Different financial statements focus on different areas of financial performances. The financial statements consist
of the statement of comprehensive income (also called an income statement), statement of financial position (also
called a balance sheet), statement of changes in equity and a statement of cash flows (also called a cash flow
statement). Marx and Swardt (2014:40) outline the role played by these statements as follows:
FINANCIAL STATEMENT
REPORTS ON:
Statement of Financial Position
Financial position on a certain date.
Statement of Comprehensive Income
Financial performance for a particular period i.e.
whether a profit or loss was recorded.
Statement of Changes in Equity
Changes to investments by the owners and retained
earnings.
Statement of Cash Flows
Cash flows from operating activities, financing
activities and investing activities.
Figure 1Figure 1-1 Financial Statements
1.3 USERS OF FINANCIAL STATEMENTS
Businesses have a number of different stakeholders each with a particular area of interest in the financial
statements of the business. Bartlett et al. (2014:676) elaborate on the specific motives of each stakeholder:
1.3.1
Owners/Shareholders
They are interested in the financial performance of the business in order to assess the safety of their investments,
profitability and more importantly the potential for future capital growth. Shareholders pay a great deal of attention
to a company’s dividend policy and operational performance when dividends have not been paid.
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Financial Reporting and Analysis
1.3.2
Banks and other providers of credit
Credit providers are mainly interested in the ability of a business to meet its capital and interest debt repayments
when they fall due.
1.3.3
South African Revenue Services (Government Tax Collection Agency)
South African Revenue Services (SARS) has to ensure that all taxpayers declare and settle their tax liabilities
correctly. Comparative information enables SARS to determine whether anomalies exist in respect of underdeclared income and assets.
1.3.4
Employees
Employees are usually concerned with job security, fair wages and future advancement prospects. They are
thus concerned with the financial sustainability, profitability and growth of the business.
1.3.5
Management
The information from financial statements helps management to plan and control the activities of the business in
a way that will achieve the objectives that have been set.
1.3.6
External auditors
An external auditor is interested in the extent to which a company’s financial statements fairly present its financial
performance and financial position at any given point in time.
1.3.7Potential investors
Potential investors analyse financial statements to search for good investment opportunities. They often look for
companies whose shares may be undervalued or underperforming companies that, through restructuring and
management changes, could be made profitable again.
1.4 GENERALLY ACCEPTED ACCOUNTING PRACTICE (GAAP)
GAAP refers to the standard framework of guidelines for financial accounting and it includes the standards,
conventions, and rules that accountants follow in recording and summarizing financial information and in the
preparation of financial statements.
Marx and Swardt (2014:41) state that financial statements must be prepared according to GAAP so that
standardisation, uniformity and quality in financial reporting may be achieved. In South Africa, statements of
Generally Accepted Accounting Practice are published by the South African Institute of Chartered Accountants
(SAICA). South African statements of GAAP are entirely consistent with International Financial Reporting
Standards (IFRS). IFRS (see Chapter 4) are designed as a common global language for business affairs so that
company financial statements are understandable and comparable across international boundaries.
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Financial Reporting and Analysis
Marx and Swardt (2014:41) provide the following brief overview of the key concepts of GAAP:
1.4.1
Accounting entity
Only transactions that relate to the specific entity must be recorded and transactions that do not concern the entity
must be excluded.
1.4.2
Money measurement
The financial position and financial result can only be described accurately and meaningfully if the assets, liabilities,
equity, income and expenses are expressed in terms of money e.g. in South Africa the Rand is the unit of
measurement for all transactions.
1.4.3
Consistency concept
The consistency concept is based on the principle uniformity that prevails in the accounting treatment of like items
within each accounting period and from one period to the next. Any change in methods or policies must be
disclosed together with the financial statements.
1.4.4
Materiality
Information is regarded as material if its omission or misrepresentation could influence the economic decision of
users taken on the basis of the financial statements. Transactions that are not material in relation to the nature
and scope of an entity’s activities need not be taken into account if the cost and difficulty in recording them are not
justified by the resulting benefit.
1.4.5
Historic cost
Assets are recorded at their original cost to the entity.
1.4.6
Double-entry system
For every debit entry there must be a credit entry for the same amount.
1.4.7
Going-concern concept
In terms of the going concern concept it is presumed that the entity will continue to operate in the future. The
amounts reflected in the statement of financial position thus do not reflect the liquidation value of the assets.
1.4.8
Accounting period
The accounting period, which is usually one year, is the period of time chosen to report on the results of operations
and the financial position.
1.4.9
Matching concept
In terms of the matching concept all income earned and expenses incurred to earn the income are matched with
each other to calculate the profit (or loss) for the period for which they relate.
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Financial Reporting and Analysis
1.4.10 Conservatism
Conservatism in accounting requires accountants to be conservative when in doubt. When the principle of
conservatism is applied to making judgements, lower profits and asset valuations are estimated rather than higher
values.
1.4.11 Realisation principle
Income must be recorded as soon as it has been earned and realised. To be realised, income must be measurable
and there must be reasonable certainty that it can be recovered. Likewise, expenses must be recorded as soon
as they have been incurred and realised.
1.4.12 Accrual principle
When calculating the profit for a specific period, the income earned during that period (regardless when it was
received) is brought into account and the value consumed during that period as expenses (regardless of when
payment is made) is brought into account.
1.5
VALUE AND LIMITATIONS OF FINANCIAL STATEMENTS
1.5.1Value of financial statements
The financial statements of a company are its primary source of financial information
(www.smallbusiness.chron.com). If one wants to invest in a company and needed to know if the company is
worth the investment, one would study the company’s financial statements.
Financial statements provide information about the financial position, financial performance and changes in
financial position of an enterprise that is useful to a wide range of users in making economic decisions. By
publishing financial statements, companies are able to communicate with interested outside parties about its
accomplishments.
The financial statements reveal a lot to investors regarding the safety and profitability of their investments, the
company’s asset investments, and the company’s outstanding debt and equity components. Debt and equity
investors can thus better understand their relative positions in a company’s capital mix.
1.5.2
Limitations of financial statements
Bartlett et al. (2014:674) identify the following limitations of financial statements:
■
Historical cost: Since financial statements are prepared on the historical cost basis, the net asset value
reflected in the statement of financial position rarely reflects the true economic value of the enterprise.
■
Inflation: No adjustments are made to reflect the effect of inflation on the financial results that are reported
in the financial statements. The financial results of the current year cannot be easily compared to its results
to the previous years because currency is not worth the same amount each year.
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Financial Reporting and Analysis
■
Items that are not accounted for in financial statements: The annual reports of companies are largely
quantitative in nature and do not reflect information that cannot be expressed in monetary value terms. For
example internally generated goodwill, brand values and good corporate wisdom and management are
excluded from financial statements in terms of IFRS.
■
Backward-looking bias: Financial statements do not reflect the future expectations of a business, which
may have an impact on its financial ratios. For example, a company may have won a large profitable
contract or on the other hand may be facing the threat of new major competitors.
■
Accounting policies: Different companies make different choices regarding the application of policies
related to, for example, inventory valuation and depreciation. Furthermore, some values that are reflected
in the financial statements depend on estimates by management, which may differ widely across companies
and distort comparisons.
■
Focus on monetary information: The information contained in financial statements is stated mainly in
monetary terms. The financial reporting does not include, for example, the number of items sold, the total
number of kilometres travelled etc.
1.6
CHARACTERISTICS OF GOOD FINANCIAL STATEMENTS
Lodewyckx et al. (2013: 26) identify the following as characteristics that are necessary to ensure that financial
statements of quality are produced:
1.6.1
Understandable
The user should be able to understand the information that the financial statements contain.
Think Point
Suggest ways in which one can make sure that financial statements are
understandable
1.6.2
Relevant
Information is considered to be relevant if it is of assistance to users to make financial decisions. When assessing
the relevance of information, materiality must also be considered. Information is considered material if it is of a
size or nature that will influence the financial decisions of users.
1.6.3
Prudent
Financial statements often include estimates e.g. the amount of bad debts expected from the balance owing by
debtors. Prudence requires that caution should be exercised when estimates are made. This implies that one
should avoid overstating income and assets and understating expenses and liabilities in the financial statements.
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Financial Reporting and Analysis
1.6.4
Neutral
Financial statements should be unbiased, based on accounting principles alone and not serving the interests of an
individual. For example, the amount of tax payable is based on the profit (taxable income) of an entity.
Manipulating the profit by showing a lower amount than is the case shows bias towards the entity.
1.6.5
Reliable
Accountants decide which items to include in the financial statements. A recognition test helps with this decision.
They must also decide on the value of the item and this is called measurement. Accountants must use the best
measurement and recognition practices to ensure that the financial statements are reliable.
1.6.6
Complete
Descriptions in words as well as numbers are desirable. Categorising assets and liabilities into non-current and
current helps to form a complete picture of the financial position of an entity.
1.6.7
Comparable
Comparative figures should be included in financial statements i.e. the current year and previous year figures. This
helps the users to compare current performance with the performance of the previous year. Using similar
accounting methods when preparing financial statements also assists users to compare the performance of
different entities of a similar kind.
1.7
CLASSIFICATION OF FINANCIAL INFORMATION
The classification of the vast array of financial information requires a system of accounts. Marx and Swardt (2014:
43) correctly point out that an accountant may use a computerised system or a manual system. Our approach is
to explain manual accounting procedures but the knowledge gained can be applied to any type of automated
accounting system. Any system must provide for five types of accounts, namely:
■
Assets
■
Liabilities
■
Equity
■
Income
■
Expenses
Asset, equity and liability accounts are used to determine the financial position of an entity by preparing a statement
of financial position (balance sheet). Income and expense accounts are used to determine the financial
performance (profitability of the entity) by means of a statement of comprehensive income (income statement).
The record in which increases or decreases in any item in the financial statements are noted, is called a ledger
account or simple an account. The entire collection of accounts is called a ledger.
The relationship:
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Financial Reporting and Analysis
Assets = Equity + Liabilities
is called the accounting equation? Whilst the assets show what the entity owns, the equity and liabilities shows
who supplied the finance and how much each group supplied. Everything that is owned by the entity is funded by
either the owners or creditors. Thus the total claims of the owners plus the claims of the creditors equal the total
assets of the entity. That is why the total assets will always balance the equity and liabilities in the statement of
financial position.
When business events that involve money (called transactions) take place, the flow of accounting information is
summarised in the illustration below:
A business transaction takes place.
A business document is prepared or received.
Information is recorded in journals.
Posting to ledger accounts take place by means of debits and credits.
Financial statements are prepared at the end of the accounting period.
Figure 2Figure 1-2 The flow of information through the accounting system
1.8 SUMMARISING FINANCIAL INFORMATION IN THE FINANCIAL STATEMENTS
The financial information of an enterprise is summarised in financial reports called financial statements. Marx and
Swardt (2014: 43) provide an overview of the typical financial statements viz. statement of comprehensive income,
statement of financial position, statement of changes in equity and cash flow statement.
1.8.1
Statement of Comprehensive Income (Income Statement)
This statement provides a summary of the financial performance (profitability) of an entity for a period of time, by
matching income earned to expenses incurred to obtain that income. Income results from economic benefits
flowing to the entity because of various transactions with third parties, other than the owners of the entity.
Expenses are decreases in economic benefits in the form of outflows or depletion of assets. The following is an
example of a statement of comprehensive income of a sole proprietorship:
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Financial Reporting and Analysis
Santana Traders
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.14
R
Sales
1 262 000
Cost of sales
(700 000)
Gross profit
562 000
Other operating income
62 000
Rent income
60 000
Discount received
2 000
Gross operating income
624 000
Operating expenses
(313 850)
Wages
123 000
Bank charges
4 000
Packing materials
37 000
Advertising
18 000
Rates
7 000
Bad debts
2 800
Discount allowed
1 000
Stationery
19 000
Water and electricity
9 000
Insurance
11 500
Telephone
9 900
Depreciation
40 000
Other operating expenses
31 650
Operating profit
310 150
Interest income
0
Interest expense
(12 000)
Net profit for the year
298 150
Sales reflect the amount that an entity earns through selling products that it has purchased or manufactured.
Cost of sales is the cost of the merchandise sold to customers.
Gross profit is the difference between sales revenue and cost of sales.
Other operating income refers to income, other than sales, generated in the course of ordinary activities of an
entity.
Gross operating income is the sum of the gross profit and other operating income. Operating expenses are the
costs of resources used as part of the operating activities during a financial period and are not directly associated
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with specific goods and services. Operating expenses include selling expenses, general and administrative
expenses.
Operating profit is the difference between the gross profit and operating expenses. Interest expense and
interest income must be disclosed separately on the face of the statement of comprehensive income after
operating profit.
Arithmetically, the net profit (or loss) is the difference between income and expenses. Net profit will only result if
the income exceeds expenses.
1.8.2
Statement of Financial Position (Balance Sheet)
The purpose of this statement is to reflect the financial position of an entity on a particular date by reflecting its
assets, equity and liabilities. The following is an example of a statement of financial position of a sole
proprietorship:
Santana Traders
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.14
ASSETS
R
Non-current assets
856 050
Property, plant and equipment
856 050
Current assets
243 700
Inventories
137 000
Trade and other receivables
100 700
Cash and cash equivalents
6 000
Total assets
1 099 750
EQUITY AND LIABILITIES
Equity
934 850
Capital
934 850
Non-current liabilities
72 000
Loan: Len Bank
72 000
Current liabilities
92 900
Trade and other payables
68 900
Current portion of long-term borrowings
24 000
Total equity and liabilities
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1 099 750
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Financial Reporting and Analysis
The following are brief explanations of the items in the statement of financial position:
Assets are the resources that are controlled by an enterprise from which economic benefits will be derived either
now or in the future.
Non-current assets are assets such as land, buildings, vehicles and equipment that have a useful life of more
than one year.
Current assets are assets that are cash or can be converted into cash within one year. Inventory refers to the
merchandise that has been purchased but not yet sold. Trade and other receivables include the amounts owing
by customers for merchandise sold to them on credit and any other amounts owing to the entity. Cash represents
cash on hand and cash kept at the bank.
Equity may be viewed as the residual claim that the owner(s) has on the assets of the organisation after all the
liabilities have been settled. It normally consists of two parts viz. that which is invested in the entity and that which
is earned by the entity and left in the entity (i.e. retained profits).
Liabilities are claims on the assets of an organisation. Simply put, it refers to what an organisation owes.
Non-current liabilities are debts that are payable after more than one year from the statement of financial position
date.
Current liabilities refer to debts that are payable within one year from the statement of financial position date.
Trade and other payables include amounts owing to suppliers for merchandise purchased on credit and any other
debt payable within one year from the statement of financial position date. Current portion of long-term borrowings
refers to the portion of the long-term debt that is payable with one year from the statement of financial position
date.
1.8.3
Statement of changes in equity
The statement of changes in equity reflects the changes to the equity during the year. The following is a
simplified format of a statement of changes in equity of a sole proprietorship:
Santana Traders
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
28 FEBRUARY 20.14
Balance on 28 February 20.13
536 700
Additional capital contributed
100 000
Net profit for the year
298 150
Drawings
Balance on 28 February 20.14
19
(0)
934 850
MANCOSA
Financial Reporting and Analysis
Balance on 28 February 20.13 includes the investment of the owner in the organisation as well as any retained
profit from the previous year(s).
Additional capital contributed reflects an increase in the investment by the owner in the organisation during the
year.
Profit for the year refers to the net profit available to the owner as calculated in the statement of comprehensive
income.
Drawings for the year reflect the portion of the profit earned which has been withdrawn by the owner for personal
use.
Balance on 28 February 20.14 shows the value of the equity at the end of the accounting period.
1.8.4
Cash Flow Statement (Statement of Cash Flows)
The purpose of the cash flow statement is to provide information to investors, creditors and other users to assess
the ability of an entity to meet its cash requirements. It shows how changes in the accounts in the statement of
financial position and profit affect cash and cash equivalents. It breaks the analysis down into operating, investing
and financing activities. In short, it reflects the sources of cash and how the cash was used during the year. The
following is an example of a simple cash flow statement:
Santana Traders
CASH FLOW STATEMENT FOR THE YEAR ENDED 28 FEBRUARY 20.14
Cash flows from operating activities
Operating profit
Non cash flow adjustment: Depreciation
Profit before working capital changes
Working capital changes:
Increase in inventory
Increase in accounts receivable
Increase in accounts payable
Cash generated from operations
Interest paid
R
278 150
310 150
40 000
350 150
(60 000)
(50 000)
(40 000)
30 000
290 150
(12 000)
Cash flows from investing activities
Non-current assets purchased
(300 000)
300 000
Cash flows from financing activities
Cash received from owner
Repayment of non-current loan
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
60 000
100 000
(40 000)
38 150
(32 150)
6 000
MANCOSA
20
Financial Reporting and Analysis
Cash flows from operating activities pertain to the cash flows from an entity’s core business activities, such as
manufacturing, distributing, marketing and selling a product or service. These activities should provide the majority
of a company’s cash flow and will largely determine whether an entity is profitable or not.
Depreciation is added back to profit as it is a book entry and cash is not affected.
The increase in inventory is subtracted because cash was paid to increase inventory.
The increase in accounts receivable is subtracted since it reflects sales that have not yet been received.
The increase in accounts payable is added since cash has not been paid for products or services received.
Cash flows from investing activities reflect the cash used to purchase assets that have a long life.
Cash flows from financing activities include amounts received from the owner to increase capital and amounts
received (or paid) through long-term borrowing.
The net increase in cash can be verified as it is also equal to the difference in the cash balances at the beginning
and end of the accounting period.
1.9 SELF-ASSESSMENT ACTIVITIES
1.9.1
Financial statements of an enterprise are required by various individuals and organizations in order to
make decisions. Explain why each of the following user groups may need accounting information from the
financial statements of an enterprise.
■ Suppliers/Creditors
■ Government
■ Owners
■ Lenders
■ Employees
■ Investment analysts
■ Managers
21
MANCOSA
Financial Reporting and Analysis
1.9.2
Match the GAAP concept in COLUMN A with the statement in COLUMN B. Write down the letter of the
correct answer.
COLUMN A
1.9.2.1
Historic cost
COLUMN B
A
Interest on overdraft is shown separately in the financial
statements.
1.9.2.2
Accrual principle
B
The account of a debtor who is experiencing financial
difficulty is written off.
1.9.2.3
Conservatism
C
An entry is made immediately in the books for an invoice
received for goods purchased.
1.9.2.4
Materiality
D
The method and rate of depreciation on vehicles is the
same as the previous years.
1.9.2.5
Realisation principle
E
Rent income for the last month of the financial year was
not yet received but was taken into consideration to
calculate the net profit.
1.9.2.6
Consistency
F
Land and buildings are reported in the financial
statements at the purchase price of R500 000 even
though they are worth R800 000 today.
1.9.3
Your friend has picked up on the following issues in the financial statements of his business, prepared
by his accountant. What advice would you give him with regard to each of the following:
■
The financial statements contain information on the last financial year only.
■
There are no sub-categories for assets and liabilities in the statement of financial position.
■
The land and buildings are reported at the price paid for them twenty years ago.
1.9.4 Define the following terms:
■
Assets
■
Current assets
■
Non-current assets
■
Liabilities
■
Non-current liabilities
■
Current liabilities
■
Equity
■
Income
■
Expenses
■
Profit
■
Cash flow from operating activities
MANCOSA
22
Financial Reporting and Analysis
■
Cash flow from investing activities
■
Cash flow from financing activities
1.9.5
Describe the function of each of the following financial statements:
■
Statement of Financial Position
■
Statement of Comprehensive Income
■
Statement of Changes in Equity
■
Statement of Cash Flows
1.9.6
REQUIRED
Use the information given below to prepare the Statement of Financial Position as at 07 January 20.15 after the
transactions for the week ended 07 January 20.15 are taken into account.
INFORMATION
The balance sheet of a business as at 01 January 20.15 included the following items:
R
Equity
3 045 000
Equipment
3 120 000
Inventories
420 000
Bank overdraft
645 000
Trade and other receivables
495 000
Trade and other payable
345 000
Transactions
During the week ended 07 January 20.12 the following transactions took place:
■
Inventories were sold for R165 000 cash; these inventories had cost R120 000.
■
Sold inventories for R345 000 on credit; these inventories had cost R255 000.
■
Received cash from debtors totalling R270 000.
■
The owners introduced R1 500 000 cash into the business.
■
Ten computers were purchased on credit, R150 000.
■
Bought inventories on credit for R210 000.
■
Paid creditors a total amount of R195 000 in settlement of accounts.
23
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Financial Reporting and Analysis
1.10 Solutions
Think Point
THINK POINT 1!
Answers may vary and may include the following:
The statement of financial position or statement of comprehensive income should fit
in a single page so that the financial position or the financial performance can be
observed with a glance.
Individual items in the financial statements may be described in greater detail in
separate notes to the financial statements.
Explain the accounting methods that have been used to value certain items.
Explain any unusual event such as a correction of an error from the previous year
1.9.1
■
Suppliers/Creditors: To assess the ability of the business to pay for the goods and services provided.
■
Government: To assess the amount of tax the business should pay.
■
Owners: To assess how effectively the business is managed and to make judgements about likely levels
of risk and return in the future.
■
Lenders: To assess the ability of the business to pay interest and the principal sum lent.
■
Employees: To assess the ability of the business to provide employment and to reward them for their
labour.
■
Investment analysts: To assess the possible risks and returns associated with the business in order to
determine its investment potential, so that they could advise their clients accordingly.
■
Managers: To assist them in making decisions and plans for the business and to help them to exercise
control to ensure that plans succeed.
1.9.2
1.9.2.1
F
1.9.2.2
E
1.9.2.3
B
1.9.2.4
A
1.9.2.5
C
1.9.2.6
D
MANCOSA
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Financial Reporting and Analysis
1.9.3
■
The financial statements contain information on the last financial year only.
The financial statements for an accounting period (e.g. the last financial year) are supposed to report on the
results of operations and financial position that relate that that period. However, the figures of the previous year
should also have been provided to facilitate a comparison of performance.
■
There are no sub-categories for assets and liabilities in the statement of financial position.
Assets and liabilities should be categorised as current and non-current to facilitate interpretation.
■
The land and buildings are reported at the price paid for them twenty years ago.
In terms of the historic cost concept, this is correct otherwise the value can be manipulated in favour of a
particular person (bias).
1.9.4
Refer to paragraphs 1.8.1, 1.8.2 and 1.8.4
1.9.5
Refer to Figure 1-1
1.9.6
R
Equity
3 045 000 + 165 000 – 120 000 + 345 000 – 255 000 + 1 500 000
= 4 680 000
Equipment
3 120 000 + 150 000 = 3 270 000
Inventories
420 000 - 120 000 – 255 000 + 210 000 = 255 000
Bank overdraft
645 000 - 165 000 – 270 000 – 1 500 000 + 195 000
= 1 095 000 DR (favourable balance)
25
Accounts receivable
495 000 + 345 000 – 270 000 = 570 000
Accounts payable
345 000 + 150 000 + 210 000 – 195 000 = 510 000
MANCOSA
Financial Reporting and Analysis
Statement of Financial Position as at 07 January 20.15
R
ASSETS
Non-current assets
Property, plant and equipment
3 270 000
Current assets
1 920 000
Inventories
255 000
Trade and other receivables
570 000
Cash and cash equivalents
1 095 000
Total assets
5 190 000
EQUITY AND LIABILITIES
Equity
4 680 000
Current liabilities
MANCOSA
Trade and other payables
510 000
Total equity and liabilities
5 190 000
26
Financial Reporting and Analysis
Unit
2:
27
Statements of a Sole Proprietorship
MANCOSA
Financial Reporting and Analysis
Unit Learning Outcomes and Associated Assessment Criteria
LEARNING OUTCOMES OF THIS UNIT:
x
ASSOCIATED ASSESSMENT CRITERIA OF THIS UNIT:
Students should be able to prepare the Complete relevant think point, activity or self-assessment
following financial statements from a pre- question to prepare
x
x
x
adjustment trial balance and additional Statement of comprehensive income
information (including adjustments):
Statement of financial position
Statement of Comprehensive Income.
Cash flow statement
Statement of Changes in Equity
x Work out example 1
Statement of Financial Position
x Complete self-assessment activity 2.5
2.1 Introduction
2.2 Pre-Adjustment Trial Balance
2.3 Year-end adjustments
2.4 Preparing Financial Statements from a Pre-Adjustment Trial Balance and additional information
Prescribed / Recommended Readings
Kew, J and Warson, A. (2013) Financial Accounting: An Introduction. 4th
edition. Cape Town: Oxford University Press.
Lodewyckx, E., Lötter, W., Rhodes, N. and Seedat, C. (2013) Introduction to
Financial Accounting: Fresh Perspectives. 2nd edition. Cape Town: Pearson.
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Financial Reporting and Analysis
2.1 INTRODUCTION
Before the stage is reached where one is ready to prepare the financial statements of an entity, the following events
would have already taken place
x
Transactions occurred during the financial year.
x
Transaction data were entered on source documents.
x
Transactions were recorded in journals from the source documents.
x
Information from the journals was posted to ledger accounts.
A trial balance was prepared to determine whether the double-entry principle has been correctly applied during the
posting process
The financial statements can only be prepared after adjustments are made to the amounts in the trial balance, in
order to comply with the GAAP concepts discussed in topic 1 (paragraph 1.4)..
2.2 PRE-ADJUSTMENT TRIAL BALANCE
A pre-adjustment trial balance is a list of accounts and their balances at a given time. It is usually prepared at the
end of an accounting period. The accounts are listed in the order in which they appear in the general ledger. The
trial balance includes debit balances listed in the left column and credit balances in the right column. The totals of
the two columns must be equal. The main purpose of trial balance is to check that the total of all debit entries is
equal to the total of all credit entries after posting has been completed.
The following is an example of a pre-adjustment trial balance:
Simmonds Traders
PRE-ADJUSTMENT TRIAL BALANCE AS AT 28 FEBRUARY 20.15
Debit (R)
Balance sheet accounts section
Capital
Drawings
Land and buildings at cost
Equipment at cost
Vehicles at cost
Accumulated depreciation on equipment
Accumulated depreciation on vehicles
Fixed deposit: Rio Bank (10% p.a.)
Trading inventory
Debtors control
Provision for bad debts
Bank
Petty cash
Creditors control
29
Credit (R)
1 264 804
116 014
818 720
546 000
350 000
176 400
88 200
28 000
84 000
106 400
4 800
10 000
1 120
131 600
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Financial Reporting and Analysis
Loan: Rio Bank (16% p.a.)
Nominal accounts section
Sales
Cost of sales
Sales returns
Advertising
Consumable stores
Bad debts
Discount allowed
Discount received
Electricity and water
Telephone
Interest on fixed deposit
Interest on overdraft
Insurance
Salaries
Bank charges
Rent income
Municipal rates
64 400
1 432 480
795 100
25 200
16 800
22 400
6 160
9 800
5 040
50 400
24 000
1 680
840
8 400
161 040
5 180
43 470
27 300
3 212 874
3 212 874
Figure 3Figure 1 Pre-Adjustment Trial Balance
The accounts in the balance sheet accounts section are used to prepare the statement of financial position. The
accounts in the nominal accounts section are used to prepare the statement of comprehensive income.
The following is an explanation of the accounts in the balance sheet accounts section:
Capital: represents the amount invested by the proprietor plus the profits that has been retained in the business.
Drawings: refers to the cash, inventories etc. that the proprietor may have taken from the business during the
financial year for his/her personal use.
Land and buildings, Equipment and Vehicles at cost: reflect the purchase price of these assets i.e. their
original cost prices.
Accumulated depreciation on equipment and Accumulated depreciation on vehicles: Property, plant and
equipment lose value each year through usage and after a certain number of years they become obsolete. In
accordance with the matching principle, the cost of property, plant and equipment must be written off during the
period it is expected to be economically useful. As a result an expense called depreciation is provided for each
year on assets like equipment, vehicles and machinery. An account called Accumulated depreciation (with the
type of asset attached to it e.g. equipment) is created to reflect the amount of depreciation recorded each year.
This account thus shows the cumulative total of the depreciation recorded on the asset since the date of purchase.
MANCOSA
30
Financial Reporting and Analysis
Fixed deposit: Rio Bank (10% p.a.): The business invested R28 000 in an investment account at the bank,
earning interest at 10% per annum.
Trading inventory: is the cost price of the merchandise (that was purchased for resale) that has not been sold.
Debtors control: is the amount owing by the customers, to whom merchandise has been sold on credit.
Provision for bad debts: A provision is made for the portion of the amount owing by debtors, that the entity
expects that it will not be able to collect (i.e. bad debts).
Bank: The entity has R10 000 in its bank account.
Petty cash: R1 120 is set aside to make payments for small amounts, in order to save on bank charges.
Creditors control: R131 600 is owing to suppliers for credit purchases (mainly inventories for resale).
Loan: Rio Bank (16% p.a.): R64 400 is owing to Rio Bank and interest at a rate of 16% per annum is payable.
The following is an explanation of the accounts in the nominal accounts section:
Sales: include the cash and credit sales made during the year but excludes the returns of merchandise by
debtors.
Cost of sales: refers to the cost price of the merchandise sold. When an entity uses the perpetual inventory
system, the cost of sales is recorded each time a sales transaction occurs. A cost of sales account thus exists (as
is the case in the trial balance above).
If an entity uses the periodic inventory system, the cost of sales is not recorded when a sales transaction takes
place. In this case, the cost of sales may be calculated as follows:
Opening inventory (Inventory at the end of the previous year)
100 000
Purchases
750 000
Carriage on purchases (delivery costs for merchandise purchased)
29 100
Cost of inventory available for sale
879 100
Closing inventory (Inventory at the end of the current year)
(84 000)
Cost of sales
795 100
Any costs that are incurred to purchase the goods (e.g. import duties) must also be included.
Sales returns: Merchandise returned by debtors is recorded in this account. When the financial statements are
prepared the returns are deducted from sales to reflect the net sales for the period.
31
MANCOSA
Financial Reporting and Analysis
Advertising and the other accounts in the debit column of the nominal accounts section: are the other
expenses of the entity. Interest expenses such as interest in overdraft are not considered to be operating expenses
and are thus disclosed separately from them.
Discount received, Interest on fixed deposit and Rent income: (accounts in the credit column of the nominal
accounts section) are the other income accounts of the entity. Interest income accounts such as interest on fixed
deposit are not considered to be operating income and are therefore disclosed separately from them.
2.3 YEAR-END ADJUSTMENTS
The transactions that are recorded and posted during the year don’t always relate to the same financial year. In
addition, some transactions relating to a financial year are not recorded because the amounts have not yet been
received or paid. As a result, adjustments need to be made to accounts to reflect the correct amounts in
determining the profit and the financial position of a business. New accounts may be created during this process.
Only after accounts have been adjusted can the financial statements be prepared. Lodewyckx et al. (2013: 51)
identify adjustments that need to be made in respect of the following:
2.3.1
Bad debts
At the end of the financial year, the overdue accounts of debtors are often reviewed and should the proprietor or
manager conclude that the possibility of recovering the debt from the debtor is remote, authorisation is given for
the account to be written off as a bad debt. Effect:
Bad debts (expense) +
Debtors control –
2.3.2
Provision for bad debts
In terms of the amount owing for the credit sales that took place during the financial year, it is usually expected
that a certain portion will not be collected in the next financial year (bad debts). In terms of the accrual principle, a
provision must be made by means of an adjustment entry for these bad debts that may be written off in the next
financial year. The following examples illustrate the creation, increase and decrease in provision for bad debts.
Creation of provision for bad debts
Provision for bad debts adjustment (reflect as an expense)
Provision for bad debts +
Increase in provision for bad debts
Provision for bad debts adjustment (reflect as an expense)
Provision for bad debts +
Decrease in provision for bad debts
Provision for bad debts adjustment (reflect as an income)
Provision for bad debts –
MANCOSA
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Financial Reporting and Analysis
2.3.3
Depreciation
As indicated in paragraph 2.2 an expense called depreciation is provided for each year on assets like equipment,
vehicles and machinery. This provision for depreciation is made at the end of the financial year except when the
asset is sold. When an asset is purchased during the financial year, depreciation is provided only for the part of
the year that it was used.
The two most popular methods of calculating depreciation are the fixed instalment method and the diminishing
balance method. When using the fixed instalment method the cost of the asset is written off each year in equal
amounts over its expected economic life. Equal amounts of depreciation each year can be obtained by calculating
a fixed percentage on the cost price e.g. depreciation is calculated at 20% p.a. on cost. When using the
diminishing balance method, a percentage is applied to the carrying value of the asset. Note:
(Carrying value = Cost – Accumulated depreciation).
Effect:
Depreciation (expense)+
Accumulated depreciation +
2.3.4
Accrued income
Accrued income (also called income receivable) refers to income that has been earned during the financial year
but has not yet been received. In terms of the matching concept and accrual principle, any income that has been
earned but not yet received must be brought in to account during the current financial year.
Effect:
Income account +
Accrued income +
Accrued income is included in the statement of financial position as part of “Trade and other receivables” under
current assets.
2.3.5
Accrued expenses
Accrued expense (also called expenses payable) refers to an expense that has been incurred during the financial
year but has not yet been paid. In terms of the matching concept and accrual principle, any expense that has been
incurred but not yet paid must be brought in to account during the current financial year. Effect:
Expense account +
Accrued expenses +
Accrued expenses is included in the statement of financial position as part of “Trade and other payables” under
current liabilities.
33
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Financial Reporting and Analysis
2.3.6
Prepaid expenses
Prepaid expense arises when an expense is paid for in the current financial year but the whole or part of the
expense relates to the next accounting period. In terms of the matching concept, an adjustment needs to be made
so that only the amount relating to the current financial year is transferred to the statement of comprehensive
income. Effect:
Expense account –
Prepaid expenses +
Prepaid expenses is included in the statement of financial position as part of “Trade and other receivables” under
current assets.
2.3.7
Income received in advance
Income received in advance (also called deferred income) arises when income is received in the current financial
year but it relates to the next accounting period. Once again in terms of the matching concept, an adjustment
needs to be made so that only the amount relating to the current financial year is transferred to the statement of
comprehensive income. Effect:
Income account –
Income received in advance +
Income received in advance is included in the statement of financial position as part of “Trade and other payables”
under current liabilities.
2.3.8
Consumable inventory
During the financial year the business may purchase various kinds of consumable items e.g. stationery, packing
materials. At the end of the financial year it is possible that some of these consumable items may be found to be
unused during stocktaking. In terms of the matching concept, the unused consumable items (consumable
inventory) cannot be regarded as an expense for the current financial year. An adjustment thus needs to be made
so that only the amount used during the current financial year is transferred to the statement of comprehensive
income. Effect:
Consumable item account e.g. Stationery (expense) –
Consumable inventory +
Consumable inventory is included in the notes to the financial statements under Inventories.
2.4 PREPARING FINANCIAL STATEMENTS FROM A PRE-ADJUSTMENT TRIAL BALANCE AND
ADDITIONAL INFORMATION (INCLUDING ADJUSTMENTS)
We are going to examine the effects of year-end adjustments (and additional information provided) on the financial
statements without going through the account system.
It sometimes becomes necessary to draw up financial statements by taking the above year-end adjustments into
account but before these adjustments are posted. If financial statements are required urgently e.g. for decisionMANCOSA
34
Financial Reporting and Analysis
making purposes, they may have to be done directly from the balances available and the adjustments that are
necessary.
There are various methods that may be used for taking adjustments into account (without journalising and posting
them) to prepare the financial statements. The method that we recommend is to draw up the financial statements
in a logical manner from the adjustments and information provided. When using this method, the following steps
may be followed:
Prepare the formats of the financial statements viz. statement of comprehensive income, statement of changes in
equity, statement of financial position and notes to the financial statements without entering any amounts.
Now take the figures from the pre-adjustment trial balance and write them down next to the relevant detail in the
financial statements.
Study each adjustment and taking into account the double-entry principle, make the adjustments to the amounts
you have entered (in the previous step).
After adjusting the pre-adjusted amounts, enter the final figures and complete the financial statements with the
necessary calculations.
This is illustrated using the following example:
Required
x
Use the information given below for Madida Traders (owner M. Madida) to prepare the:
x
Statement of Comprehensive Income for the year ended 28 February 20.15.
x
Statement of Changes in Equity for the year ended 28 February 20.15.
Statement of Financial Position as at 28 February 20.15.
Notes to the financial statements for the year ended 28 February 20.15
Note: Madida Traders uses the periodic inventory system.
35
MANCOSA
Financial Reporting and Analysis
Ensure that the financial statements comply with the requirements of statements of Generally Accepted
Accounting Practice (GAAP).
Information
Madida Traders
PRE-ADJUSTMENT TRIAL BALANCE AS AT 28 FEBRUARY 20.15
Debit (R)
Balance Sheet Accounts Section
Capital
Drawings
Land and buildings
Equipment
Accumulated depreciation on equipment (01 March 20.14)
Fixed deposit: Ben Bank (8% p.a.)
Loan: Zen Bank (16% p.a.)
Debtors control
Creditors control
Bank
Cash float
Nominal accounts section
Sales
Opening inventory
Purchases
Sales returns
Purchases returns
Rent income
Interest on fixed deposit
Bank charges
Water and electricity
Telephone
Insurance
Interest on loan
Rates and taxes
Salaries and wages
Consumable stores
Advertising
Credit (R)
596 400
130 500
600 000
145 000
33 000
50 000
60 000
51 630
18 720
1 500
74 400
841 600
105 330
408 760
6 000
4 500
80 400
2 000
2 700
18 810
5 250
5 850
7 250
24 600
84 640
10 960
14 800
1 692 300
1 692 300
Adjustments and additional information
1.
Inventory on hand on 28 February 20.15 amounted to R91 000. Inventories are measured at cost, on a
FIFO method and at net realisable value, whichever is the lower.
2.
Consumable stores according to stocktaking on 28 February 20.15 amounted to R900.
MANCOSA
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Financial Reporting and Analysis
3.
Advertising included a payment of R1 080 for advertisements to appear in a local newspaper from 01
November 20.14 to 30 April 20.15.
4.
Depreciation is provided annually on equipment at 10% p.a. using the diminishing balance method.
5.
The loan from Zen bank is an unsecured loan that was granted to Madida Traders on
01 February 20.14. Provide for the outstanding interest on loan. The loan is repayable in 10 equal annual
instalments. The first instalment is payable on 31 March 20.15.
6.
The investment at Ben Bank was made on 01 June 20.14. Provide for the outstanding interest on the
fixed deposit. The fixed deposit matures on 01 June 20.15.
7.
The tenant has already paid the rent for March 20.15. Note that the monthly rental of R6 000 was
increased by 10% with effect from 01 December 20.14.
8.
A debit order for R500 for the insurance of the proprietor’s home was erroneously entered in the insurance
account.
9.
A debtor who owed R800 has been declared insolvent. His estate paid a first and final dividend of 70
cents in the Rand. The balance of his account must be written off. No entries have been made for these
transactions.
10. A debtor’s account with a credit balance of R200 must be transferred to her account in the creditors’
ledger.
37
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Financial Reporting and Analysis
Solution
Madida Traders
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED
28 FEBRUARY 20.15
R
Sales (841 600-6 000)
835 600
Cost of sales
(418 590)
Opening inventory (105 330)
105 330
Purchases (408 760-4 500)
404 260
Closing inventory
(91 000)
Gross profit
417 010
Other operating income
73 800
Rent income (80 400-6 600)
73 800
Gross operating income
490 810
Operating expenses
(177 290)
Bank charges (2 700)
2 700
Water and electricity (18 810)
18 810
Telephone (5 250)
5 250
Insurance (5 850-500)
5 350
Rates and taxes (24 600)
24 600
Salaries and wages (84 640)
84 640
Consumable stores (10 960-900)
10 060
Advertising (14 800-360)
14 440
Depreciation
11 200
Bad debts
240
Operating profit
313 520
Interest income (2 000+1 000)
3 000
Interest expense (7 250+2 350)
(9 600)
Net profit for the year
306 920
MANCOSA
38
Financial Reporting and Analysis
REMARKS
The effects of the adjustments and additional information on the financial statements are as follows:
Effect on the Statement of Comprehensive
Effect on the Statement of Financial Position,
Income
Statement of Changes in Equity and Notes to the
financial statements
1.
Closing inventory R91 000
Merchandise R91 000 (Note 4)
2.
Consumable stores – R900
Consumable inventory R900 (Note 4)
3.
Advertising –R360 (R1 080 X 2/6)
Prepaid expenses R360
4.
Depreciation R11 200
Depreciation for the year R11 200 (Note 2)
([R145 000 – 33 000] X 10%)
5.
Interest expense + R2 350
Accrued expenses R2 350
(60 000 X 16%) = R9 600 – R7 250
R6 000 is the current portion of loan
= R2 350
6.
Interest income + R1 000
Accrued income R1 000
(50 000 X 8% X 9/12)
Fixed deposit reflected as non-current asset as it
= R3 000 – 2 000 = 1 000
matures in more than 12 months’ time
7.
Rent income – R6 600
Income received in advance R6 600
8.
Insurance – R500
Drawings +R500
9.
Bad debts +R240
Trade debtors –R240 –R560
(R800 X 30%)
Bank +R560
No change
Trade debtors +R200
10.
Trade creditors +R200
Madida Traders
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.15
R
Balance on 28 February 20.14
596 400
Net profit for the year
306 920
Drawings (130 500 + 500)
(131 000)
Balance on 28 February 20.15
772 320
39
MANCOSA
Financial Reporting and Analysis
Madida Traders
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
Note
R
ASSETS
Non-current assets
750 800
Property, plant and equipment
2
700 800
Financial assets (50 000)
3
50 000
165 070
Current assets
Inventories
4
Trade and other receivables
91 900
52 390
Trade debtors (51 630 – 240 – 560 + 200)
51 030
Prepaid expenses (360)
360
Accrued income (1 000)
1 000
Cash and cash equivalents
20 780
Bank (18 720 + 560)
19 280
Cash float (1 500)
1 500
915 870
Total assets
EQUITY AND LIABILITIES
Equity
772 320
Capital
772 320
Non-current liabilities
54 000
Long-term borrowings
5
54 000
Current liabilities
89 550
Trade and other payables
83 550
Trade creditors (74 400 + 200)
74 600
Income received in advance (6 600)
6 600
Accrued expenses (2 350)
2 350
Current portion of long-term borrowings
Total equity and liabilities
MANCOSA
5
6 000
915 870
40
Financial Reporting and Analysis
NOTES TO THE FINANCIAL STATEMENTS
1.
Accounting policy
The accounting policy of Madida Traders is consistent with that of the previous year, and is as follows:
1.1
Measurement basis
The financial statements are based on the historical cost and comply with Generally Accepted Accounting
Practice.
1.2
Property, plant and equipment
Equipment is written off at 10% per annum on the diminishing balance.
1.3
Inventories
Inventories are measured at the lower of cost, on the FIFO method, and net realisable value, whichever is lower.
2.
Property, plant and equipment
Land and
buildings
Equipment
Total
Carrying value at beginning of year
600 000
112 000
712 000
Cost
600 000
145 000
745 000
Accumulated depreciation
(33 000)
(33 000)
Depreciation for the year
(11 200)
(11 200)
Carrying value at end of year
600 000
100 800
700 800
Cost
600 000
145 000
745 000
(44 200)
(44 200)
Accumulated depreciation
3.
Financial assets
Fixed deposit: Ben Bank (8% p.a.)
50 000
50 000
4.
Inventories
Inventories consist of:
Merchandise
Consumable inventory
91 000
900
91 900
41
MANCOSA
Financial Reporting and Analysis
5.
Long term borrowings
Unsecured
Loan from Zen Bank. Interest rate is 16% p.a.
60 000
Less: Instalment payable within one year, transferred to current liabilities
(6 000)
54 000
2.5
SELF-ASSESSMENT ACTIVITIES
Use the given information for Ajax Traders to prepare the:
equired
„ Statement of Comprehensive Income for the year ended 28 February 20.15.
„ Statement of Changes in Equity for the year ended 28 February 20.15.
„ Statement of Financial Position as at 28 February 20.15.
„ Notes to the financial statements for the year ended 28 February 20.15.
Note: Ajax Traders uses the perpetual inventory system.
Ensure that the financial statements comply with the requirements of statements of Generally
Accepted Accounting Practice (GAAP)
MANCOSA
42
Financial Reporting and Analysis
Information
Ajax Traders
PRE-ADJUSTMENT TRIAL BALANCE AS AT 28 FEBRUARY 20.15
Debit (R)
Credit (R)
Balance Sheet Accounts Section
Capital
395 700
Drawings
87 000
Land and buildings
400 000
Equipment
90 000
Accumulated depreciation on equipment (01 March 20.14)
Fixed deposit: Ben Bank (12% p.a.)
22 000
40 000
Loan: Zen Bank (16% p.a.)
40 000
Trading inventory
70 220
Debtors control
34 420
Provision for bad debts
1 900
Creditors control
49 600
Bank
12 480
Cash float
1 000
Nominal Accounts Section
Sales
563 000
Cost of sales
298 000
Sales returns
4 000
Rent income
52 800
Interest on fixed deposit
3 200
Bank charges
1 800
Water and electricity
12 540
Telephone
3 500
Insurance
3 900
Interest on loan
7 500
Rates and taxes
16 400
Salaries and wages
40 640
Consumable stores
1 600
Advertising
3 200
1 128 200
43
1 128 200
MANCOSA
Financial Reporting and Analysis
Adjustments and additional information
1.
According to a physical stocktaking the following inventories were on hand on
28 February 20.15:
Merchandise R69 000
Consumable stores R200.
2.
Rates and taxes included a payment of R4 080 for the period 01 January 20.15 to
30 June 20.15.
3.
Depreciation is provided annually on equipment at 10% p.a. using the diminishing balance method. Note:
Equipment costing R30 000 was purchased on credit on
01 February 20.15. The purchase has not been recorded.
4.
Rent for February 20.15 is still outstanding.
5.
A portion of the interest on loan has been paid in advance. The unsecured loan was obtained on 28
February 20.14. Equal annual repayments of R10 000 will commence on 01 March 20.15.
6.
On 28 February 20.15, a cheque of R500 was received from O. Henry whose account was previously
written off as irrecoverable. No entry has been made for this.
7.
A debtor, A. Donald who owed R800, is declared insolvent. His estate paid Ajax Traders a first and final
dividend of 60 cents in the Rand. This has been recorded. The balance of his account must now be
written off.
8.
The provision for bad debts must be adjusted to 5% of trade debtors.
9.
The fixed deposit at Ben Bank was made on 01 March 20.14 and matures on 30 June 20.15. Provide for
the outstanding interest on fixed deposit.
10.
Service fees according to the bank statement for February 20.15 have not yet been recorded, R160.
11.
The telephone account for February 20.15 has not yet been paid, R320
MANCOSA
44
Financial Reporting and Analysis
2.6 SUGGESTED SOLUTIONS
Ajax Traders
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED
28 FEBRUARY 20.15
R
Sales (563 000 – 4 000)
559 000
Cost of sales (298 000)
(298 000)
Gross profit
261 000
Other operating income
58 295
Rent income (52 800 + 4 800)
57 600
Bad debts recovered
500
Provision for bad debts adjustment (1 900 – 1 705)
195
Gross operating income
319 295
Operating expenses
(89 730)
Bank charges (1 800 + 160)
1 960
Water and electricity (12 540)
12 540
Telephone (3 500 + 320)
3 820
Insurance (3 900)
3 900
Rates and taxes (16 400 – 2 720)
13 680
Salaries and wages (40 640)
40 640
Consumable stores (1 600 – 200)
1 400
Advertising (3 200)
3 200
Trading inventory deficit (70 220 – 69 000)
1 220
Depreciation
7 050
Bad debts
320
Operating profit
229 565
Interest income : on fixed deposit (3 200 + 1 600)
4 800
Interest expense : on loan (7 500 – 1 100)
(6 400)
Net profit for the year
227 965
45
MANCOSA
Financial Reporting and Analysis
REMARKS
The effects of the adjustments and additional information on the financial statements are as follows:
Effect on Statement of Comprehensive
Effect on Statement of Financial Position,
Income
Statement of Changes in Equity and Notes to
the financial statements
1.
Trading inventory deficit
Merchandise (Note 4) R69 000
(R70 220–R69 000) = R1 220
(Loss incurred through shortfall in inventory.)
Consumable stores – R200
Consumable inventory (Note 4) R200
2.
Rates and taxes – R2 720 (4 080 X 4/6)
Prepaid expenses R2 720
3.
Depreciation R7 050 (R6 800 + R250)
Depreciation for the year R7 050 (note 2)
Old: (90 000-22 000) X 10% = R6 800
Purchase of equipment:
New: 30 000 X 10% X 1/12 = R250
* “Additions at cost” R30 000
* Trade creditors +R30 000
4.
Rent income +R4 800 (R52 800/11)
Accrued income R4 800
5.
Interest expense – R1 100
Prepaid expenses R1 100
(R7 500 – R6 400)
R10 000 to be shown as current portion of loan
R40 000 X 16% = R6 400 (interest for the year)
(payment due in less than 12 months)
6.
Bad debts recovered R500
Bank + R500
7.
Bad debts +R320 (R800 X 40%)
Trade debtors – R320
8.
Provision for bad debts – R195
Provision for bad debts:
(R1 900 – R195) = R1 705
Provision for bad debts has decreased.
(R34 420 – R320) X 5% = R1 705
Interest income +R1 600
Accrued income R1 600
(R4 800 – R3 200)
Fixed deposit matures in less than 1 year and is
R40 000 X 12% = R4 800 (interest for year)
thus part of Cash & cash equivalents
10.
Bank charges + R160
Bank – R160
11.
Telephone + R320
Accrued expenses R320
9.
MANCOSA
46
Financial Reporting and Analysis
Ajax Traders
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.15
R
Balance on 28 February 20.14
395 700
Net profit for the year
227 965
Drawings
(87 000)
Balance on 28 February 20.15
536 665
Ajax Traders
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
Note
R
ASSETS
Non-current assets
Property, plant and equipment
490 950
2
165 635
Current assets
Inventories
Trade and other receivables
490 9500
3
69 200
42 615
Trade debtors (34 420 – 320)
34 100
Provision for bad debts (1 900 – 195)
(1 705)
Prepaid expenses (2 720 + 1 100)
3 820
Accrued income (4 800 + 1 600)
6 400
Cash and cash equivalents
53 820
Fixed deposit: Ben Bank (12% p.a.)
40 000
Bank (12 480 + 500 – 160)
12 820
Cash float (1 000)
1 000
Total assets
656 585
47
MANCOSA
Financial Reporting and Analysis
EQUITY AND LIABILITIES
Equity
536 665
Capital
536 665
Non-current liabilities
30 000
Long term borrowings
4
30 000
Current liabilities
89 920
Trade and other payables
79 920
Trade creditors (49 600 + 30 000)
79 600
Accrued expenses (320)
320
Current portion of long term borrowings
4
Total equity and liabilities
10 000
656 585
NOTES TO THE FINANCIAL STATEMENTS
1.
Accounting policy
The accounting policy of Ajax Traders is consistent with that of the previous year, and is as follows:
1.1
Measurement basis
The financial statements are based on the historical cost and comply with Generally Accepted Accounting
Practice.
1.2
Property, plant and equipment
Equipment is written off at 10% per annum on the diminishing balance.
1.3
Inventories
Inventories are measured at the lower of cost, on the FIFO method, and net realisable value, whichever is lower.
2.
Property, plant and equipment
Land and
buildings
Equipment
Total
Carrying value at beginning of year
400 000
68 000
468 000
Cost
400 000
90 000
490 000
Accumulated depreciation
(22 000)
(22 000)
Additions at cost
30 000
30 000
Depreciation for the year
(7 050)
(7 050)
Carrying value at end of year
400 000
90 950
490 950
Cost
400 000
120 000
520 000
(29 050)
(29 050)
Accumulated depreciation
MANCOSA
48
Financial Reporting and Analysis
3.
Inventories
Inventories consist of:
Merchandise (70 220 – 1220)
Consumable inventory
69 000
200
69 200
4.
Long term borrowings
Unsecured
Loan from Zen Bank payable in equal instalments commencing 01 March 20.15. Interest rate is
16% p.a.
40 000
Less: Instalment payable within one year, transferred to current liabilities
(10 000)
30 000
49
MANCOSA
Financial Reporting and Analysis
Unit
3:
MANCOSA
Financial Statements
of a Partnership
50
Financial Reporting and Analysis
Unit Learning Outcomes and Associated Assessment Criteria
LEARNING OUTCOMES OF THIS UNIT:
ASSOCIATED ASSESSMENT CRITERIA OF THIS UNIT:
x Identify the equity accounts pertaining to a
x Complete relevant think point, activity or self-assessment
partnership
question to understand how partnership equity accounts are
affected by transactions
x Perform the necessary calculation related to the
appropriation of the profit between partners
x
Work out example 1
x Prepare the financial statements of a partnership
x
Complete self-assessment activity 3.5.2, 3.5.3
x
Complete relevant think point, activity or self-assessment
question to calculate profits due to each partner
x
Work out example 2
x
Complete self-assessment activity 3.5.1
x
Complete relevant think point, activity or self-assessment
question to prepare statement of changes in equity for a
partnership
x
Work out example 2
x
Complete self-assessment activity 3.5.3, 3.5.4
3.1
Introduction
3.2
Equity accounts in a partnership
3.3
Sharing profits in a partnership
3.4
Preparation of the financial statements of partnership
Prescribed / Recommended Readings
x Kew, J and Warson, A. (2013) Financial Accounting: An introduction. 4th
edition. Cape Town: Oxford University Press.
x Lodewyckx, E., Lötter, W., Rhodes, N. and Seedat, C. (2013) Introduction
to Financial Accounting: Fresh Perspectives. 2nd edition. Cape Town:
Pearson.
51
MANCOSA
Financial Reporting and Analysis
3.1 Introduction
A partnership is an agreement between two or more persons who invest in a business with the aim of making a
profit, which is subsequently shared. A partnership, like a sole proprietorship, is not a separate legal entity.
Consequently, a partnership cannot own assets, incur liabilities, enter into contracts, sue or be sued. Instead, the
rights and obligations of a partnership are vested in the partners.
The accounting entries related to income, expenses, assets and liabilities of a partnership are the same as for a
sole proprietorship. The differences between sole proprietorships and partnerships relate to the recording and
reporting of transactions involving the sharing of profit and equity.
For the purposes of this module, the examples will be restricted to partnerships that have two partners. However,
the same accounting procedures apply if there are more than two partners.
3.2 EQUITY ACCOUNTS IN A PARTNERSHIP
According to Lodewyckx et al. (2013:266) the equity of a partnership includes the capital accounts and the current
accounts. Separate capital accounts are opened for each partner. Capital contributed by each partner may be
in the form of cash or other assets and is credited to the respective capital account of the partner. The capital
accounts are used strictly for capital contributions or capital decreases.
Current accounts are also opened for each partner. These accounts are used to record items such as salaries,
bonuses, interest on capital, interest on drawings and the share of profits or losses that belong to each partner.
The drawings of each partner (e.g. withdrawals of cash, trading inventory etc.) are also recorded in separate
accounts. The drawings accounts are closed off to the respective current accounts of the partners at the end of
the financial year.
3.3 SHARING PROFITS IN A PARTNERSHIP
Lodewyckx et al. (2013:268) state that the profit of a partnership is calculated in the same way as one would for a
sole proprietorship. Instead of transferring the profit to the capital account as is the case of a sole proprietorship,
there is a need to record the partners’ salaries, bonuses and interest on capital before the remaining profit (loss)
is shared. If a partner withdraws more than he/she is entitled to, the current account of that partner will show a
debit balance.
3.3.1
Partners’ salaries
Since many partnerships pay partners regular salaries in their capacities as owners, partners’ salaries should be
treated as an appropriation of profit and not a business expense. To record a partner’s salary, the partner’s
salary account will be debited and respective current account will be credited.
MANCOSA
52
Financial Reporting and Analysis
3.3.2
Partners’ bonus and commission
If a partnership agreement provides for a bonus or commission to partners, these are also treated an
appropriation of profits.
3.3.3
Interest on capital
Interest on capital is provided for in partnership agreements to be fair to partners where the capital contributions
are different and profits are not shared in the same ratio as the capital contributed. Interest on capital is not treated
as an expense since it arises from a transaction with partners in their capacity as equity participants. It is recorded
by debiting the interest on capital account and crediting the respective current accounts of the partners.
3.3.4
Interest on drawings
Partnership agreements may provide for interest on drawings specially to cater for instances where partners draw
varying amounts or withdraw at different times during the year. Interest on drawings is not treated as an income
to the business since it arises from a transaction with partners in their capacity as equity participants. It is recorded
by debiting the respective current accounts of the partners and crediting the interest on drawings account.
3.3.5
Share of the remaining profit or loss
After taking into account the net profit (or loss), salaries, bonuses, interest on capital and interest on drawings, the
remaining profit or loss is shared between the partners in the profit-sharing ratio as contained in the partnership
agreement. The partners’ respective current accounts are credited with the remaining profit.
The following example reflects how the profit is appropriated in a partnership”
Example 1
The information given below was extracted from the accounting records of Sebcom Traders, a partnership
business with Seb and Com as partners.
Required
Use the information provided to calculate the
■
remaining profit or loss of each partner.
■
current account balances of each partner.
53
MANCOSA
Financial Reporting and Analysis
Information
Balances in the General ledger on 28 February 20.15
R
Capital: Seb
200 000
Capital: Com
150 000
Current a/c: Seb (01 March 20.14)
20 000
CR
Current a/c: Com (01 March 20.14)
4 000
DR
Drawings: Seb
40 000
Drawings: Com
60 000
On 28 February 20.15 the statement of comprehensive income reflected a net profit of R194 200.
The following must be taken into account:
(a) Interest on capital at 15% p.a. on the balances on the capital accounts must be provided for.
(b) Interest on drawings was calculated at R1 200 for Seb and R1 000 for Com.
(c)
The partners are entitled to an annual salary of R30 000 each.
(d) The balance of the profit must be shared between Seb and Com in the ratio 2:3 respectively.
Solution
„
Calculation of the remaining profit or loss of each partner.
Interest on capital is calculated as follows:
Seb: R200 000 X 15/100 = R30 000
Com: R150 000 X 15/100 = R22 500
Remaining profit
= Net profit + Interest on drawings – Salaries – Interest on capital
= R194 200 + R2 200 – R60 000 – R52 500
= R83 900
Seb’s share
= R83 900 X 2/5
= R33 560
Com’s share
= R83 900 X 3/5
= R50 340
Note:
The ratio 2:3 implies that there are 5 shares.
Seb gets 2 of the 5 shares (2/5), and
Com gets 3 of the 5 shares (3/5).
MANCOSA
54
Financial Reporting and Analysis
„ Calculation of the current account balances of each partner
The credit balance of R20 000 on 01 March 20.14 in the Current account: Seb means that the
partnership owes Seb R20 000. The debit balance of R4 000 on 01 March 20.14 in Current account:
Com means that Seb owes the partnership R4 000.
Current account balance of each partner =
Opening balance + Interest on capital + Salaries + Remaining profit – Interest on drawings – Drawings
Current account: Seb
= R20 000 + R30 000 + R30 000 + R33 560 – R 1 200 – R40 000
= R72 360
Current account: Com
= – R4 000 + R22 500 + R30 000 + R50 340 – R 1 000 – R60 000
= R37 840
3.4 PREPARATION OF THE FINANCIAL STATEMENTS OF A PARTNERSHIP
The basic financial statements of a partnership, like a sole proprietorship, consist of a statement of comprehensive
income, statement of changes in equity and a statement of financial position. These financial statements must
fairly present the financial performance and financial position of the business.
3.4.1
Statement of Comprehensive Income
The financial result of the business is reflected in the statement of comprehensive income. The statement of
comprehensive income will reflect all the income earned and expenses incurred during the accounting period.
The following example will be used to illustrate the preparation of a statement of comprehensive income, statement
of changes in equity, statement of financial position and notes to the financial statements.
Example 1
The information below was extracted from the accounting records of Matrix Traders, a partnership with Mathew
and Rixon as partners.
Required
Use the given information for Matrix Traders to prepare the:
Statement of Comprehensive Income for the year ended 28 February 20.15.
Statement of Changes in Equity for the year ended 28 February 20.15.
Statement of Financial Position as at 28 February 20.15
Notes to the financial statements for the year ended 28 February 20.15.
55
MANCOSA
Financial Reporting and Analysis
Matrix Traders
Debit (R)
Credit (R)
Balance Sheet Accounts Section
Capital: Mathew
200 000
Capital: Rixon
150 000
Current account: Mathew
3 660
Current account: Rixon
1 200
Drawings: Mathew
40 000
Drawings: Rixon
64 000
Land and buildings
265 600
Equipment
54 500
Accumulated depreciation on equipment (01 March 20.14)
Fixed deposit: Den Bank (16% p.a.)
24 500
12 000
Loan: Den Bank (20% p.a.)
Debtors control
35 000
18 900
Creditors control
Bank
Cash float
18 000
123 000
300
Nominal Accounts Section
Sales
717 000
Opening inventory
65 000
Purchases
434 000
Sales returns
9 000
Purchases returns
3 800
Interest on fixed deposit
1 440
Bank charges
600
Water and electricity
7 500
Telephone
4 900
Insurance
5 900
Interest on loan
7 000
Sundry expenses
17 400
Consumable stores
2 900
Advertising
19 700
1 153 400
MANCOSA
1 153 400
56
Financial Reporting and Analysis
PRE-ADJUSTMENT TRIAL BALANCE AS AT 28 FEBRUARY 20.15
Adjustments and additional information
1.
The loan at Den Bank is an unsecured loan granted on 01 March 20.14 for a period of five years. Equal
annual instalments commence on 01 March 20.15. Interest payments are up to date.
2.
According to a physical stocktaking the following stocks were on hand on 28 February 20.15:
Trading inventory R61 600
Consumable stores R400
3.
The advertising amount includes a contract for R1 200 that was taken for the period
01 June 20.14 to 31 May 20.15.
4.
A debtor who owed R800 was declared insolvent. His account must now be written off.
5.
Provide for outstanding interest on fixed deposit. The investment in fixed deposit was made on 01
February 20.14 and it matures on 31 January 20.17.
6.
Provide for depreciation on equipment at 20% p.a. using the fixed instalment method.
7.
The telephone account for February 20.15 has not yet been paid, R450.
8.
A part of the building has been leased to a tenant on 01 February 20.15 at R30 000 per annum. The rent
for February 20.15 has not yet been received.
9.
The partnership agreement provides for the following which must be taken into account:
9.1
A salary of R5 000 is awarded to each partner monthly.
9.2
Interest on capital at 12% p.a. is allowed on the capital balances. Note that on
01 March 20.14 Mathew increased his capital by R50 000 while Rixon decreased his capital by R30 000. These
capital changes have been recorded.
9.3
Rixon is entitled to a bonus of R12 000.
9.4
Interest on partners’ drawings is charged on daily balances. The amounts for each partner are as follows:
Mathew R3 000
Rixon
R3 200
9.5
The remaining profit (loss) is shared equally between Mathew and Rixon.
57
MANCOSA
Financial Reporting and Analysis
Solution
Matrix Traders
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED
28 FEBRUARY 20.15
R
Sales (717 000 – 9 000)
708 000
Cost of sales
(433 600)
Opening inventory (65 000)
65 000
Purchases (434 000 – 3 800)
430 200
Closing inventory
(61 600)
Gross profit
274 400
Other operating income
2 500
Rent income
2 500
Gross operating income
276 900
Operating expenses
(70 350)
Bank charges (600)
600
Water and electricity (7 500)
7 500
Telephone (4 900 + 450)
5 350
Insurance (5 900)
5 900
Sundry expenses (17 400)
17 400
Consumable stores (2 900 – 400)
2 500
Advertising (19 700 – 300)
19 400
Bad debts
800
Depreciation
10 900
Operating profit
206 550
Interest income: on fixed deposit (1 440 + 480)
1 920
Interest expense: on loan (7 000)
(7 000)
Net profit for the year
201 470
MANCOSA
58
Financial Reporting and Analysis
REMARKS
„
The effects of the adjustments and additional information on the financial statements are as follows:
Effect on Statement of Comprehensive
Effect on Statement of Financial Position,
Income
Statement of Changes In Equity and Notes to the
financial statements
1.
No change
R7 000 (R35 000/5) treated as current portion of loan
2.
Closing inventory R61 600
Merchandise (note 4) R61 600
Consumable stores – R400
Consumable inventory (Note 4) R400
3.
Advertising – R300 (R1 200 X 3/12)
Prepaid expenses R300
4.
Bad debts +R800
Trade debtors – R800
5.
R12 000 X 16% = R1 920 (interest for year)
(R1 920 – R1 440 = R480 owing)
Interest income + R480
Accrued income R480
6.
Depreciation R10 900
Depreciation for the year R10 900 (Note 2)
(R54 500 X 20%)
7.
Telephone +R450
Accrued expenses R450
8.
Rent income R2 500 (R30 000/12)
Accrued income R2 500
9.1
No change
Statement of changes in equity
Salaries (R5 000 X 12):
Mathew: R60 000
Rixon:
9.2
R60 000
Statement of changes in equity
Changes in capital (bracket for decrease)
No change
Interest on capital:
Mathew: R24 000 (R200 000 X 12%)
Rixon: R18 000 (R150 000 X 12%)
9.3
Statement of changes in equity
No change
Bonus:
Rixon: R12 000
9.4
Statement of changes in equity
No change
Interest on drawings:
Mathew R3 000
Rixon R3 200
59
MANCOSA
Financial Reporting and Analysis
9.5
Statement of changes in equity
No change
Remaining profit is R33 670
[R201 470 – R120 000 – R42 000 – R12 000 + 6
200]
R33 670 ÷ 2 = R16 835 for each partner
3.4.2
Statement of Changes in Equity
The statement of changes in equity shows the movements in capital and current accounts of partners. These
movements include:
„
the opening and closing balances of each partner.
„
the transactions with partners including increases and decreases in capital and current accounts.
„
the distribution of profit to the partners.
Example 2
Using the information from example 1 and the statement of comprehensive income drawn up, the statement of
changes in equity for Matrix Traders will be completed as follows:
Matrix Traders
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.15
Capital Accounts
Mathew (R)
Rixon (R)
Total (R)
Balance as at 28 February 20.14
150 000
180 000
330 000
Changes in capital
50 000
(30 000)
20 000
Balance as at 28 February 20.15
200 000
150 000
350 000
Balance as at 28 February 20.14
3 660
(1 200)
2 460
Net profit for the year
97 835
103 635
201 470
Interest on Capital
24 000
18 000
42 000
Salaries
60 000
60 000
120 000
Bonus
-
12 000
12 000
Interest on drawings
(3 000)
(3 200)
(6 200)
Profit Share
16 835
16 835
33 670
Drawings
(40 000)
(64 000)
(104 000)
Balance as at 28 February 20.15
61 495
38 435
99 930
Current Accounts
MANCOSA
60
Financial Reporting and Analysis
REMARKS
A suggested sequence for completing the current accounts is as follows. Note that the use of brackets is to
denote a negative effect on the partners’ current account balances.
„
Record balance at 28 February 20.14 (bracket the debit balance).
„
Fill in total column of net profit for the year, R201 470.
„
Calculate and enter the amounts for interest on capital, salaries and bonus.
„
Enter interest on drawings (remember to bracket the amounts).
„
Now calculate total profit share as follows:
Net profit for year – Interest on capital – Salaries – Bonus + Interest on drawings
R201 470 – R42 000 – R120 000 – R12 000 + R6 200 = R33 670
„
Share the profit between the partners according to the partnership agreement:
R33 670 ÷ 2 = R16 835 for each partner
„
Next calculate the net profit for the year for each partner (using the figures in the block below).
„
Record the drawings of both partners (remember to bracket the amounts).
„
Lastly, calculate the balance as at 28 February 20.15 by using the following in the calculation:
Balance as at 28 February 20.14 + Net profit for the year – Drawings
(Note that when a calculation results in a negative value, the amount must be bracketed.)
In this statement, the partnership owes Mathew R61 495 and Rixon R38 435.
3.4.3
Statement of Financial Position and Notes to the Financial Statements
The statement of financial position and notes to the financial statements are drawn up in the same way as for sole
proprietorships except for the equity section. The equity section of the statement of financial position of a
partnership consists of the partners’ capital accounts and current accounts as opposed to the capital account only
of a sole proprietorship. The balance as at 28 February 20.15 (total) for capital and current accounts (from the
statement of changes in equity) are now transferred to the statement of financial position under equity.
Example 3
Using the information from example 1 as well as the statement of changes in equity (example 2), the statement of
financial position and notes to the financial statement of Matrix Traders can now be completed as follows:
61
MANCOSA
Financial Reporting and Analysis
Matrix Traders
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
Note
R
ASSETS
Non-current assets
296 700
Property, plant and equipment
2
284 700
Financial assets (12 000)
3
12 000
206 680
Current assets
Inventories
4
Trade and other receivables
62 000
21 380
Trade debtors (18 900 – 800)
18 100
Prepaid expenses (300)
300
Accrued income (480 + 2 500)
2 980
Cash and cash equivalents
123 300
Bank (123 000)
123 000
Cash float (300)
300
503 380
Total assets
EQUITY AND LIABILITIES
Equity
449 930
Capital
350 000
Current accounts
99 930
Non-current liabilities
28 000
Long-term borrowings
5
28 000
Current liabilities
25 450
Trade and other payables
18 450
Trade creditors (18 000)
18 000
Accrued expenses (450)
450
Current portion of long-term borrowings
Total equity and liabilities
MANCOSA
5
7 000
503 380
62
Financial Reporting and Analysis
NOTES TO THE FINANCIAL STATEMENTS
1.
Accounting policy
The accounting policy of Matrix Traders is consistent with that of the previous year, and is as follows:
1.1
Measurement basis
The financial statements are based on the historical cost and comply with Generally Accepted Accounting
Practice.
1.2
Property, plant and equipment
Equipment is written off at 20% per annum on cost.
1.3
Inventories
Inventories are measured at the lower of cost, on the FIFO method, and net realisable value, whichever is lower.
2.
Property, plant and equipment
Land and
buildings
Equipment
Total
Carrying value at beginning of year
265 600
30 000
295 600
Cost
Accumulated depreciation
Depreciation for the year
Carrying value at end of year
Cost
Accumulated depreciation
265 600
54 500
(24 500)
(10 900)
19 100
54 500
(35 400)
320 100
(24 500)
(10 900)
284 700
320 100
(35 400)
3.
265 600
265 600
Financial assets
Fixed deposit: Den Bank (16% p.a.) maturing on 31 January 20.14
12 000
12 000
4.
Inventories
Inventories consist of:
Merchandise
Consumable inventory
61 600
400
62 000
5.
Long term borrowings
Unsecured
Loan from Den Bank. Interest rate is 20% p.a.
35 000
Less: Instalment payable within one year, transferred to current liabilities
(7 000)
28 000
63
MANCOSA
Financial Reporting and Analysis
3.5 Self-Assessment Activities
3.5.1
Required
Calculate the share of the remaining profit for each partner (Ed and Con) from the following information.
Information
The balances in the capital accounts in the ledger of Edcon Traders on 28 February 20.15 (end of the financial
year) are as follows:
Capital: Ed
R75 000
Capital: Con
R50 000
Additional information
„
The net profit for the year according to the statement of comprehensive income amounted to R80 000.
„
Interest on capital at 15% p.a. on the balances on the capital accounts must be provided for. On 01
December 20.14 Ed increased his capital by R25 000 while Con decreased his capital by R25 000. These
capital changes have been recorded.
„
Interest on drawings amounts to R800 for Ed and R900 for Con.
„
The remaining profit or loss must be shared by the partners in the ratio of their capital contributions at the
end of the financial year.
3.5.2 The information given below was extracted from the accounting records of Samsing Traders, a
partnership business with Sam and Sing as partners.
Required
Use the information provided to calculate the current account balance of each partner as at 28
February 20.15.
Information
Balances in the ledger as at 28 February 20.15
Capital: Sam
R400 000
Capital: Sing
R300 000
Current a/c: Sam (01 March 20.14)
R10 000 (CR)
Current a/c: Sing (01 March 20.14)
R13 000 (DR)
Drawings: Sam
R52 000
Drawings: Sing
R60 000
MANCOSA
64
Financial Reporting and Analysis
On 28 February 20.15 the statement of comprehensive income reflected a net profit of R74 800.
The following must be taken into account:
(a) Interest on capital at 12% p.a. must be calculated on the balances on the capital accounts up to 31 August
20.14. On 01 September 20.14, the rate of interest on capital was increased to 15% p.a.
(b) Interest on drawings for the year for each partner are as follows:
Sam R2 700
Sing R3 000
(d) The balance of the profit/loss must be shared between Sam and Sing in the ratio of their capital balances.
3.5.3
The information given below was extracted from the accounting records of Protea Traders, a
partnership business with Hashim and Steyn as partners.
Required
■
Prepare the Statement of Changes In Equity for the year ended 28 February 20.15
■
Prepare an extract of the Statement of Financial Position showing only the equity.
Information
Balances in the ledger on 28 February 20.15
R
Capital: Hashim
200 000
Capital: Steyn
300 000
Current a/c: Hashim (01 March 20.14)
22 000 CR
Current a/c: Steyn (01 March 20.14)
10 000 DR
Drawings: Hashim
45 000
Drawings: Steyn
55 000
The following must be taken into account:
(a)
On 28 February 20.15 the statement of comprehensive income reflected a net profit of R250 000.
(b)
Interest on capital at 12% p.a. on the balances on the capital accounts must be provided for. On 01 June
20.14 Hashim decreased his capital by R100 000. On
01 December 20.14 Steyn increased his capital by R60 000. The capital changes have been recorded.
(c)
Interest on drawings has been calculated on the daily balance of the drawings accounts. The amounts for
the year are as follows:
Hashim R2 250
Steyn
(d)
R2 750
The balance of the profit (loss) must be shared between Hashim and Steyn in the ratio of their capital
balances at the end of the financial year.
65
MANCOSA
Financial Reporting and Analysis
3.5.4
The information below was extracted from the accounting records of Kiveshnie Traders, a partnership
with Kivesh and Niemand as partners.
Required
Use the given information for Kiveshnie Traders to prepare the:
■
Statement of Comprehensive Income for the year ended 28 February 20.15.
■
Statement of Changes in Equity for the year ended 28 February 20.15.
MANCOSA
66
Financial Reporting and Analysis
Kiveshnie Traders
PRE-ADJUSTMENT TRIAL BALANCE AS AT 28 FEBRUARY 20.15
Adjustments and additional information
Debit (R)
Credit (R)
Balance Sheet Accounts Section
Capital: Kivesh
370 000
Capital: Niemand
330 000
Current account: Kivesh
7 320
Current account: Niemand
2 400
Drawings: Kivesh
80 000
Drawings: Niemand
128 000
Land and buildings
531 200
Equipment
109 000
Accumulated depreciation on equipment (01 March 20.14)
Fixed deposit: Vin Bank (8% p.a.)
49 000
24 000
Loan: Vin Bank (16% p.a.)
70 000
Trading inventory
130 000
Debtors control
37 800
Creditors control
Bank
Cash float
36 000
232 000
600
Nominal Accounts Section
Sales
1 409 920
Cost of sales
860 400
Sales returns
23 000
Interest on fixed deposit
960
Rent income
26 000
Bank charges
10 200
Water and electricity
15 000
Telephone
9 800
Insurance
11 800
Interest on loan
14 000
Sundry expenses
34 800
Consumable stores
5 800
Advertising
39 400
2 299 200
67
2 299 200
MANCOSA
Financial Reporting and Analysis
1.
According to physical stocktaking the following inventories were on hand on
28 February 20.15:
Merchandise R128 500
Consumable stores R300
2.
The loan at Vin Bank is an unsecured loan granted on 01 February 20.14 and will be repaid in 10 equal
annual repayments commencing on 01 April 20.15. Interest has been paid in advance.
3.
A debtor who owed R700 disappeared without trace. Her account must now be written off.
4.
Provide for outstanding interest on fixed deposit. Two fixed deposit accounts were opened on 01 June
20.14. One of the fixed deposits, R 9 000, matures on 31 May 20.15. The other matures on 31 May
20.16.
5.
Provide for depreciation on equipment at 20% p.a. using the diminishing balance method.
6.
The water and electricity account for February 20.15 has not yet been paid, R1 300.
7.
Rent has been received up to 31 March 20.15.
8.
The partnership agreement provides for the following which must be taken into account:
8.1
A salary of R9 000 is allowed to each partner monthly.
8.2
Interest on capital at 15% p.a. is allowed on the capital balances. Note that on
01 September 20.14 Niemand increased his capital by R60 000 while Kivesh decreased her capital by R48 000.
These capital changes have been recorded.
8.3
Kivesh is to receive a bonus of R15 000.
8.4
Interest on the partners’ drawings is charged on the daily balances. The amounts for each partner for the
year are as follows:
Kivesh
R4 000
Niemand R6 400
8.5
The remaining profit (loss) is shared in the ratio 3:2 between Kivesh and Niemand respectively.
3.6 Suggested Solutions
3.5.1
Calculation of interest on capital
Ed
Balance on 01 March 20.13
R50 000 X 15% X 9/12
Capital increase on 1 December 20.13
R25 000
Balance on 28 February 20.14
R75 000 X 15% X 3/12
= R5 625
= R2 812.50
R8 437.50
Note: Since the balance in the capital account on 28 February 20.14 was R75 000 and there was a capital increase
on 01 December 20.13 (that was recorded), the balance on 01 March 20.13 was less than R75 000 (i.e. R75 000
– R25 000 = R50 000).
MANCOSA
68
Financial Reporting and Analysis
Con
R75 000 X 15% X 9/12
(R25 000)
R50 000 X 15% X 3/12
Balance on 01 March 20.13
Capital decrease on 1 December 20.13
Balance on 28 February 20.14
= R8 437.50
= R1 875.00
R10 312.50
Note: Since the balance in the capital account on 28 February 20.14 was R50 000 and there was a capital decrease
on 01 December 20.13 (that was recorded), the balance on 01 March 20.13 was more than R50 000 (i.e. R50 000
+ R25 000 = R75 000).
Total interest on capital = R8 437.50 + R10 312.50 = R18 750
Calculation of remaining profit
Net profit + Interest on drawings – Interest on capital
= R80 000 + R1 700 – R18 750 = R62 950
Calculation of share in remaining profit
Ed: R62 950 X 3/5 = R37 770
Con: R62 950 X 2/5 = R25 180
Note: Ratio of capitals at the end of the year R75 000:R50 000 = 75:50 = 3:2
3.5.2
„
Interest on capital is calculated as follows:
Sam
R400 000 X 12% X 6/12
= R24 000
R400 000 X 15% X 6/12
= R30 000
R54 000
Sing
R300 000 X 12% X 6/12
= R18 000
R300 000 X 15% X 6/12
= R22 500
R40 500
„
The share of the remaining shortfall (Sam R8 000 and Sing R6 000) is calculated as follows:
(Note: There was a remaining shortfall as the profit calculated in the statement of comprehensive
income, even with the interest on drawings, was not enough to cover the interest on capital.)
Remaining shortfall
= Net profit + Interest on drawings – Interest on capital
= R74 800 + R5 700 – R94 500
= (R14 000)
69
MANCOSA
Financial Reporting and Analysis
Sam’s share
= R14 000 X 4/7
= R8 000
Sing’s share
= R14 000 X 3/7
= R6 000
Note: The ratio of their capitals is R400 000:R300 000 = 4:3
„
Current account: Sam
= R10 000 + R54 000 – R 2 700 – R52 000 – R8 000
= R1 300 (i.e. a credit balance)
Current account: Sing
= – R13 000 + R40 500 – R3 000 – R60 000 – R6 000
= – R41 500 (i.e. a debit balance)
3.5.3
Protea Traders
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.15
Hashim (R)
Steyn (R)
Total (R)
Balance as at 28 February 20.14
300 000
240 000
540 000
Changes in capital
(100 000)
60 000
(40 000)
Balance as at 28 February 20.15
200 000
300 000
500 000
Balance as at 28 February 20.14
22 000
(10 000)
12 000
Net profit for the year
103 710
146 290
250 000
Interest on Capital
27 000
30 600
57 600
Interest on drawings
(2 250)
(2 750)
(5 000)
Profit Share
78 960
118 440
197 400
Drawings
(45 000)
(55 000)
(100 000)
Balance as at 28 February 20.15
80 710
81 290
162 000
Capital Accounts
Current Accounts
REMARKS
■
The capital balances that are provided are the financial year end balances. Hence they are entered in the
line: Balance as at 28 February 20.15. The capital changes (decrease is bracketed) are shown above these
balances. Now the balance as at 28 February 20.14 is determined.
■
Follow the sequence (steps) suggested for example 2 to complete the current accounts.
■
Interest on capital is calculated as follows:
MANCOSA
70
Financial Reporting and Analysis
Calculate interest on the capital from the beginning of the year until the date of change of the balance.
Then calculate interest from the date of change of the balance until the end of the financial year. Thus the
interest is calculated as follows:
Hashim
R300 000 X 12% X 3/12 = R9 000
R200 000 X 12% X 9/12 = R18 000
Interest for financial year R27 000
Steyn
R240 000 X 12% X 9/12 = R21 600
R300 000 X 12% X 3/12 = R9 000
Interest for financial year R30 600
■
The profit share is calculated as follows:
First calculate total profit share:
Net profit for year – [Interest on capital – Interest on drawings]
250 000 – [57 600 – 5 000] = R197 400
Share the profit between the partners according to the ratio of their capital balances at the end of the
financial year viz. R200 000: R300 000 = 2:3
Hashim’s share = R197 400 X 2/5 = R78 960
Steyn’s share = R197 400 X 3/5 = R118 440
Protea Traders
Extract of Statement of Financial Position as at 28 February 20.15
EQUITY AND LIABILITIES
Equity
662 000
Capital
500 000
Current accounts
162 000
REMARKS
■ The balance as at 28 February 20.15 (total) for capital and current accounts from the statement of changes in
equity are transferred to the equity section of the Statement of Financial Position.
71
MANCOSA
Financial Reporting and Analysis
3.5.4
Kiveshnie Traders
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED
28 February 20.15
R
Sales (1 409 920 – 23 000)
1 386 920
Cost of sales (860 400)
(860 400)
Gross profit
526 520
Other operating income
24 000
Rent income (26 000 – 2 000)
24 000
Gross operating income
550 520
Operating expenses
(142 000)
Bank charges (10 200)
10 200
Water and electricity (15 000 + 1 300)
16 300
Telephone (9 800)
9 800
Insurance (11 800)
11 800
Sundry expenses (34 800)
34 800
Consumable stores (5 800 – 300)
5 500
Advertising (39 400)
39 400
Bad debts
700
Trading stock deficit (130 000 – 128 500)
1 500
Depreciation
12 000
Operating profit
408 520
Interest income: on fixed deposit (960 + 480)
1 440
Interest expense: on loan (14 000 – 2 800)
(11 200)
Net profit for the year
398 760
MANCOSA
72
Financial Reporting and Analysis
REMARKS
The effects of the adjustments and additional information on the financial statements are as follows:
Effect on Statement of Comprehensive
Effect on Statement of Financial Position,
Income
Statement of Changes in Equity and Notes to the
Financial Statements
1.
Trading stock deficit R1 500
Merchandise R128 500 (Note 4)
(R130 000 – R128 500)
Consumable stores – R300
2.
Consumable inventory R300 (Note 4)
R70 000 X 16% = R11 200
(R14 000 – R11 200)
Interest expense – R2 800
Prepaid expenses R2 800
Current portion of loan R7 000
(R70 000/10)
3.
Bad debts R700
Trade debtors – R700
4.
Interest income + R480
Accrued income R480
(R1 440 – R960)
R24 000 X 8% X 9/12 = R1 440
5.
Depreciation R12 000
Depreciation for year R12 000 (Note 2)
(R109 000 – R49 000) X 20% =
R12 000
6.
Water and electricity +R1 300
Accrued expenses R1 300
7.
Rent income – R2 000
Income received in advance R 2000
8.1
No entry
Salaries:
Kivesh: R108 000 (R9 000 X 12)
Niemand: R108 000 (R9 000 X 12)
8.2
No entry
Interest on capital R51 000 + R53 100
(Refer to workings below statement of changes in
equity.)
8.3
No entry
Bonus:
Kivesh: R15 000
8.4
No entry
Interest on drawings R4 000 + R6 400
8.5
No entry
Profit share R44 436 + R29 624
(Refer to workings below statement of changes in
equity.)
73
MANCOSA
Financial Reporting and Analysis
Kiveshnie Traders
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.15
Capital Accounts
Kivesh
Niemand (R)
(R)
Total
(R)
Balance as at 28 February 20.14
310 000
378 000
688 000
Changes in capital
60 000
(48 000)
12 000
Balance as at 28 February 20.15
370 000
330 000
700 000
7 320
(2 400)
4 920
Net profit for the year
214 436
184 324
398 760
Interest on Capital
51 000
53 100
104 100
Salaries
108 000
108 000
216 000
Bonus
15 000
-
15 000
Interest on drawings
(4 000)
(6 400)
(10 400)
Profit Share
44 436
29 624
74 060
Drawings
(80 000)
(128 000)
(208 000)
Balance as at 28 February 20.15
141 756
53 924
195 680
Current Accounts
Balance as at 28 February 20.14
REMARKS
■ The capital balances provided in the information are the end of the financial year balances. Hence they are entered
in the line: Balance as at 28 February 20.15. The capital changes (decrease is bracketed) are shown above these
balances. Now the balance as at 28 February 20.14 is determined.
■ Follow the sequence (steps) suggested for example 2 to complete the current accounts.
■ Interest on capital is calculated as follows:
Calculate interest on the capital from the beginning of the year until the date of change of the balance. Then
calculate interest from the date of change of the balance until the end of the financial year. Thus the interest is
calculated as follows:
Kivesh
R310 000 X 15% X 6/12 = R23 250
R370 000 X 15% X 6/12 = R27 750
Interest for financial year R51 000
Niemand
R378 000 X 15% X 6/12 = R28 350
R330 000 X 15% X 6/12 = R24 750
Interest for financial year R53 100
MANCOSA
74
Financial Reporting and Analysis
■
The profit share is calculated as follows:
First calculate total profit share:
Net profit for year – Interest on capital – Salaries – Bonus + Interest on drawings
R398 760 – R104 100 – R216 000 – R15 000 + R10 400 = R74 060
Share the profit between Kivesh and Niemand according to the ratio 3:2.
Kivesh’s share = R74 060 X 3/5 = R44 436
Niemand’s share = R74 060 X 2/5 = R29 624
Kiveshnie Traders
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
Note
R
ASSETS
Non-current assets
594 200
Property, plant and equipment
2
579 200
Financial assets
3
15 000
410 780
Current assets
Inventories
4
Trade and other receivables
128 800
40 380
Trade debtors (37 800 – 700)
37 100
Prepaid expenses (2 800)
2 800
Accrued income (480)
480
Cash and cash equivalents
241 600
Fixed deposit
9 000
Bank
232 000
Cash float
600
1 004 980
Total assets
EQUITY AND LIABILITIES
Equity
895 680
Capital
700 000
Current accounts
195 680
Non-current liabilities
63 000
Long term borrowings
5
63 000
Current liabilities
46 300
Trade and other payables
39 300
Trade creditors
75
36 000
MANCOSA
Financial Reporting and Analysis
Accrued expenses (1 300)
1 300
Income received in advance (2 000)
2 000
Current portion of long term borrowings
5
7 000
Total equity and liabilities
1 004 980
NOTES TO THE FINANCIAL STATEMENTS
1.
Accounting policy
The accounting policy of Kiveshnie Traders is consistent with that of the previous year, and is as follows:
1.1
Measurement basis
The financial statements are based on the historical cost and comply with Generally Accepted Accounting
Practice.
1.2
Property, plant and equipment
Equipment is written off at 20% per annum on the diminishing balance.
1.3
Inventories
Inventories are measured at the lower of cost, on the FIFO method, and net realisable value, whichever is lower.
2.
Property, plant and equipment
Land and
buildings
Equipment
Total
Carrying value at beginning of year
531 200
60 000
591 200
Cost
531 200
109 000
640 200
Accumulated depreciation
(49 000)
(49 000)
Depreciation for the year
(12 000)
(12 000)
Carrying value at end of year
531 200
48 000
579 200
Cost
531 200
109 000
640 200
(61 000)
(61 000)
Accumulated depreciation
3.
Financial assets
Fixed deposit: Vin Bank (8% p.a.)
24 000
Less: Fixed deposit maturing on 31 May 20.15
(9 000)
15 000
MANCOSA
76
Financial Reporting and Analysis
4.
Inventories
Inventories consist of:
Merchandise
Consumable inventory
128 500
300
128 800
5.
Long term borrowings
Unsecured
Loan from Vin Bank. Interest rate is 16% p.a.
70 000
Less: Instalment payable within one year, transferred to current liabilities
(7 000)
63 000
77
MANCOSA
Financial Reporting and Analysis
Unit
4:
MANCOSA
Financial Statements of a Company
78
Financial Reporting and Analysis
Unit Learning Outcomes and Associated Assessment Criteria
LEARNING OUTCOMES OF THIS UNIT:
ASSOCIATED ASSESSMENT CRITERIA OF THIS UNIT:
x disclose share capital, company tax, dividends x
Complete relevant think point, activity or self-
and retained earnings correctly in the financial
assessment question to process transactions to the
statements of a company.
correct accounts
x understand the role played by the International x
Accounting Standards Board (IASB) in setting
accounting standards.
x
Complete example 1, 2
Complete self-assessment activity 4.5.1, 4.5.2
Complete relevant think point, activity or self-
x prepare the financial statements of a company
assessment question to explain the standard setting
process
x
Complete relevant think point, activity or selfassessment question to prepare the financial
statements of a company
x
Complete example 1, 2
x
Complete self-assessment activity 4.5.1, 4.5.2
Prescribed / Recommended Readings
x Kew, J and Warson, A. (2013) Financial Accounting: An introduction. 4th
edition. Cape Town: Oxford University Press.
x Lodewyckx, E., Lötter, W., Rhodes, N. and Seedat, C. (2013) Introduction
to Financial Accounting: Fresh Perspectives. 2nd edition. Cape Town:
Pearson.
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4.1 INTRODUCTION
A company is an association of people who work together in order to make a profit (Lodewyckx et al., 2013:290).
It is a legal person and is incorporated in accordance with the Companies Act No. 71 of 2008. Its existence is
independent of the shareholders (owners) and consequently the liability of shareholders for the debts of the
company is limited to the amount that they have invested in the enterprise.
A company invites the public (including the business community) to invest in it. To make it possible for many
people (hundreds or even thousands) to invest in a company, it divides the capital it requires (e.g. R500 000) into
small units called shares. Shareholders obtain a share of the profit by receiving a dividend per share. The shares
of a public company are freely transferable.
There are two basic types of companies viz. for-profit companies and non-profit companies. For-profit companies
include public companies, private companies, state-owned companies, and personal liability companies. Nonprofit companies are companies that are formed with the aim of benefitting the public or for cultural or social
activities.
A company must be established in accordance with the requirements of the Companies Act No. 71 of 2008. The
people who start a company are called incorporators or promoters. One or more persons may start a for-profit
company. The promoters complete and sign a document called the Memorandum of Incorporation (MOI) and file
a Notice of Incorporation with an organisation called Companies and Intellectual Properties Commission (CIPC).
The first shareholders of the company are the subscribers to the MOI. Public companies issue a document called
a prospectus to invite the public to buy shares in the company. The first issue of shares is called the Initial Public
Offering (IPO).
4.2
TRANSACTIONS RELATED TO COMPANIES
4.2.1
Share Capital
The MOI stipulates the maximum number of shares that a company is authorised to issue and this is
called the authorised share capital (Lodewyckx et al., 2013:295). Companies usually register an
authorised share capital that is larger than what is needed at the time. The shares that are actually sold
are called the issued share capital.
Preference shares and ordinary shares are main classes of shares in a public company.
Preference shares provide holders of them with a fixed percentage dividend. These shareholders have
preferential rights to dividends over other shareholders and in respect of claims in the event of liquidation.
Ordinary shares only qualify for dividends once preference shareholders have been paid. The share in the profit
varies and depends on the availability of profits and the amount of dividend approved. It is possible for a company
to buy back its own shares.
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4.2.2
Debentures
Public companies are entitled to raise capital by issuing debentures. A debenture is a long-term loan (non-current
liability) and is redeemed at the end of its term. Debenture holders receive a fixed percentage interest usually paid
annually to them. The interest on debentures is an expense and is taken into account when the profit is calculated.
4.2.3
Dividends and retained earnings
Dividends may only be declared from the profit after tax. The board of directors makes a recommendation in
respect of the proposed dividend to shareholders at the annual general meeting. The proposed dividend is stated
as the number of cents per share. A current liability, shareholders for dividends, is created. When the dividend is
paid, the liability is settled. The directors may be authorized to pay an interim dividend during the financial year.
The total dividends for the year are reflected in the statement of changes in equity.
Companies usually do not distribute all the profits after tax as dividends. A portion of it is retained, often to finance
expansion. The portion of the profit after tax that is retained by the company is reflected in an account called
retained earnings.
4.2.4.
Company Tax
Companies pay tax each year at a specific rate (e.g. 28%) on their taxable income. From 01 April 2012 Dividends
Tax replaced Secondary Tax on Companies. The Dividends Tax is levied at a rate of 15% of the amount of
dividends paid by a company. It is a form of withholding tax in that company withholds the tax before paying the
net amount to the shareholders (dividends less dividends tax).
Companies are required to make two provisional tax payments to the South African Revenue Services (SARS).
The first payment is made at the end of the first six months of the financial year and the second is made by the last
day of the financial year. The first payment should equal half the company’s estimated total tax liability for the
year. The second payment is for the balance. If the actual tax liability exceeds the estimated amount, then the
amount owing is reflected as a current liability and a third payment is made to SARS within 6 months after the
financial year-end.
The provisional tax payments are debited to an account called South African Revenue
Services. Remember that the actual total tax liability for the year is credited to this same account. Thus the
account will reveal the balance owing to SARS (current liability) or by SARS (current asset). The actual tax liability
for the year is reflected in the statement of comprehensive income.
4.3
FINANCIAL REPORTING FOR COMPANIES
Financial statements are intended to provide information about the financial position, financial performance and
changes in the financial position of an enterprise, which will enable the various users to make economic decisions.
Each year financial statements are presented during the annual general meeting of the company. Companies
usually produce different sets of financial statements aimed at different users. Financial statements that are
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prepared for internal use (the focus of this topic) are similar to that of sole proprietorships and partnerships.
Statements for internal use are prepared in detail and contain information required by management. Financial
statements are also prepared for external users such as shareholders and South African Revenue Services (for
income tax purposes). Financial statements submitted to SARS reflect the profit on which the company tax is
based. Financial statements that are made available to shareholders or the public contain as little information as
possible but must contain certain minimum requirements as prescribed by the Companies Act. The Companies
Act also compels companies to comply with certain standards especially in relation to the valuation of assets and
liabilities as well as the reporting on revenue and expenses.
The International Accounting Standards Board (IASB) plays an important role in setting accounting standards for
professional accountants and auditors throughout the world (Kew and Watson, 2013:444). An important function
of this body is to develop the International Financial Reporting Standards (IFRS) which is made up of statements
on how particular types of transactions should be reported in the financial statements. Issues that are addressed
by the IASB by means of the IFRS include inventory valuations, treatment of tangible and intangible assets,
pensions etc. IFRS also covers the presentation of financial statements. Public companies must comply with
IFRS in the preparation and presentation of its financial statements, and in doing so financial statements of different
companies can be easily compared.
4.4
PREPARATION OF THE FINANCIAL STATEMENTS OF A COMPANY
4.4.1
Statement of Comprehensive Income, Statement of Changes in Equity and Statement of
Financial Position
The preparation of statement of comprehensive income, statement of changes in equity and statement of
financial position a company for internal use will be illustrated by means of the following example:
Example 1
The information that follows was taken from the accounting records of Hart Ltd on
30 June 20.15 (the end of the financial year).
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Financial Reporting and Analysis
Hart Ltd
TRIAL BALANCE AS AT 30 JUNE 20.15
Balance Sheet Accounts Section
Ordinary share capital
Retained earnings
Land and buildings
Vehicles (cost)
Equipment (cost)
Accumulated depreciation on vehicles
Accumulated depreciation on equipment
Long-term loan: Mac Bank (14% p.a.)
Debentures (13% p.a.)
Investment in Vac (Pty) Ltd
Inventory (30 June 20.14)
Debtors control
Provision for bad debts
Bank
Creditors control
South African Revenue Services: Company tax
Debit (R)
Credit (R)
400 000
432 000
991 600
80 000
150 000
14 000
28 000
264 000
200 000
48 000
112 000
128 000
2 560
114 260
54 260
35 000
Nominal accounts section
Sales
Purchases
Sales returns
Purchases returns
Customs duty
Carriage on purchases
Carriage on sales
Sundry expenses
Salaries
Motor expenses
Interest on loan
Discount allowed
Commission income
Directors’ fees
Auditor’s fee
Ordinary share dividends (interim)
Repairs
83
1 055 080
458 000
10 000
12 000
10 800
35 000
6 000
29 740
128 000
3 600
36 960
3 880
36 100
60 000
12 000
16 000
29 160
2 498 000
2 498 000
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Financial Reporting and Analysis
Additional information
1.
The provision for bad debts must be increased by R1 840.
2.
Trading inventory according to stocktaking on 30 June 20.15 amounted to R96 000.
3.
Capital repayments totalling R24 000 are payable on the unsecured loan from Mac Bank in the next
financial year.
4.
Depreciation must be provided for as follows:
x
on vehicles at 20% on cost
x
on equipment at 28% on cost
5.
A dividend of 20% of the investment value has been declared by Vac (Pty) Ltd. The dividend has not yet
been received.
6.
The authorised share capital consists of 500 000 ordinary shares.
Note: On 01 July 20.14, the company increased the ordinary share capital by issuing 100 000 shares at R1
each.
7.
A non-distributable asset replacement reserve of R100 000 must be created.
8.
Debentures consist of 20 000 13% debentures of R10 each, issued on 01 July 20.13 and redeemable on 30
June 20.18. The debentures are secured by a first mortgage bond over land. Provision must be made for
the current year’s interest.
9.
The company tax for the year amounted to R62 400.
10. The directors declared a final dividend of 8 cents per share.
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Financial Reporting and Analysis
Solution
Hart Ltd
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 20.15
Sales (1 055 080-10 000)
R
1 045 080
Cost of sales
(507 800)
Opening inventory
112 000
Purchases (458 000-12 000)
446 000
Customs duty (10 800)
10 800
Carriage on purchases (35 000)
35 000
Closing inventory
(96 000)
Gross profit
537 280
Other operating income
36 100
Commission income (36 100)
36 100
Gross operating income
573 380
Operating expenses
(332 220)
Carriage on sales (6 000)
6 000
Sundry expenses (29 740)
29 740
Salaries (128 000)
128 000
Motor expenses (3 600)
3 600
Discount allowed (3 880)
3 880
Directors’ fees (60 000)
60 000
Auditor’s fees (12 000)
12 000
Repairs (29 160)
29 160
Provision for bad debts adjustment
1 840
Depreciation (16 000+42 000)
58 000
Operating profit
241 160
Dividend income
9 600
Interest expense: on loan (36 960)
: on debentures
(36 960)
(26 000)
Profit before tax
187 800
Company tax
(62 400)
Profit after tax
125 400
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Financial Reporting and Analysis
REMARKS
The effects of the adjustments and additional information on the financial statements are as follows:
Effect on Statement of
Effect on Statement of Financial Position, Statement
Comprehensive Income
of Changes in Equity and Notes to the financial
statements
1.
Provision for bad debts adjustment
Provision for bad debts +R1 840
R1 840
2.
Closing inventory R96 000
Trading inventory R96 000
3.
–
Long-term loan – R24 000
Current portion of loan R24 000
4.
Depreciation on:
Note 3 Depreciation for the year:
Vehicles (R80 000 X 20%) = R16 000
Vehicles
Equipment (R150 000 X 28%) =
Equipment R42 000
R16 000
R42 000
5.
Dividend income R48 000 X 20% =
Accrued income R9 600
R9 600
6.
–
Information available to complete the note for Share
capital and statement of changes in equity
7.
–
Recorded in statement of changes in equity
8.
Interest on debentures
Accrued expenses R26 000
R200 000 X 13% = R26 000
9.
Company tax R62 400
SARS-Income tax R62 400 – R35 000
10.
–
Dividend on preference shares
R300 000 X 12% = R36 000
Dividends on ordinary shares
400 000 shares X R0.08 = R32 000
Shareholders for dividends
R36 000 + R32 000 = R68 000
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Financial Reporting and Analysis
Hart Ltd
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.15
Ordinary
share capital
R
Balance on 01 July 20.14
300 000
Issue of share capital
100 000
Asset replace
reserve
R
Retained
earnings
R
Total
R
432 000
732 000
100 000
Profit for the year
125 400
125 400
(100 000)
0
Ordinary interim
(16 000)
(16 000)
Ordinary final
(32 000)
(32 000)
409 400
909 400
Transfer to asset replacement. reserve
100 000
Dividends:
Balance on 30 June 20.15
400 000
100 000
Hart Ltd
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.15
Note
R
ASSETS
Non-current assets
1 169 600
Property, plant and equipment
2
1 121 600
Financial assets
3
48 000
343 460
Current assets
Inventories
4
96 000
Trade and other receivables
133 200
Trade debtors (128 000)
128 000
Provision for bad debts (2 560+1840)
(4 400)
Accrued income (9 600)
9 600
Cash and cash equivalents
114 260
Bank (114 260)
Total assets
87
114 260
1 513 060
MANCOSA
Financial Reporting and Analysis
EQUITY AND LIABILITIES
Equity
909 400
Share capital
5
400 000
Other reserves
100 000
Retained earnings
409 400
Non-current liabilities
440 000
Long-term borrowings
6
440 000
Current liabilities
163 660
Trade and other payables
80 260
Trade creditors (54 260)
54 260
Accrued expenses (26 000)
26 000
Current portion of long-term borrowings
6
24 000
South African Revenue Services: Company tax (62 400–35 000)
27 400
Shareholders for dividends
32 000
Total equity and liabilities
1 513 060
NOTES TO THE FINANCIAL STATEMENTS
1.
Accounting policy
The accounting policy of Hart Ltd is consistent with that of the previous year, and is as follows:
1.1
Measurement basis
The financial statements are based on the historical cost and comply with Generally Accepted Accounting
Practice.
1.2
Property, plant and equipment
Depreciation has been provided as follows:
Vehicles:
20% per annum on the cost price
Equipment: 28% per annum on the cost price.
1.3
Financial assets
Financial assets are measured at fair value.
1.4
Inventories
Inventories are measured at the lower of cost, on the FIFO method, and net realisable value, whichever is lower.
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Financial Reporting and Analysis
1.5
Revenue recognition
Sales are recognised upon delivery of products.
2.
Property, plant and equipment
Land and
buildings
Vehicles
Equipment
Total
Carrying value at beginning of year
991 600
66 000
122 000
1 179 600
Cost
991 600
80 000
150 000
1 221 600
Accumulated depreciation
(14 000)
(28 000)
(42 000)
Depreciation for the year
(16 000)
(42 000)
(58 000)
Carrying value at end of year
991 600
50 000
80 000
1 121 600
Cost
991 600
80 000
150 000
1 221 600
(30 000)
(70 000)
(100 000)
Accumulated depreciation
3.
Financial assets
Investment in Vac (Pty) Ltd at fair value
4.
48 000
Inventories
Inventories consist of:
Merchandise
5.
96 000
Share capital
Authorised
500 000 ordinary shares
Issued
300 000 ordinary shares in issue at beginning of year
300 000
100 000 ordinary shares of R1 each issued during the year
100 000
400 000
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Financial Reporting and Analysis
6.
Long term borrowings
Unsecured
Loan from Mac Bank payable in instalments commencing 01 July 20.15. Interest rate is 14% p.a.
264 000
Less: Instalment payable within one year, transferred to current liabilities
(24 000)
240 000
Secured
13% Debentures, secured by a first mortgage bond over land. The debentures are redeemable
on 30 June 20.15.
200 000
440 000
4.4.2
Cash flow statement
Kew and Watson (2013:500) describe a cash flow statement (or statement of cash flows) as a statement that
reflects all the cash flows of an entity in a standardised format. The cash flow statement was developed to fulfil
the needs of the users of financial statements in respect of the cash position of an entity. This is largely due to the
fact that the statement of comprehensive income is based on the accrual basis and does not show the cash flows
from operating activities and also does not provide valuable information relating to cash flows from investing and
financing activities (except for some related expenses and income). The main purpose of a cash flow statement
is to provide information about the cash receipts and cash payments of an entity for a specific period. The
statement provides reasons why cash and cash equivalents changed during the period by reflecting the net cash
utilised or generated by operating activities, investing activities and financing activities.
Having an understanding of a company’s cash flows and the reasons for the cash flows are important to
investors, managers, and other decision-makers. To be able to grow, a company must generate adequate cash
flows to pay its bills, repay its debt, and provide an adequate return to its owners. Information obtained from a
cash flow statement is used for evaluating past performance and future prospects.
x
Operating activities
The cash flows from operating activities are derived from the main revenue-generating activities of the entity. They
are cash flows that result from transactions reflected in the statement of comprehensive income. However, due to
the determination of income and expenses according to the accrual basis, certain non-cash items are also included
and they need to be excluded to determine the cash resulting from operating activities.
The cash flow statement can be presented using two different formats. These formats only differ in the manner in
which “cash generated from operations” is disclosed on the face of the statement. The remaining parts of the cash
flow statement are identical for both formats.
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Financial Reporting and Analysis
The first format called the direct method prescribes that the operating cash flows be disclosed according to the
entity’s major classes of gross cash receipts and gross cash payments. The following is an illustration of the
disclosure on the face of the cash flow statement of cash generated from operations using this method.
Direct method
Cash received from customers
Cash paid to suppliers and employees
R
2 000 000
(950 000)
Cash generated from operations
1 050 000
The second format is called the indirect method (which will be followed in this module). Using this method, the
cash flows from operating activities are calculated by adjusting the profit before interest and tax in order to
determine cash generated from operations. The adjustments involve the following:
* items relating to investing and financing decisions e.g. loss on sale of equipment
* non-cash flow adjustments e.g. depreciation
* the effect of using the accrual basis (changes in working capital).
The following is an illustration of the disclosure on the face of the cash flow statement of cash generated from
operations using the indirect method.
Indirect method
R
Profit before interest and tax
1 450 000
Adjustments to convert to cash from operations
91
Non-cash flow adjustments
100 000
Add: Depreciation
60 000
Add: Foreign exchange loss
40 000
Profit before working capital changes
1 550 000
Working capital changes
(500 000)
Increase in inventory
(400 000)
Increase in receivables
(200 000)
Increase in payables
100 000
Cash generated from operations
1 050 000
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Financial Reporting and Analysis
Note that increases in current assets (inventory and receivables) and decreases in current liabilities (payables) are
reported as operating uses of cash (and is indicated by bracketing the amount). On the other hand, decreases in
current assets (inventory and receivables) and increases in current liabilities (payables) are reported as operating
sources of cash
x
Investing activities
This category of the cash flow statement provides details about specific expenditures made to generate future
income and outflows. It relates mainly to the purchase and sale of non-current assets. Separate disclosure of
investing activities to expand operations is recommended. Examples of cash flows from investing activities include:
payments to acquire non-current assets;
receipts from sale of non-current assets;
payments to acquire other entities and other equity or debt instruments;
receipts from sale of interests in other entities, and sale of other equity or debt instruments;
loans made to other parties or receipts from the repayment of such loans.
The following is an example of how cash flow from investing activities would appear on the face of the cash flow
statement:
R
Cash flow from investing activities
(50 000)
Additions to plant and equipment
(200 000)
Proceeds from sale of land and buildings
150 000
Note that any use of cash (e.g. additions to plant and equipment) is indicated by bracketing the amount.
4.4.2.3
Financing activities
Cash flows from financing activities provide information relating to cash flows to and from providers of capital.
This is useful to investors who wish to predict any future claims on the cash of the entity. Examples of cash
flows from financing activities include:
proceeds from the issue of shares;
proceeds from loans, bonds and debentures ;
repayments of amounts borrowed.
The following is an example of the disclosure of cash flow from financing activities on the face of the cash flow
statement:
R
Cash flow from financing activities
250 000
Proceeds from issue of shares
300 000
Long-term borrowings redeemed
(50 000)
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Financial Reporting and Analysis
Note again that any use of cash (e.g. long-term borrowings redeemed) is indicated by bracketing the amount.
The following example illustrates how the cash flow statement is drawn up:
Example 2
Required
Use the information provided below to prepare the cash flow statement of Schion Ltd for the year ended 31
December 20.14.
Information
Schion Ltd
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED
31 DECEMBER 20.14
Sales
Cost of sales
R
1 800 000
(1 125 000)
Gross profit
675 000
Operating expenses
(474 000)
Directors’ fees
127 500
Auditor’s fees
67 500
Depreciation
81 000
Loss on sale of asset
21 000
Other non-disclosable costs
177 000
Operating profit
201 000
Investment income
24 600
Interest expense: on debentures
(3 900)
Profit before tax
221 700
Company tax
(77 595)
Profit for the year
144 105
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Financial Reporting and Analysis
Schion Ltd
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.14
Ordinary
Retained
share capital
earnings
R
R
R
263 775
788 775
Balance on 01 January 20.14
525 000
Issue of share capital
150 000
Profit for the year
Total
150 000
144 105
144 105
Ordinary interim
(18 750)
(18 750)
Ordinary final
(35 250)
(35 250)
353 880
1 028 880
Dividends:
Balance on 31 December 20.14
675 000
Schion Ltd
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER
20.14
20.13
R
R
Non-current assets
996 090
858 075
Property, plant and equipment (See Note 1)
790 590
699 600
Financial assets: Investment – Subsidiary company
85 500
60 000
120 000
98 475
Current assets
188 925
203 505
Inventories
120 690
119 700
Trade and other receivables
67 335
82 305
Trade debtors
67 335
82 305
900
1 500
-
-
Petty cash
900
1 500
Total assets
1 185 015
1 061 580
ASSETS
Investment – Listed shares (at cost)
Cash and cash equivalents
Bank
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Financial Reporting and Analysis
EQUITY AND LIABILITIES
Equity
1 028 880
788 775
Share capital
675 000
525 000
Retained earnings
353 880
263 775
Non-current liabilities
30 000
135 000
Long-term borrowings: 13% Debentures
30 000
135 000
Current liabilities
126 135
137 805
Trade and other payables
43 185
59 805
Trade creditors
43 185
59 805
South African Revenue Services (Company tax payable)
45 000
30 000
Shareholders for dividends
35 250
39 000
Bank overdraft
2 700
9 000
1 185 015
1 061 580
Total equity and liabilities
Note 1
Property, plant and equipment
20.14
Land
Cost
20.13
and
Land and
buildings
Equip
Vehicles
buildings
Equip
Vehicles
R
R
R
R
R
R
462 000
242 340
300 000
346 500
188 100
300 000
(82 500)
(131 250)
(45 000)
(90 000)
159 840
168 750
143 100
210 000
Accumulated
depreciation
Carrying value
462 000
346 500
Additional information
1.
Equipment was sold for cash, R16 500. The cost price of the equipment sold was R39 750 and the
accumulated depreciation on it to the date of sale was R2 250. Equipment was also purchased for cash.
2.
95
Additions were made to the buildings for cash.
MANCOSA
Financial Reporting and Analysis
Solution
Schion Ltd
CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20.14
R
Cash flows from operating activities
200 715
Profit before interest and tax (a)
201 000
Adjustments to convert to cash from operations
Non-cash flow adjustments
102 000
Add: Depreciation (b)
81 000
Loss on disposal of asset (c)
21 000
Profit before working capital changes
303 000
Working capital changes
(2 640)
Increase in inventory (d)
(990)
Decrease in receivables (e)
14 970
Decrease in payables (f)
(16 620)
Cash generated from operations
300 360
Interest paid (g)
(3 900)
Investment income (h)
24 600
Dividends paid (i)
(57 750)
Company tax paid (j)
(62 595)
Cash flow from investing activities
(240 015)
Investment in listed shares (k)
(21 525)
Investment in subsidiary company (l)
(25 500)
Non-current assets purchased (m)
(209 490)
Proceeds from sale of equipment (n)
16 500
Cash flow from financing activities
45 000
Proceeds from issue of ordinary shares (o)
150 000
Long-term borrowings redeemed (p)
(105 000)
Net increase in cash and cash equivalents
5 700
Cash and cash equivalents at beginning of year (q)
(7 500)
Cash and cash equivalents at end of year (r)
(1 800)
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Financial Reporting and Analysis
Calculations and explanatory notes
(a)
Profit before interest and tax
This amount is obtained from the statement of comprehensive income (operating profit).
(b)
Depreciation
The amount is obtained from the statement of comprehensive income.
(c)
Loss on disposal of asset
The amount is obtained from the statement of comprehensive income.
(d)
Increase in inventory
The increase is calculated by comparing the inventory figures for both years:
R120 690 – R119 700 = R990 (The amount is bracketed as it represents a use of cash.)
(e)
Decrease in receivables
The decrease is calculated by comparing the Trade and other receivables figures for both years:
R82 305 – R67 335 = R14 970 (The amount represents a source of cash.)
(f)
Decrease in payables
The decrease is calculated by comparing the Trade and other payables figures for both years:
R59 805 – R43 185 = R16 620 (The amount is bracketed as it represents a use of cash.)
(g)
Interest paid
The amount is obtained from the statement of comprehensive income.
(h)
Investment income
The amount is obtained from the statement of comprehensive income.
(i)
Dividends paid
The amount paid is calculated as follows:
Dividends due on 31 December 20.13
(39 000)
Dividends for the year
(54 000)
Dividends due on 31 December 20.14
35 250
(57 750)
97
MANCOSA
Financial Reporting and Analysis
Note:
„
Dividends due on 31 December 20.13/20.14 is obtained from the item “Shareholders for dividends” in
the statement of financial position.
„
Dividends for the year are obtained from the statement of changes in equity:
R13 200 + R21 000 + R35 250 = R69 450
(j)
Company tax paid
The amount paid is calculated as follows:
Company tax due on 31 December 20.13
(30 000)
Company tax for the year
(77 595)
Company tax due on 31 December 20.14
45 000
(62 595)
Note:
„ Company tax due on 31 December 20.13/20.14 is obtained from the item “South African Revenue
Services” in the statement of financial position.
„ Company tax for the year is obtained from the statement of comprehensive income.
(k) Investment in listed shares
The amount is calculated by comparing the figures for “Investment – Listed shares” (in the statement of
financial position) for both years:
R120 000 – R98 475= R21 525 (The amount is bracketed as it represents a use of cash.)
(l) Investment in subsidiary company
The amount is calculated by comparing the figures for “Investment – Subsidiary company” (in the
statement of financial position) for both years:
R85 500 – R60 000= R25 500 (The amount is bracketed as it represents a use of cash.)
(m) Non-current assets purchased
The amount is obtained by using the figures for both years for Land and buildings and Equipment in the
statement of financial position and after consideration was given to the additional information:
Land and buildings purchased: R462 000 – R346 500 = R115 500
Equipment purchase is calculated as follows:
Carrying value of equipment on 31 December 20.13
143 100
Additions (Purchase)
*93 990
MANCOSA
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Financial Reporting and Analysis
Disposals at carrying value (Cost R39 750 – Acc. dep. R2 250)
(37 500)
Depreciation (R45 000 – R2 250) – (R82 500)
(39 750)
Carrying value of equipment on 31 December 20.14
159 840
*Purchase of equipment is calculated as follows:
(R143 100 – R37 500 – R39 750) – (R159 840) = R93 990
Non-current assets purchased = R115 500 + R93 990 = R209 490
(n) Proceeds from sale of equipment
The amount is calculated by using figures from the statement of comprehensive income (Loss on sale of
equipment) and after consideration was given to the additional information:
Carrying value of equipment sold is:
Cost R39 750 – Acc. dep. R2 250 = R37 500
However, the equipment was sold at a loss of R21 000. Therefore the proceeds from the sale of
equipment is R16 500 (R37 500 – R21 000).
(o) Proceeds from issue of ordinary shares
The amount is obtained from the statement of changes in equity.
(p) Long-term borrowings redeemed
The amount is obtained by comparing the figures for both years for “13% Debentures” (Long-term
borrowings) in the statement of financial position:
R135 000 – R30 000 = R105 000 (The amount is bracketed as it represents a use of cash.)
(q) Cash and cash equivalents at beginning of year
This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31
December 20.13:
(r)
Cash and cash equivalents
1 500
Bank overdraft
(9 000)
Net unfavourable balance
(7 500)
Cash and cash equivalents at end of year
This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31
December 20.14:
Cash and cash equivalents
99
900
Bank overdraft
(2 700)
Net unfavourable balance
(1 800)
MANCOSA
Financial Reporting and Analysis
Other calculations:
„ Profit before working capital changes
R201 000 + R102 000 = R303 000
„ Cash generated from operations:
R303 000 – R2 640 = R300 360
„ Cash flows from operating activities:
R300 360 – R3 900 + R24 600 – R57 750 – R62 595 = R200 715
„ Net increase in cash and cash equivalents
This amount can be calculated by comparing the cash balances of 20.13 and 20.14 i.e. a net unfavourable
balance of R7 500 (2013) turned into a net unfavourable balance of R1 800 (2014) resulting in a net
increase in cash and cash equivalents of R5 700.
The net increase can be verified as follows:
R200 715 – R240 015 + R45 000 = R5 700
4.5 SELF ASSESSMENT ACTIVITIES
4.5.1
The information given below was extracted from the accounting records of Ralco Ltd on 31 December
20.14 (the end of the financial year).
Information
Ralco Ltd
PRE-ADJUSTMENT TRIAL BALANCE AS AT 31 DECEMBER 20.14
Balance Sheet Accounts Section
Debit (R)
Credit (R)
Ordinary share capital
300 000
Retained earnings
58 900
Land and buildings
390 210
Vehicles (cost)
142 000
Equipment (cost)
88 000
Accumulated depreciation on vehicles
51 120
Accumulated depreciation on equipment
39 600
Loan from Nero Bank (14% p.a.)
120 000
Debentures (12% p.a.)
150 000
Investment (10 000 shares in DSL Ltd)
55 000
Debtors control
36 200
Provision for bad debts
Bank
3 100
24 700
Creditors control
South African Revenue Services: Company tax
MANCOSA
48 300
18 000
100
Financial Reporting and Analysis
Nominal accounts section
Sales
666 100
Opening inventory
104 000
Purchases
423 500
Sales returns
3 100
Purchases returns
12 500
Carriage on purchases
7 000
Maintenance
2 780
Rates
2 670
Commission on sales
4 400
Carriage on sales
3 900
Wages and salaries
72 000
Stationery
1 430
Bad debts
890
Sundry expenses
990
Insurance
1 250
Telephone
4 800
Water and electricity
5 300
Directors’ fees
48 000
Auditor’s fees
8 000
Interest on loan
12 000
Ordinary share dividends
7 500
Rent income
18 000
1 467 620
1 467 620
Additional information
1.
Provision for bad debts must be adjusted to 5% of trade debtors.
2.
Trading inventory according to stocktaking on 31 December 20.14 amounted to
R112 000.
3.
Depreciation must be provided for as follows:
* on vehicles at 20% per annum on the diminishing balance
* on equipment at 15% on cost
4.
Debentures consist of 30 000 12% debentures of R5 each, that were issued on
31 December 20.13 and are redeemable on 31 December 20.19. The debentures are secured by a first
mortgage bond on land.
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Financial Reporting and Analysis
5.
The unsecured loan from Nero bank is payable in equal instalments of R12 000 per annum commencing on
01 July 20.14. Provide for the outstanding interest on loan.
6.
A dividend of R3 000 is receivable on the listed shares in DSL Ltd.
7.
An asset replacement reserve (non-distributable) of R40 000 must be created.
8.
The authorised share capital consists of 250 000 ordinary shares. Note that on
01 July 20.14 the company issued 50 000 shares at R2 each.
9.
The company tax for the year amounted to R18 500.
10. A final dividend of 9 cents per share was declared by the directors.
4.5.2
The information given below was extracted from the accounting records of Starc Ltd.
Required
Prepare the Cash flow statement for the year ended 31 December 20.14.
Information from the Statement of Financial Position as at 31 December:
20.14
20.13
R
R
Ordinary share capital
800 000
590 000
Retained earnings
110 000
10 000
Property, plant and equipment (see note 1)
460 000
390 000
Investments
330 000
220 000
12.5% Debentures
40 000
120 000
Inventory
248 000
240 000
Trade debtors
74 000
57 000
-
3 000
Trade creditors
50 000
85 000
Bank overdraft
42 000
50 000
South African Revenue Services (Income tax payable)
10 000
15 000
Shareholders for dividends
60 000
40 000
Prepaid expenses (Rates)
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102
Financial Reporting and Analysis
Extract from the Statement of Comprehensive Income for the year ended
31 December 20.14
R
Profit before interest and tax
299 000
Depreciation on equipment
10 000
Dividends received on investment
36 000
Interest on debentures
15 000
Income tax
100 000
Extract from Statement of changes in equity for the year ended 31 December 20.14
R
Dividends on ordinary shares
120 000
Note 1
20.14
Property, plant and equipment
20.13
R
R
Land and buildings at cost
400 000
320 000
Equipment at carrying value
60 000
70 000
460 000
390 000
Additional information
1.
No equipment was purchased or sold during the financial year ended 31 December 20.14.
2.
Ordinary shares were issued during the year.
103
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Financial Reporting and Analysis
4.6
SUGGESTED SOLUTIONS
4.5.1
Ralco Ltd
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED
31 DECEMBER 20.14
Sales (666 100-3 100)
Cost of sales
Opening inventory (104 000)
Purchases (423 500-12 500)
Carriage on purchases (7 000)
Closing inventory
Gross profit
Other operating income
Rent income (18 000)
Provision for bad debts adjustment
Gross operating income
Operating expenses
Maintenance (2 780)
Rates (2 670)
Commission on sales (4 400)
Carriage on sales (3 900)
Wages and salaries (72 000)
Stationery (1 430)
Bad debts (890)
Sundry expenses (990)
Insurance (1 250)
Telephone (4 800)
Water and electricity (5 300)
Directors’ fees (48 000)
Auditor’s fees (48 000)
Depreciation (18 176+13 200)
Operating profit
Dividends earned
Interest expense: on loan (12 000+4 800)
: on debentures
Profit before tax
Company tax
Profit for the year
MANCOSA
R
663 000
(410 000)
104 000
411 000
7 000
(112 000)
253 000
19 290
18 000
1 290
272 290
(187 786)
2 780
2 670
4 400
3 900
72 000
1 430
890
990
1 250
4 800
5 300
48 000
8 000
31 376
84 504
3 000
(16 800)
(18 000)
52 704
(18 500)
34 204
104
Financial Reporting and Analysis
REMARKS
The effects of the adjustments and additional information on the financial statements are as follows:
Effect on Statement of Comprehensive Effect on Statement of Financial Position,
Income
Statement of Changes in Equity and Notes to the
Financial Statements
1.
Provision for bad debts adjustment
Provision for bad debts
R3 100 – R1 810 = R1 290 (decrease)
(R36 200 X 5%) = R1 810
2.
Closing inventory R112 000
Trading inventory R112 000
3.
Depreciation on:
Note 3 Depreciation for the year:
Vehicles (R142 000 – R51 120) X 20% =
R18 176
Vehicles R18 176
Equipment (R88 000 X 15%) = R13 200
4.
Interest on debentures
Equipment R13 200
Accrued expenses R18 000
R150 000 X 12% = R18 000
5.
Interest on loan
Accrued expenses
R120 000 X 14% = R16 800
(R16 800 – R12 000) = R4 800
Loan 120 000 – R12 000 = R108 000
Current portion of loan R12 000
6.
Dividend income R3 000
Accrued income R3 000
7.
–
Recorded in statement of changes in equity
8.
–
Information available to complete the note for share
capital and statement of changes in equity
9.
Company tax R18 500
SARS-Company tax
R18 500 – R18 000 = R500 (owing)
10.
–
Dividends on ordinary shares
150 000 shares X R0,09 = R13 500
(N.B. R300 000 ÷R2 = 150 000 shares)
Shareholders for dividends R13 500
105
MANCOSA
Financial Reporting and Analysis
Ralco Ltd
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.14
Ordinary
share
capital
R
Balance on 01 January 20.14
200 000
Issue of share capital
100 000
Asset
replace
reserve
Retained
earnings
R
R
R
58 900
258 900
100 000
Profit for the year
Transfer to asset replacement reserve
40 000
Dividends: Ordinary interim
Ordinary final
Balance on 31 December 20.14
300 000
Total
40 000
34 204
34 204
(40 000)
0
(7 500)
(7 500)
(13 500)
(13 500)
32 104
372 104
Ralco Ltd
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.14
Note
R
ASSETS
Non-current assets
553 114
Property, plant and equipment
2
498 114
Financial assets
3
55 000
174 090
Current assets
Inventories
4
112 000
Trade and other receivables
37 390
Trade debtors (36 200)
36 200
Provision for bad debts (3 100 – 1 290)
(1 810)
Accrued income (3 000)
3 000
Cash and cash equivalents
24 700
Bank (24 700)
24 700
Total assets
727 204
MANCOSA
106
Financial Reporting and Analysis
EQUITY AND LIABILITIES
Equity
372 104
Share capital
5
300 000
Other reserves
40 000
Retained earnings
32 104
Non-current liabilities
258 000
Long-term borrowings
6
258 000
Current liabilities
97 100
Trade and other payables
71 100
Trade creditors (48 300)
48 300
Accrued expenses (18 000 + 4 800)
22 800
Current portion of long-term borrowings
6
South African Revenue Services: Company tax
12 000
500
Shareholders for dividends
13 500
Total equity and liabilities
727 204
NOTES TO THE FINANCIAL STATEMENTS
1.
Accounting policy
The accounting policy of Ralco Ltd is consistent with that of the previous year, and is as follows:
1.1
Measurement basis
The financial statements are based on the historical cost and comply with Generally Accepted Accounting
Practice.
1.2
Property, plant and equipment
Depreciation has been provided as follows:
Vehicles:
20% per annum on the diminishing balance
Equipment: 15% per annum on cost
1.3
Financial assets
Listed shares are measured at market value.
1.4
Inventories
Inventories are measured at the lower of cost, on the FIF0 method, and net realisable value, whichever is
lower.
1.5
Revenue recognition
Sales is recognised upon delivery of products.
107
MANCOSA
Financial Reporting and Analysis
2.
Property, plant and equipment
Land and
buildings
Vehicles
Carrying value at beginning of year
390 210
90 880
48 400
529 490
Cost
390 210
142 000
88 000
620 210
Accumulated depreciation
(51 120)
(39 600)
(90 720)
Depreciation for the year
(18 176)
(13 200)
(31 376)
Equipment
Total
Carrying value at end of year
390 210
72 704
35 200
498 114
Cost
390 210
142 000
88 000
620 210
(69 296)
(52 800)
(122 096)
Accumulated depreciation
3.
Financial assets
Investment in listed shares in DSL Ltd at market value
4.
55 000
Inventories
Inventories consist of:
Merchandise
6.
112 000
Share capital
Authorised
250 000 ordinary shares
Issued
100 000 ordinary shares in issue at beginning of year
200 000
50 000 shares of R2 each issued during the year
100 000
300 000
6.
Long term borrowings
Unsecured
Loan from Nero Bank payable in equal instalments commencing on 01 July 20.14. Interest rate
is 14% p.a.
120 000
Less: Instalment payable within one year, transferred to current liabilities
(12 000)
108 000
MANCOSA
108
Financial Reporting and Analysis
Secured
12% Debentures, secured by a first mortgage bond over land. The debentures are redeemable
on 31 December 20.19
150 000
258 000
4.5.2
Starc Ltd
CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20.14
R
Cash flows from operating activities
68 000
Profit before interest and tax (a)
299 000
Adjustments to convert to cash from operations
Non-cash flow adjustments
10 000
Add: Depreciation (b)
10 000
Profit before working capital changes
309 000
Working capital changes
(57 000)
Increase in inventory (c)
(8 000)
Increase in receivables (d)
(14 000)
Decrease in payables (e)
(35 000)
Cash generated from operations
252 000
Interest paid (f)
(15 000)
Investment income (g)
36 000
Dividends paid (h)
(100 000)
Company tax paid (i)
(105 000)
Cash flow from investing activities
(190 000)
Increase in investments (j)
(110 000)
Non-current assets purchased (k)
(80 000)
Cash flow from financing activities
130 000
Proceeds from issue of ordinary shares (l)
210 000
Long-term borrowings redeemed (m)
(80 000)
Net increase in cash and cash equivalents
109
8 000
Cash and cash equivalents at beginning of year (n)
(50 000)
Cash and cash equivalents at end of year (o)
(42 000)
MANCOSA
Financial Reporting and Analysis
Calculations and explanatory notes
(a)
Profit before interest and tax
This amount is obtained from the statement of comprehensive income.
(b)
Depreciation
The amount is obtained from the statement of comprehensive income.
(c)
Increase in inventory
The increase is calculated by comparing the Inventory figures for both years:
R248 000 – R240 000 = R8 000 (The amount is bracketed as it represents a use of cash.)
(d)
Increase in receivables
The increase is calculated by comparing the Trade and other receivables figures (Trade debtors and
Prepaid expenses) for both years:
R74 000 – (57 000 + 3 000) = R14 000 (The amount is bracketed as it represents a use of cash.)
(e)
Decrease in payables
The decrease is calculated by comparing the Trade and other payables figures (Trade creditors) for
both years:
R85 000 – R50 000 = R35 000 (The amount is bracketed as it represents a use of cash.)
(f)
Interest paid
The amount is obtained from the statement of comprehensive income.
(g)
Investment income
The amount is obtained from the statement of comprehensive income (Dividends received).
(h)
Dividends paid
The amount paid is calculated as follows:
Dividends due on 31 December 20.13
(40 000)
Dividends for the year
(120 000)
Dividends due on 31 December 20.14
60 000
(100 000)
Note:
„ Dividends due on 31 December 20.13/20.14 is obtained from the item “Shareholders for dividends” in the
statement of financial position.
„ Dividends for the year are obtained from the statement of changes in equity.
MANCOSA
110
Financial Reporting and Analysis
(i)
Company tax paid
The amount paid is calculated as follows:
Company tax due on 31 December 20.13
(15 000)
Company tax for the year
(100 000)
Company tax due on 31 December 20.14
10 000
(105 000)
Note:
„ Company tax due on 31 December 20.13/20.14 is obtained from the item “South African Revenue Services” in
the statement of financial position.
„ Company tax for the year is obtained from the statement of comprehensive income.
(j)
Increase in investments
The amount is calculated by comparing the figures for “Investments” (in the statement of financial position) for both
years:
R330 000 – R220 000= R110 000 (The amount is bracketed as it represents a use of cash.)
(k)
Non-current assets purchased
The amount is obtained by comparing the figures for both years for Land and buildings in the note to the statement
of financial position and after consideration was given to the additional information:
R400 000 – R320 000 = R80 000
(l)
Proceeds from issue of ordinary shares
The amount is obtained by comparing the figures for Ordinary share capital in the statement of financial position
for both years:
R800 000 – R590 000 = R210 000
(m)
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MANCOSA
Financial Reporting and Analysis
Long-term borrowings redeemed
The amount is obtained by comparing the figures for both years for “12,5% Debentures” in the statement of financial
position:
R120 000 – R40 000 = R80 000 (The amount is bracketed as it represents a use of cash.)
(n)
Cash and cash equivalents at beginning of year
There was only a Bank overdraft of R50 000.
(o)
Cash and cash equivalents at end of year
There was only a Bank overdraft of R42 000.
Other calculations
„
Profit before working capital changes
R299 000 + R10 000 = R309 000
„
Cash generated from operations:
R309 000 – R57 000 = R252 000
„
Cash flows from operating activities:
R252 000 – R15 000 + R36 000 – R100 000 – R105 000 = R68 000
„Net increase in cash and cash equivalents
This amount can be calculated by comparing the cash balances of 20.13 and 20.14 i.e. an unfavourable balance
of R50 000 (20.13) turned into an unfavourable balance of R42 000 (20.14) resulting in a net increase in cash and
cash equivalents of R8 000.
The net increase can be verified as follows:
R68 000 – R190 000 + R130 000 = R8 000
MANCOSA
112
Financial Reporting and Analysis
Unit
5:
113
Analysis of Financial Statements
MANCOSA
Financial Reporting and Analysis
Unit Learning Outcomes and Associated Assessment Criteria
LEARNING OUTCOMES OF THIS UNIT:
ASSOCIATED ASSESSMENT CRITERIA OF THIS UNIT:
x distinguish between industry comparative and x Complete relevant think point, activity or self-assessment
time-series analysis.
question to analyse ratios in terms of industry and time based
comparisons
x calculate profitability, liquidity, activity, solvency
and securities market ratios.
x
Complete relevant think point, activity or self-assessment
question to calculate and comment on profitability, liquidity
x evaluate each ratio and recommend possible
and solvency ratios
corrective actions, if necessary
x
complete self-assessment activities 5.8.1, 5.8.2, 5.8.3, 5.8.4,
5.8.5
5.1 Introduction
5.2 Types of comparison
5.3 Profitability ratios
5.4 Liquidity ratios
5.5 Activity ratios
5.6 Debt(solvency ratios)
5.7 Securities market ratios
Prescribed / Recommended Readings
Bartlett, G., Beech, G., de Hart, F., de Jager, P., de Lange, J., Erasmus, P., Hefer, J.,
Madiba, T., Middelberg, S., Plant, G., Streng, J., Thayser, D. and van Rooyen, S. (2014)
Financial Management: Turning theory into practice. 1st Edition. Cape Town: Oxford
University Press.
Lodewyckx, E., Lötter, W., Rhodes, N. and Seedat, C. (2013) Introduction to Financial
Accounting: Fresh Perspectives. 2nd edition. Cape Town: Pearson.
Marx, J., de Swardt, C., Smith, M.B. and Erasmus, P. (2014) Financial Management in
Southern Africa. 4th Edition. Cape Town: Pearson Education.
MANCOSA
114
Financial Reporting and Analysis
5.1 Introduction
Financial statements provide insight into the financial performance and financial position of an entity. According
to Marx and Swardt (2014:65) the statements need to be further analysed by means of financial ratios in order to
extract more meaningful conclusions in order to diagnose and make a prognosis.
A ratio may be defined as the relationship between two sets of values. Ratios provide the means to summarise
complex accounting information into a small number of key indicators. They make figures more easily comparable.
The purpose of financial analysis is to either evaluate the financial performance and financial position of an entity
during the past accounting period or to evaluate the future plans of the entity based on the pro forma (budgeted)
financial statements. Financial analysis can also be used to identify and assess risks. The information required
for financial analysis is obtained from the statement of comprehensive income (income statement) and statement
of financial position (balance sheet).
Marx and Swardt (2014:65) add that the financial performance of a company cannot be ascribed to management
alone as economic conditions and competitive forces within the relevant industry also have an influence. During
periods of economic expansion, most firms usually experience rising sales, improved cash flows, lower bad debts
and higher profitability. The opposite is true during periods of economic contraction. Entities that have no or few
competitors usually achieve superior profitability compared to entities that have many competitors.
Financial ratios may be divided into five basic groups:
■
Profitability ratios
■
Liquidity ratios
■
Activity ratios
■
Debt (solvency) ratios
■
Securities market ratios
The most commonly used financial ratios are shown in Figure 5-1 :
Profitability
Liquidity
Activity
Debt/Solvency
Securities market
Gross margin
Current ratio
Inventory turnover
Debt to assets
Earnings per share
Profit margin
Acid test
Debtors collection
Debt/equity
Dividend per share
Interest coverage
Price/Earnings ratio
period
Return on assets
Creditor payment
period
Return on equity
Earnings yield
Dividend yield
Figure 4Figure 5-1 Financial ratios
115
MANCOSA
Financial Reporting and Analysis
This topic will explain the calculation and interpretation of the ratios indicated in Figure 5-1 above, and the
possible corrective actions that management may consider using wherever required.
5.2 Types Of Comparison
Ratio analysis does not involve only the calculation of ratios. The interpretation of the ratios is more important.
One must be able to ascertain whether the ratio is favourable or unfavourable; whether the ratio is too high or too
low, and so on. The interpretation is facilitated by having meaningful benchmarks or by means of comparisons.
Marx and Swardt (2014:66) distinguish between industry comparative and time-series analysis.
5.2.1
Industry comparative analysis
This involves a comparison of the financial ratios of different entities at the same point in time. This enables one
to determine how well an entity has performed in relation to its competitors. This is also known as the
“benchmarking approach” since the entity’s performance may be compared to the industry leader or industry
average.
5.2.2
Time-series analysis
This is undertaken to evaluate the performance of an entity over time. Comparing current performance with past
performance using ratio analysis allows one to determine whether an entity is progressing as planned. Significant
year-to-year changes should be investigated to determine whether they are symptomatic of major problems.
The most appropriate approach to ratio analysis is one that combines industry comparative and time-series
analyses.
The ratios indicated in Figure 5-1 will be explained using figures from the statement of comprehensive income
(income statement) and statement of financial position (balance sheet).as contained in Figure 5-2 and Figure 5-3
respectively:
Spire Limited
Statement of Comprehensive Income for the year ended 31 December:
20.14
20.13
Sales (all credit)
1 672 400
1 574 800
Cost of sales (all credit)
(878 700)
(812 600)
Gross profit
793 700
762 200
Operating expenses:
(487 900)
(466 600)
Selling, general and administrative
396 300
371 200
Other expenses
91 600
95 400
Operating profit
305 800
295 600
Other income:
2 700
3 300
2 700
3 300
Interest income
MANCOSA
116
Financial Reporting and Analysis
Profit before interest
308 500
298 900
Interest expense
(11 100)
(10 900)
Profit before tax
297 400
288 000
Company tax
(74 350)
(72 000)
Profit after tax
223 050
216 000
Figure 5Figure 5-2: Statement of Comprehensive Income
Spire Limited
Statement of Financial Position as at 31 December:
Assets
20.14
20.13
Non-current assets
814 300
783 000
Current assets:
637 900
606 600
Inventories
231 200
203 000
Accounts receivable
289 100
277 800
Cash and cash equivalents
117 600
125 800
1 452 200
1 389 600
Equity
653 100
628 900
Ordinary share capital (600 000 shares)
600 000
600 000
Retained earnings
53 100
28 900
Non-current liabilities
323 700
378 800
Current liabilities
475 400
381 900
Accounts payable
108 100
100 800
Other current liabilities
367 300
281 100
Total Equity and liabilities
1 452 200
1 389 600
Total assets
Equity and liabilities
Figure 6Figure 5-3: Statement of Financial Position
5.3 PROFITABILITY RATIOS
According to Marx and Swardt (2014:69) there are many measures of profitability, all of which relate the returns of
the entity relative to sales, assets or equity. Profitability ratios evaluate the effectiveness and efficiency of
management and employees in generating profit by means of sales and in their productive use of the assets and
equity. The most common measures of profitability include:
Gross margin
Profit margin
Return on assets
Return on equity
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Financial Reporting and Analysis
These ratios are now explained.
5.3.1
Gross margin (Gross profit margin)
The gross margin ratio indicates the profit of the firm relative to sales after deducting the cost of sales. It reflects
the contribution from an entity’s core business towards covering the operating expenses. It is calculated by
expressing the gross profit as a percentage of sales:
Gross margin
=
Gross profit
X
Sales
100
1
In the case of Spire Limited the gross margin is as follows:
20.14
20.13
Gross margin
=
Gross profit
X
Sales
=
R793 700
R1 672 400
=
100
Gross margin
=
1
X
100
X
100
Sales
=
1
47,46%
Gross profit
R762 200
1
X
100
R1 574 800
=
1
48,40%
A gross margin decline of 0.94% occurred from the previous year. Gross margin can be affected by a
combination of changes in:
■
the price charged for products sold.
■
the price paid for products purchased.
■
any variation in the product mix of the business.
The gross margin ratio may be improved by:
■
attempting to produce at a lower cost or buy at better prices, whilst maintaining the current selling price.
■
selling a greater proportion of goods that have a higher mark-up.
■
purchasing goods in bulk to get quantity discounts.
5.3.2
Profit margin (Net profit margin)
This ratio pertains to the relationship of profit after taxes to sales and is indicative of management’s ability to
operate the enterprise profitably. To be successful an enterprise must not only recover the cost of the merchandise,
the operating expenses, and the cost of borrowed funds but also there must also be reasonable compensation to
the owners for putting their capital at risk. The profit margin ratio is important to operating managers since it reflects
an enterprise’s pricing strategy and its ability to control operating costs.
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118
Financial Reporting and Analysis
Profit margin is calculated by expressing the Profit after taxes as a percentage of sales:
Profit margin
=
Profit after tax
X
100
Sales
1
The profit margin of Spire Limited is as follows:
20.14
20.13
Profit margin
=
Profit margin
Profit after tax
X
Sales
=
=
Profit after tax
1
R223 050
X
R1 672 400
=
100
X
100
Sales
100
=
1
R216 000
1
X
100
R1 574 800
13.34%
=
1
13.72%
A small decline of 0.38% from 20.13 is noted signifying a slight drop in profitability. Net profit margin is
significantly lower than the gross margin and is probably due to the high operating expenses.
The profit margin ratio may be improved by:
■ increasing sales through more effective and efficient marketing.
■ reducing expenses by ranking them from the greatest to the lowest and considering reductions in each type
of expense, such as cutting down on overtime.
5.3.3
Return on assets (Operating profit on total assets)
Return on assets (ROA) measures the efficiency of management in generating profits with its available assets. It
differs from return on equity since it measures profit as a percentage of the funds provided by both owners and
creditors as opposed to funds provided by the owners only. ROA is calculated as follows:
Return on assets = Operating profit X 100
Total assets
1
Return on assets of Spire Limited is calculated as follows:
20.14
20.13
Return on assets
=
=
Operating profit
X 100
Total assets
1
R305 800
X 100
R1 452 200
1
= 21,06%
119
Return on assets
=
=
Operating profit
X 100
Total assets
1
R295 600
X 100
R1 389 600
1
= 21,27%
MANCOSA
Financial Reporting and Analysis
Spire Limited experienced a slight decline in profitability. A comparison of this return to the inflation rate, return
on alternative investments, and interest rate on borrowed capital is required to determine whether the return is
satisfactory or not.
The return on assets may be improved by:
■ increasing sales through effective marketing strategies.
■ reducing investment in current assets such as inventories and accounts receivable during periods of declining
sales.
■ unbundling of business assets that achieve low or no profitability.
■ evaluating the effectiveness and efficiency of fixed assets with a view to improving productivity.
5.3.4
Return on equity (ROE)
Return on equity measures the rate of return on shareholders’ investment. It enables one to check whether the
return made on an investment is better than the alternatives available. It is calculated by expressing the net profit
after tax on the equity (as a percentage):
Return on equity = Profit after tax X 100
Equity
1
Return on equity for Spire Limited is calculated as follows:
20.14
Return on equity
=
=
Profit after tax
X 100
Equity
1
R223 050 X 100
R653 100
1
= 34,15%
20.13
Return on equity
=
Profit after tax
X 100
Equity
=
1
R216 000 X 100
R628 900
1
= 34,35%
Owners often compare this return to the return offered on alternative investments. In the case of Spire Limited,
the owners should be satisfied with the return of over 34% which is higher than the inflation rate (although there
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120
Financial Reporting and Analysis
was a slight decline in profitability). A good return on equity fuels investment interest from prospective investors.
It increases share prices and makes it easier for the company to borrow money.
The return on equity may be improved in the following ways:
■
increasing revenue by generating more sales through effective marketing strategies.
■
reducing operating expenses.
■
buying back some of the entity’s ordinary shares by raising more long-term loans.
5.4 Liquidity Ratios
Marx and Swardt (2014:72) define liquidity ratios as the measure of the ability of an enterprise to meet its shortterm obligations as they become due. These ratios focus on the liquid assets of the enterprise i.e. current assets
that can readily be converted into cash on the assumption that they form a cushion against default. The most
commonly used liquidity ratios are the current ratio and acid test ratio.
5.4.1
Current ratio
The current ratio shows the relationship between current assets and current liabilities and is an attempt to show
the safety of current debt holders’ claims in the case of default. A current ratio of at least 2:1 is usually
considered to be an acceptable value. However, this depends on the industry in which the entity operates. The
current ratio is calculated as follows:
Current ratio
=
Current assets
Current liabilities
The current ratio for Spire Limited is as follows:
20.14
20.13
Current ratio
=
Current ratio
Current assets
=
Current liabilities
=
Current assets
Current liabilities
R637 900
=
R606 600
R475 400
=
1,34:1
R381 900
=
1,59:1
A decline in the ratio (from 1,59:1 to 1,34:1) is largely due to the increase in current liabilities from the previous
year. Based on the norm of at least 2:1, Spire Limited may experience liquidity problems. An enterprise with a
low current ratio may not be able to convert its current assets into cash to meet maturing obligations. From a
debt holder’s point of view, a higher ratio appears to provide a cushion against losses in the event of business
failure. A large excess of current assets over current liabilities seems to protect claims. However, from a
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Financial Reporting and Analysis
management point of view a very high current ratio may point towards slack management practices. It may
indicate idle cash, high inventory levels that may be unnecessary and poor credit management resulting in
overextended accounts receivable.
If the current ratio is not satisfactory, then management should consider:
■ accelerating cash inflow by offering cash discounts for early settlement of debtors’ accounts.
■ improving its management of inventories by, for example, purchasing goods that satisfy the needs of the
target market.
■ selling more goods on credit, but ensuring that debtors settle their accounts on time.
Think Point
Some current assets have a higher return than others do. Can you think of
an example?.
5.4.2
Acid test ratio (Quick ratio)
This ratio is a more stringent test of liquidity. The intention of the acid test ratio is to test the collectability of current
liabilities under distress conditions, on the assumption that inventories would have no value at all. In the case of
a real crisis creditors may realise little cash from the sale of inventory. The acid test ratio is similar to the current
ratio except that the current assets (numerator) are reduced by the value of the inventory. An acid test ratio of at
least 1:1 is considered acceptable. The calculation is done as follows:
Acid test ratio
=
Current assets – Inventory
Current liabilities
Spire Limited’s acid test ratio is as follows:
20.14
20.13
Acid test ratio
=
Acid test ratio
Current assets – Inventory
=
Current assets – Inventories
Current liabilities
=
Current liabilities
R637 900 – R231 200
=
R606 600 – R203 000
R475 400
=
MANCOSA
0,86:1
R381 900
=
1,06:1
122
Financial Reporting and Analysis
It is clear that a ratio of less than 1:1 would pose liquidity problems in the event of a crisis. Spire Limited faces this
position at the end of 20.14 as the ratio indicates there only R0,86 of liquid assets is available to settle every R1
of current liabilities.
Corrective actions to improve the acid test ratio are similar to those of the current ratio.
5.5 Activity Ratios
Marx and Swardt (2014:75) state that activity ratios are used to measure the speed with which various accounts
are converted into sales or cash. We will focus on the rate at which inventory is sold, the time taken by debtors to
pay accounts and the time taken to settle creditors accounts.
5.5.1
Inventory turnover
In evaluating the effectiveness of an enterprise’s inventory management, it is common to use the number of times
inventory has turned over during the period of analysis. The higher the turnover rate the better, since low
inventories usually suggest a minimal risk of non-saleable merchandise and also indicates efficient use of capital.
Inventory turnover is calculated as follows:
Inventory turnover
=
Cost of sales
Average inventory
Average inventory refer to the average of the beginning and ending inventories. The inventory turnover
of Spire Limited is calculated as follows:
(Note: Inventories at the end of 20.12 amounted to R224 680.):
20.14
20.13
Inventory turnover
=
Cost of sales
Inventory turnover
=
Average inventory
=
R878 700
Cost of sales
Average inventory
=
R812 600
R217 100
=
R213 840
4,05 times
=
3,80 times
Note: Average inventory is calculated as follows:
20.14
=
20.13
R231 200 + R203 000
=
R203 000 + R224 680
2
=
123
R217 100
2
=
R213 840
MANCOSA
Financial Reporting and Analysis
The inventory turnover of Spire Limited shows an improvement from 3,80 times to 4,05 times per annum. The
inventory turnover of 4,05 times for 20.14 implies that merchandise remains in inventory for an average of 90
days (365 days ÷ 4,05 times) before being sold.
An entity may try to improve its inventory turnover by:
■ lowering inventory levels through more accurate demand forecasts.
■ having specials and monthly sales.
Think Point
What do you think are the implications for an enterprise if the:
5.5.2
x
Inventory turnover is low.
x
inventory turnover is high
Debtor collection period
This ratio tells us how long trade debtors take to meet their obligations to pay following the sale on credit. It
highlight’s the enterprise’s management of debtors (or accounts receivable) by evaluating credit and collection
policies. One would want to know whether the accounts receivable that are outstanding at the end of the period
closely approximate the amount of credit sales one would expect to remain outstanding under prevailing credit
terms. This is done as follows:
Debtor collection period
=
Accounts receivable
X 365
Credit sales
20.14
20.13
Debtor collection period
Debtor collection period
= Accounts receivable X 365
= Accounts receivable X 365
Credit sales
=
R289 100
R1 672 400
= 63,10 days
Credit sales
X 365
=
R277 800
X 365
R1 574 800
= 64,39 days
The debtor collection period may be interpreted in two ways. One can say that Spire Limited has an average of
63,10 days’ worth of credit sales tied up in accounts receivable, or one can say that the average time lag between
sale and receipt of cash from the sale is 63,10 days. This collection period allows us to compare it with the terms
of sale. Thus if Spire Limited sells on 30 day terms, the collection period is very unsatisfactory. It could mean
that some customers had difficulty paying, or were abusing their credit privileges, or that some sales were made
on extended terms.
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124
Financial Reporting and Analysis
An entity with an unfavourable debtor collection period may consider doing the following:
■
Provide incentives to increase cash sales, thereby lowering credit sales and thus accounts receivable.
■
Accelerate the collection period by offering debtors discounts for early settlement.
■
Send account statements out early, using electronic and traditional means.
■
Charge interest on overdue accounts.
5.5.3 Creditor payment period
This ratio tells us how long, on average, an enterprise takes to pay for goods bought following the purchase on
credit. It is used to evaluate an enterprise’s performance with regard to the management of accounts payable
(creditors). The number of days of accounts payable (or creditor payment period) is compared to the credit terms
under which the enterprise makes purchases. Significant deviations from this norm can be detected. Optimal
management of accounts payable requires making payment within the stated terms and no earlier except for
taking advantage of discounts whenever offered for early payment
Creditor payment period may be calculated as follows:
Creditor payment period
=
Accounts payable
X 365
Credit purchases
20.14
20.13
Creditor payment period
=
Accounts payable
Creditor payment period
X 365
=
Credit purchases
=
R108 100
Accounts payable
Credit purchases
X 365
=
R100 800
R906 900
=
X 365
X 365
R790 920
43,51 days
=
46,52 days
Note: Purchases are calculated as follows:
20.14
20.13
Cost of sales
878 700
812 600
Add: Closing inventory
231 200
203 000
1 109 900
1 015 600
Less opening inventory
(203 000)
(224 680)
Purchases
906 900
790 920
Since all the purchases are on credit, in this case total purchases = credit purchases. Spire Limited is probably
allowed credit terms of between 30 days and 60 days by creditors.
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Financial Reporting and Analysis
If the credit terms are exceeded, reasons for the late payment should be investigated and the entity should in future
adhere to the credit terms to avoid damaging its credit record.
5.6 Debt Ratios
According to Marx and Swardt (2014:78) lenders are concerned with an entity’s degree of indebtedness and ability
to service debts since the more indebted a firm, the greater the probability that the firm will be unable to satisfy the
claims of all its creditors.
An enterprise increases its financial leverage when it raises the proportion of debt relative to equity to finance the
business. The successful use of debt enhances the earnings for the owners of the enterprises since returns on
these funds, over and above the interest paid, belongs to the owners, and therefore increases the return on equity.
However, from the point of view of the lender, when earnings are insufficient to cover the interest cost, the fixed
interest and principal commitments must still be met. The most common measures of debt are the debt to assets
and debt/equity ratios.
5.6.1
Debt to assets (Debt ratio)
Debt to assets ratio is used to reflect the proportion of debt to the total claims against the assets of the
enterprise. The greater the ratio, the higher the risk. Debt to asset ratio is expressed as follows:
Debt to assets
=
Total debt
X
Total assets
100
1
The debt to assets ratio of Spire Limited is as follows:
20.14
20.13
Debt to assets
=
Total debt
Debt to assets
X
Total assets
=
R799 100
R1 452 200
=
55,03%
100
=
1
X
100
Total debt
X
Total assets
=
1
R760 700
R1 389 600
=
100
1
X
100
1
54,74%
The ratio indicates that more than half of Spire Limited assets, in book value terms, come from creditors of one
type or another. If the company is efficient in generating satisfactory returns on the assets at its disposal, then
the return on equity may be boosted as a result of using less equity and more debt.
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126
Financial Reporting and Analysis
If the debt to assets ratio is too high, management may consider:
■
buying back some of its ordinary shares by obtaining long-term loans.
■
reducing its current liabilities by accelerating cash inflow (e.g. having special offers and sales).
5.6.2 Debt to equity
This ratio attempts to show the relative proportions of non-current claims to ownership claims, and is used as a
measure of debt exposure. Debt to equity ratio is expressed as follows:
Debt to equity
=
Non-current debt
X
100
Equity
1
The debt to equity ratio of Spire Limited is as follows:
20.14
20.13
Debt to equity
=
Debt to equity
Non-current debt
X
Equity
=
100
=
Non-current debt
1
R323 700
X
R653 100
100
Equity
=
1
= 49,56%
X
R378 800
R628 900
=
100
1
X
100
1
60,23%
The ratio indicates that the non-current creditors supply Spire Limited with 49.65 cents for every Rand supplied
by the owners. The ratios over the two year period show a decrease in the use of non-current debt by the
company.
If the debt/equity ratio is too high, management should consider issuing new ordinary shares and using the cash
raised to pay off long-term debt.
5.6.3 Interest coverage (Times interest earned ratio)
Although this ratio is not a measure of debt, it does give some indication of a firm’s ability to cover the interest
payments that will result from any loan agreements it enters into. This ratio is based on the premise that annual
operating earnings are the basic source for debt service, and that any major change in this relationship may signal
difficulties. Debt holders often stipulate the number of times the business is expected to cover its debt service
obligations. The ratio for interest coverage is as follows:
Interest coverage =
Operating profit
Interest expense
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MANCOSA
Financial Reporting and Analysis
Spire Limited interest coverage ratio is as follows:
20.14
20.13
Interest coverage
=
Operating profit
Interest coverage
=
Interest expense
=
R305 800
Operating profit
Interest expense
=
R295 600
R11 100
R10 900
= 27,55 times
= 27,12 times
A value of between 3 and 5 times is usually recommended. Spire Limited interest coverage of 27, 55 times
means that the enterprise’s profit covers its interest obligations adequately.
5.7 Securities Market Ratios
According to Marx and Swardt (2014:80) the earnings per share, dividend per share, price/earnings, earnings yield
and dividend yield ratios are applicable only to companies listed on a stock exchange such as the Johannesburg
Securities Exchange (JSE).
5.7.1
Earnings per share (EPS)
The earnings per share ratio is considered to be an indicator of profitability. It is a ratio that both management and
shareholders pay a great deal of attention to. It is also carefully monitored by investment analysts and portfolio
managers. The ratio simply involves dividing the profit after tax by the number of ordinary shares in issue:
Earnings per share
=
Profit after tax
Number of ordinary shares issued
Earnings per share for Spire Limited is calculated as follows:
20.14
20.13
Earnings per share
Earnings per share
=
=
Profit after tax
Profit after tax
Number of ordinary shares issued
Number of ordinary shares issued
R223 050
X 100
=
600 000
= 37,18 cents
MANCOSA
R216 000
X 100
600 000
=
36 cents
128
Financial Reporting and Analysis
The earnings per share have increased by 1.18 cents per share, signalling a slight improvement in profitability.
Shareholders look forward to an increase in the earnings per share as their dividends per share depend on it.
If the EPS is too low, then management may consider:
■
buying back some of its ordinary shares by obtaining long-term loans to finance it.
■
improving the profitability of the entity by better marketing strategies etc.
5.7.2 Dividend per share (DPS)
Dividends are usually declared on a per share basis by the company’s board of directors. The board of directors
usually has a dividend policy in place. Because the value of ordinary shares is partly influenced by dividends
paid and anticipated, the board has to deal with this periodic decision very carefully. DPS is calculated by dividing
the dividends for the year by the number of ordinary shares issued:
Dividend per share
=
Dividends for the year
Number of ordinary shares issued
If the dividends of Spire Limited for 20.14 and 20.13 were R105 000 and
R100 000 respectively, then the dividend per share is calculated as follows:
=
=
20.14
20.13
Dividend per share
Dividend per share
Dividends for the year
Dividends for the year
Number of ordinary shares issued
Number of ordinary shares issued
R105 000
X 100
=
600 000
= 17,5 cents
R100 000
X 100
600 000
=
16,67 cents
The dividend per share has risen by 0.83 cents per share, probably due to the increase in the earnings per share.
If the dividend per share is too low, management should investigate ways of improving the profitability of the
entity.
5.7.3 Price/Earnings (P/E) ratio
This ratio is one of the most important measures used by investors and managers to evaluate the market price
of a company’s ordinary shares. It is also used to indicate how the stock market is judging the company’s earnings
performance and prospects. This is one reason why the EPS (used in the calculation) is reported prominently on
the face of the income statement. The price/earnings ratio is calculated as follows:
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MANCOSA
Financial Reporting and Analysis
Price/Earnings ratio
=
Market price per share
Earnings per share
The price/earnings ratio for Spire Limited (the market price per share for 20.14 and 20.13 was 130 cents and
120 cents respectively) is calculated as follows:
20.14
20.13
Price/Earnings ratio
Price/Earnings ratio
= Market price per share
= Market price per share
Earnings per share
Earnings per share
=
130 cents
=
37,18 cents
= 3,50 times
120 cents
36 cents
= 3,33 times
The ratio shows that investors are willing to pay approximately 3.50 times the earnings for the shares. This ratio
needs to be compared to the average P/E ratio of similar companies. An above-average P/E ratio indicates that
the market price is high relative to the company’s current earnings, possibly because investors anticipate
favourable future developments such as increased EPS or higher DPS. Low P/E ratios usually indicate poor
earnings expectations.
The management of a company with a price/earnings ratio that is considered to be too low should focus on
improving profitability.
5.7.4 Earnings yield
The earnings yield ratio reflects the current profit-generating power per ordinary share at the current market price.
It is a way to measure returns, and it helps investors evaluate whether those returns are commensurate with
an investment's risk. It is the opposite of the price/earnings ratio. The ratio is thus:
Earnings yield
=
Earnings per share
Market price per share
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Financial Reporting and Analysis
Earnings yield for Spire Limited is calculated as follows:
20.14
20.13
Earnings yield
Earnings yield
=
Earnings per share
X 100
Earnings per share
Market price per share
=
37,18 cents
X 100
Market price per share
X 100
=
36 cents
130 cents
X 100
120 cents
= 28,60%
=
30 %
The percentage return that the shareholders of Spire Limited achieved by way of total earnings on their investment
in terms of the market value of the shares has dropped from 30% to 28,60%. The earnings yield may be improved
by improving the profitability of the company or using leverage to reduce the number of ordinary shares.
5.7.5
Dividend yield
The dividend yield ratio reflects the percentage return that a shareholder receives by way of dividend on his/her
investment valued in terms of the market value of the shares in the company. The ratio is calculated as follows:
Dividend yield
=
Dividends per share
Market price per share
Dividend yield for Spire Limited is calculated as follows:
=
20.14
20.13
Dividend yield
Dividend yield
Dividend per share
X 100
Dividend per share
Market price per share
=
17,5 cents
X 100
Market price per share
=
130 cents
= 13.46%
X 100
16,67 cents
X 100
120 cents
=
13.89%
The dividend yield has dropped marginally. A higher dividend yield has been considered to be desirable among
many investors. A high dividend yield may be considered to be evidence that a stock is under-priced or that the
company has fallen on hard times and future dividends may not be as high as previous ones. Similarly a low
dividend yield can be considered evidence that the stock is overpriced or that future dividends might be higher.
A company needs to improve its profitability in order to improve the dividend yield.
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Financial Reporting and Analysis
5.8
Self-Assessment Activities
5.8.1
Financial data for Zebcom Limited are as follows:
Statement of Comprehensive Income
20.14
20.13
Sales (all credit)
3 201 150
1 937 300
Cost of sales (all credit)
2 618 010
1 599 370
Profit before tax
183 140
122 642
Tax (25%)
45 785
30 660
Profit after tax
137 355
91 982
Statement of Financial Position as at 31 Dec
20.14
20.13
Current assets
2 866 530
4 974 530
Inventories
482 200
38 860
Accounts receivable
261 290
155 200
Marketable securities
326 950
2 306 440
Cash
1 796 090
2 474 030
Current liabilities
1 088 860
588 310
Accounts payable
190 660
192 040
Other current liabilities
898 200
396 270
Required
„ Calculate the gross margin and profit margin for 20.14 and 20.13.
„ Comment on your answers calculated in 5.8.1.1.
„ Calculate the current ratio and acid test ratio at the end of each year. How has the enterprise’s liquidity changed
over this period?
„ Compute the following for 20.14 (ratios for 20.13 are given in brackets):
„ Inventory turnover (2013: 20 times)
„ Debtors collection period (2013: 29,24 days)
„ Creditors payment period (2013: 43,83 days)
„ What is your interpretation of the enterprise’s performance with respect to your answers in 5.8.1.4?
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Financial Reporting and Analysis
5.8.2 Answer the questions below based on the following information. Tax is calculated at 35% of profit.
Vuyo Traders
Sipho
Stores
Operating profit
R400 000
R420 000
Debt (at 10% interest)
R200 000
R1 200 000
Equity
R800 000
R300 000
Number of shares issued
300 000
100 000
Dividends for the year
R140 000
R110 000
Market price per share
500 cents
600 cents
Required
x
Calculate the return on assets for both enterprises.
x
Calculate the return on equity for both enterprises.
x
Why is the return on equity for Sipho Stores so much higher than Vuyo Traders?
x
Should Vuyo Traders be satisfied with its return on assets? Explain.
x
Calculate the earnings per share and dividend per share for both enterprises.
x
Calculate the price/earnings ratio, earnings yield and dividend yield of both enterprises.
5.8.3
In 20.14, Mestle Wholesalers had R2 000 000 of assets, R600 000 of non-current liabilities and
R200 000 of current liabilities. Operating profit was R500 000, interest expense was R120 000 and the
tax rate was 40%.
Required
x
Calculate the following ratios:
■ Debt to assets
■ Debt to equity
■ Interest coverage
x
5.8.4
Comment on your answers obtained in 5.8.3.1.
INFORMATION
Impress Limited
Extract of Statement of Comprehensive Income for the year ended 31 December 20.14
R
Sales (all credit)
1 343 300
Cost of sales
1 023 610
Operating profit
257 150
Profit before tax
80 000
N.B. Income tax = 30% of the profit before tax
133
MANCOSA
Financial Reporting and Analysis
Extract of Statement of Financial Position as at 31 December:
20.14 (R)
20.13 (R)
3 416 720
2 900 080
Inventories
65 350
54 650
Trade and other receivables/Accounts receivable
267 350
230 260
Cash and cash equivalents
214 210
202 270
Owners’ equity
2 063 410
1 926 260
Non-current liabilities
1 232 580
940 580
Current liabilities
667 640
520 420
Non-current assets
REQUIRED
x
Calculate the gross margin for 20.14.
x
Has the liquidity position of the company improved? Motivate your answer by doing the relevant calculations.
x
Use two relevant ratios to comment on the effectiveness with which the company has employed two of the
current assets entrusted to it by the shareholders of the enterprise during 20.14.
x
The effectiveness with which the management of Impress Limited has employed the total assets and own
capital is significant. Use the two applicable ratios and comment on the profitability of Impress Limited for
20.14 from the point of view of management.
5.8.5
INFORMATION
Gantt Limited
Extract of Statement of Comprehensive Income for the year ended 31 December 20.14
R
Sales
1 343 000
Cost of sales
803 000
Operating profit
257 000
Profit after tax
56 000
Extract of Statement of Financial Position as at 31 December:
20.14 (R)
20.13 (R)
3 416 000
2 900 000
Inventories
65 000
54 000
Trade and other receivables/Accounts receivable
267 000
230 000
Cash and cash equivalents
214 000
202 000
Owners’ equity
2 063 000
1 926 000
Non-current liabilities
1 232 000
940 000
Current liabilities
667 000
520 000
Non-current assets
MANCOSA
134
Financial Reporting and Analysis
Additional information
■ Credit terms to debtors are 30 days.
■ All sales are on credit.
REQUIRED
Use the information provided below to answer the following questions. Answers to ratios must be expressed to
two decimal places.
x
Calculate the gross margin for 20.14.
x
Calculate the ratio that measures the efficiency with which the total assets of company were managed for
20.14.
x
Has the liquidity position of the company improved since 20.13? Use two ratios to motivate your answer.
x
Use a relevant ratio and assess the effectiveness of the credit administration of the company in respect of
its debtors for 20.14.
x
5.9
Suggest two ways in which the management of Gantt Limited can improve its profit margin.
SOLUTIONS
THINK POINT 1!
Answers may vary. One possible answer:
Credit card customers in large retail firms such are a good source of income because interest is
charged on their accounts. Interest rates may range between 20% and 30%. If debtors’
balances in these companies are high, a large source of income is generated.
THINK POINT 1!
A low inventory turnover may mean that:
Demand for merchandise available on sale is low.
Items of inventory may be obsolete.
There is too much inventory.
A high inventory turnover may mean that:
There is a potential for inventory shortages and the resultant poor customer service.
There is a lower dependency on capital to carry inventory.
There is a lower dependency on capital to carry inventory.
135
MANCOSA
Financial Reporting and Analysis
20.14
20.13
Profit margin
=
Profit after tax
Profit margin
X
Sales
=
R137 355
x
=
Profit after tax
1
X
R3 201 150
=
100
4,29%
100
X
100
Sales
=
1
R91 982
1
X
100
R1 937 300
=
1
4,75%
Gross margin has increased marginally while profit margin showed a slight decrease. The cost of sales is
high in relation to sales. It thus appears that Zebcom Limited is operating on very low profit margins.
Operating expenses does appear to be high as there is a large difference between the gross margin and
profit margin.
5.9.1
20.14
20.13
Current ratio
=
Current ratio
Current assets
=
Current liabilities
=
Current assets
Current liabilities
R2 866 530
=
R4 974 530
R1 088 860
=
R588 310
2,63:1
=
8,46:1
20.14
20.13
Acid test ratio
=
Acid test ratio
Current assets – Inventory
=
Current assets – Inventories
Current liabilities
=
Current liabilities
R2 866 530 – R482 200
=
R4 974 530 – R38 860
R1 088 860
=
2,19:1
R588 310
=
8,39:1
The liquidity has deteriorated considerably from the previous year. However, one could say that high liquidity
ratios for 20.13 may point towards slack management in respect of the idle cash. The ratios for 20.14 have
dropped to more acceptable levels.
MANCOSA
136
Financial Reporting and Analysis
5.9.2
20.14
Inventory turnover
=
Cost of sales
Average inventory
=
R2 618 010
R260 530
=
10,05 times
N.B. Average inventory = (R482 200 + R38 860) ÷2 = R260 530
20.14
Debtor collection period
= Accounts receivable X 365
Credit sales
=
R261 290
X 365
R3 201 150
= 29,79 days
20.14
Creditor payment period
= Accounts payable X 365
Credit purchases
=
R190 660
X 365
R3 061 350
= 22,73 days
Note: Credit purchases are calculated as follows:
Cost of sales
2 618 010
Add: Closing inventory
482 200
3 100 210
137
Less opening inventory
(38 860)
Purchases (all credit)
3 061 350
MANCOSA
Financial Reporting and Analysis
5.9.3 Inventory turnover has dropped sharply from 20 times to 10,05 times per annum suggesting that the
management may have not had efficient control over inventory. Debtors’ collections seem to be good, with
the outstanding debt expected to be collected within 30 days. Creditors accounts are being settled earlier
than the previous year and the enterprise should not settle accounts earlier than required unless a discount
for early settlement is forthcoming.
5.9.4
Vuyo Traders
Sipho Stores
Return on assets
=
=
Return on assets
Operating profit
X 100
Total assets
1
R400 000
X 100
R1 000 000
1
=
=
= 40%
Operating profit
X 100
Total assets
1
R420 000
X 100
R1 500 000
1
= 28%
N.B. Total assets = R200 000 + R800 000 = R1 000 000 (Vuyo Traders)
Total assets = R1 200 000 + R300 000 = R1 500 000 (Sipho Stores)
5.9.5
Vuyo Traders
Return on equity
=
Profit after tax
X 100
Equity
=
1
R247 000 X 100
R800 000
1
= 30,88%
N.B. Profit after tax = R400 000 – R20 000 (interest) – R133 000 (tax)
= R247 000
Sipho Stores
Return on equity
=
Profit after tax
X 100
Equity
=
1
R195 000 X 100
R300 000
1
= 65%
MANCOSA
138
Financial Reporting and Analysis
N.B. Profit after tax = R420 000 – R120 000 (interest) – R105 000 (tax)
= R195 000
5.9.7 Sipho Stores higher return on own capital is due to its higher financial leverage. The enterprise is
financed more by debt than own capital.
5.9.8 Yes. A 40% return is greater than the cost of borrowing funds (10%). It is also greater than the inflation
rate and the return that one could get from alternative investments e.g. fixed deposits.
5.9.9
Vuyo Traders
Sipho Stores
Earnings per share
Earnings per share
=
=
Profit after tax
Profit after tax
Number of ordinary shares issued
Number of ordinary shares issued
R247 000
X 100
=
300 000
=
X 100
100 000
= 82,33 cents
=
R195 000
=
195 cents
Vuyo Traders
Sipho Stores
Dividend per share
Dividend per share
Dividends for the year
Dividends for the year
Number of ordinary shares issued
Number of ordinary shares issued
R140 000
X 100
=
300 000
R110 000
X 100
100 000
= 46,67 cents
=
110 cents
5.9.10
Vuyo Traders
Price/Earnings ratio
Price/Earnings ratio
= Market price per share
= Market price per share
Earnings per share
Earnings per share
=
500 cents
82,33 cents
= 6,07 times
139
Sipho Stores
=
600 cents
195 cents
= 3,08 times
MANCOSA
Financial Reporting and Analysis
=
Vuyo Traders
Sipho Stores
Earnings yield
Earnings yield
Earnings per share
X 100
Earnings per share
Market price per share
=
82,33 cents
Market price per share
X 100
=
195 cents
500 cents
=
32,50 %
Vuyo Traders
Sipho Stores
Dividend yield
Dividend yield
Dividend per share
X 100
Dividend per share
Market price per share
=
X 100
600 cents
= 16,47%
=
X 100
46.67 cents
X 100
Market price per share
X 100
=
110 cents
500 cents
X 100
600 cents
= 9,33%
=
18,33%
5.9.11
Debt to assets
=
Total debt
X
100
Total assets
=
R800 000
1
X
100
R2 000 000
=
1
40%
Debt to equity
=
Non-current debt
X
Equity
=
R600 000
R1 200 000
100
1
X
100
1
= 50%
MANCOSA
140
Financial Reporting and Analysis
N.B. Equity = R2 000 000 – R800 000 = R1 200 000
Interest coverage
=
Operating profit
Interest expense
=
R500 000
R120 000
=
4,17 times
5.9.12
The debt to assets ratio indicates that 40% of Mestle Wholesalers assets come from borrowed funds.
The debt to equity ratio indicates that the non-current debt suppliers provide Mestle Wholesalers with 50 cents
for every Rand supplied by the owners.
Mestle Wholesalers earned its interest obligations 4,17 times over in 20.14; or one could say that profit before
interest and tax was 4,17 times as large as interest.
5.9.13
Gross margin = Gross profit X 100
Sales
=
1
R319 690
X 100
R1 343 300
1
= 23,80%
5.9.14
20.14
20.13
Current ratio
=
Current ratio
Current assets
=
Current liabilities
=
Current assets
Current liabilities
R546 910
=
R487 180
R667 640
=
141
0,82:1
R520 420
=
0,94:1
MANCOSA
Financial Reporting and Analysis
20.14
20.13
Acid test ratio
=
Acid test ratio
Current assets – Inventory
=
Current assets – Inventories
Current liabilities
=
=
Current liabilities
R546 910 – R65 350
=
R487 180 – R54 650
R667 640
R520 420
R481 560
R432 530
R667 640
R520 420
0,72:1
=
0,83:1
No. The liquidity has deteriorated as evidenced by the decrease in both the current and acid test ratios.
Etc
5.9.15
20.14
Inventory turnover
=
Cost of sales
Average inventory
=
R1 023 610
R60 000
= 17,06 times
Debtor collection period
= Accounts receivable X 365
Credit sales
=
R267 350
X 365
R1 343 300
= 72,64 days
Inventory turnover rate is fairly high.
f credit terms are 30 days, then debtors are taking too long to pay. Etc
MANCOSA
142
Financial Reporting and Analysis
5.9.16
20.14
Return on assets
=
=
Operating profit
X 100
Total assets
1
R257 150
X 100
R3 963 630
1
= 6,49%
20.14
Return on own capital
=
Profit before tax
X 100
Own capital
=
1
R80 000
X 100
R2 063 410
1
= 3,88%
The return for both ratios are very low when compared to return on alternative investments, inflation rate, interest
rate on borrowed money, owners’ expectations etc.
5.9.17
Gross margin
=
Gross profit
X 100
Sales
=
1
R540 000
X 100
R1 343 000
1
= 40,21%
5.9.18
Return on assets
=
=
Operating profit
X 100
Total assets
1
R257 000
X 100
R3 962 000
1
= 6,49%
143
MANCOSA
Financial Reporting and Analysis
5.9.19
20.14
20.13
Current ratio
=
Current ratio
Current assets
=
Current liabilities
=
Current assets
Current liabilities
R546 000
=
R486 000
R667 000
=
R520 000
0,82:1
=
20.14
20.13
Acid test ratio
=
0,93:1
Acid test ratio
Current assets – Inventory
=
Current assets – Inventories
Current liabilities
=
Current liabilities
R546 000 – R65 000
=
R486 000 – R54 000
R667 000
=
R520 000
R481 000
=
R432 000
R667 000
=
R520 000
0,72:1
=
0,83:1
No. The current and acid test ratios have dropped.
5.9.20
Debtor collection period
= Accounts receivable X 365
Credit sales
=
R267 000
X 365
R1 343 000
= 72,57 days
The company has been ineffective in debt collection. Debtors are exceeding their credit terms of 30 days. Etc
5.9.21
*
Reduce administrative expenses by cutting down on overtime.
*
Institute control measures to prevent the misuse of company resources such as telephone, vehicles etc.
*
Develop effective marketing strategies to increase sales.
*
Negotiate with suppliers for higher discounts, to reduce costs.
*
Seek alternative suppliers for better deals.
*
Etc
MANCOSA
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Financial Reporting and Analysis
Bibliography
x Bartlett, G., Beech, G., de Hart, F., de Jager, P., de Lange, J., Erasmus, P., Hefer, J., Madiba, T., Middelberg,
S., Plant, G., Streng, J., Thayser, D. and van Rooyen, S. (2014) Financial Management: Turning theory into
practice. 1st Edition. Cape Town: Oxford University Press.Conradie, W.M. and Fourie, C.M.W. (2013) Basic
Financial Management. 1st Edition. Cape Town: Juta & Co.
x Kew, J and Warson, A. (2013) Financial Accounting: An Introduction. 4th edition. Cape Town: Oxford University
Press.
x Lodewyckx, E., Lötter, W., Rhodes, N. and Seedat, C. (2013) Introduction to Financial Accounting: Fresh
Perspectives. 2nd edition. Cape Town: Pearson.
x Marx, J., de Swardt, C., Smith, M.B. and Erasmus, P. (2014) Financial Management in Southern Africa. 4th
Edition. Cape Town: Pearson Education.
x Schutte, M. (2014) Accounting for All. 1st Edition. Cape Town: Juta & Company Ltd.
x www.smallbusiness.chron.com
x www.studymode.com
145
MANCOSA
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