BLANTYRE INTERNATIONAL UNIVERSITY

COURSE OUTLINE FOR

Financial Accounting 11 (ACF 121)

Private Bag 98,

Blantyre, Malawi
Telephone: 265 991 095 434
Email: nelliekishombe31@[Link]
Lecturer: Miss Nellie Kishombe

1. Programme : Bachelor of Accounting and Finance

2. Department : Accounting and Finance
3. Course Title : Financial Accounting II
4. Course Code : ACF 121
5. Course Duration : Semester
6. Lecture hours per week :3
7. Tutorial hours per week :1
8. Course Credits :3
9. Course Assessment : Course Work 40%
: Final Examination 60%

10. Course Description

This course presents fairly complex matters in basic book keeping.

11. Aim of this Course

The aim of the course is to develop students’ understanding of accounting treatment of specialized
transactions such as Consignee Accounts, interpretation of financial statements and cash flow projections as
they apply to a business organisation.

12. Learning outcomes

By the end of this course, students should be able to:
a) Design partnership accounts;
b) Design necessary accounts on issue of shares and on declaring of dividends.;
c) Present shareholders’ equity on a balance sheet;
d) Prepare accounts for non trading organisations such as clubs;
e) Interpret accounting information using techniques such as financial ratios and cash flow analysis;
f) Prepare cash flow projections.

13. Topics of Study

13.1Partnership Accounts
a) The nature of a partnership
b) Partnership agreement

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c) Appropriation of profit
d) Partnership capital and current accounts
e) Final accounts of a partnership (statement of profit and loss and statement of financial
position
f) Changes in sharing ratio
g) Dissolution of partnership

13.2Company accounts
a) The corporate form of organisation
b) Stock issue consideration
c) Accounting for Dividends
d) Retained earnings
e) Financial statement presentation of stockholders’ equity.

13.3 Accounting for specialized transactions

a) Clubs and societies
b) Imprest/Petty Cash Accounts
c) Joint ventures

13.4 Analysis of Financial Statements

a) Basic Ratio analysis;
b) Cash flow analysis – IAS 7 – Accounting for receipts and payments
c) Issues in financial reporting.

13.5 Single Entry and Incomplete Records

a) Accounting Equation
b) Ledger accounts to calculate missing figure
c) Profit percentages to calculate missing figures
d) Preparing profit and loss
e) Preparing statement of financial position.

13.6. Control Accounts

a) The purpose of control accounts
b) Purchases ledger and sales ledger control accounts.

13.7 Bank Reconciliation Statement

a) Purpose of bank reconciliation
b) Causes of differences between the cash book balance and the bank statement balance.
c) Bank reconciliations
d) Bank overdraft
e) Dishonoured cheques.

13.8. Property, Plant and Equipment (IAS 16) – basic knowledge

a) Define plant assets
b) Describe the accounting techniques for plant assets
c) Classify plant asset costs as either capital expenditures or revenue expenditures
d) Compute depreciation, using straight-line method, units-of-production method and reducing-
balance method
e) Accounting entries for the disposal of plant assets.

14. Prescribed Texts

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Libby, Robert., Libby, Patricia. A. and Hodge, Frank. (2016) Financial Accounting, 9th Edition, McGraw
Hill Higher Education

Thomas, Andrew. (2015) Introduction to Financial Accounting (UK Higher Education Business
Accounting), UK ed., McGraw-Hill Higher Education

Marshall, David., McManus, Wayne. William., Marshall, Ian. and Viele, Daniel. (2016) Accounting: What
the Numbers Mean, 11th edition, McGraw-Hill Higher Education
Wood, F. and Sangster, A. (2012): Business Accounting 2, 12th Edition, Pearson Education

15. Recommended Texts

Harrison, Walter. T., Horngren, Charles., Thomas, C. William., Berberich, Greg. and Seguin, Catherine.
(2015) Financial Accounting, Fifth Canadian Edition, Pearson.

Larson, K.D. and Jenson, T. (2013) Fundamental Accounting Principles, Volume 2, 14th Canadian ed,
McGraw-Hill.

Wild, John., Shaw, Ken. and Chiappetta, Barbara. (2016) Fundamental Accounting Principles, 23rd Edition,
McGraw-Hill Education.

Wood, F. and Sangster, A. (2012): Business Accounting 1, 12th Edition, Pearson Education

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CHAPTER 1: Partnership
A partnership consists of two or more people forming a business with a view of making profit.
The maximum number of people in a partnership is 20. The partners draw up a partnership deed
which sets out the rights and duties of partners. The usual accounting contents for a partnership
agreement are:
1. The capital to be contributed by each partner
2. The ratio in which profits or losses are to be shared
3. The rate of interest to be paid on capital before profits are shared.
4. The rate of interest to be charged on partners’ drawings
5. salaries to be paid to partners
6. Arrangements for the admission of new partners.
7. Procedures to be carried out when a partner retires or dies.

Requirements for a partnership (unincorporated)

Minimum 2 partners to set up

Business Names Act 1985 requires the names of partners to be shown on
stationery
In the absence of a partnership deed, the Partnership Act 1890 applies to profit
sharing, interest on capital, interest on loans and partners’ salaries
Capital is restricted to what partners can invest
Partners have ‘joint and several’ liability
Must keep accounting records, but no requirement to disclose financial
information

 Fixed ratio
Partners may agree to share the profits equally (eg 50:50)

4
 If a partner has contributed more capital or spends more time working for the
partnership than the other, they may decide an alternative basis (eg 75:25)
 Ratio based on capital balances
If partners have contributed unequal amounts of capital, they may agree to share
the profits in the same ratio (eg if one partner has contributed £60,000 capital and
the other only £40,000, the profit sharing ratio will be 60:40)
 Making allocations and sharing the balance
The partners may agree that interest will be paid on the capital contributed by the
partners, that partners who spend a certain amount of time working in the business
will receive a salary or that interest will be charged on any drawings
All these transactions will be allocations of the net profit earned by the business
Once these allocations have been made, any balance (whether a profit or a loss) will be shared
amongst the partners in an agreed ratio
 The profit and loss account of an unincorporated partnership is similar to that of a sole
trader except the net profit or loss is transferred to an additional section known as an
appropriation account
 An appropriation account is ‘a record of how the net profit/(loss) for the period has been
distributed’ (Collis and Hussey, 2007, p. 153
It is part of the double-entry bookkeeping system and shows the partners’ interest on loans and
drawings, as well as their interest on capital and salaries, before showing how the net profit/(loss)
is shared
 Rob and John own a business called Hearth & Home which is an unincorporated
partnership
 They have agreed to share the profits/(losses) of the business equally
 A profit and loss account has been drawn up from the trial balance and additional
information for the year ending 31 December 2005 and you can see that so far it is
similar to that of a sole trader
Hearth & Home Profit and loss
account for the year ending 31 December 2005
Sales $532,000
Cost of Sales
Opening Stock 96,000
Purchases 245,000
341,000
Less closing Stock 148,000
Gross profit
Less expenses 339,000
Wages 67,000
Administration 43,000
Prov. for doubtful debts 1,000
Net profit available for appropriation 228,000

We are now ready to add the appropriation account which shows the interest payable on
drawings, any interest due on capital and loans, the partners’ salaries and how the balance of
profit is shared
Required
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Complete the profit and loss appropriation account for Hearth & Home from the trial balance and
additional information available at 31 December 2005
Hearth and Home
Trial Balance as at 31 December 2005
Sales 532000
Purchases 245000
Premises 300000
Fixtures & Fittings 60000
Trade Debtors 198000
Trade Creditors 37000
Bank 93000
Stock at 1 January 2008 96000
Wages 67000
Administration expenses 43000
Provision for doubtful debts 1000
Capital Accounts
Rob 270000
John 130000
Current Accounts
Rob 7000
John 6000
Drawings
Rob 40000
John 27000
1076000 1076000
Additional Information
1. Stock at 31 December 2005 $148,000
2. Provision for doubtful debts $2000 3. Interest on Drawings :
Rob $4000 4. Salaries: Rob $44000, John $40000.
5. Profit Sharing: 50%
6. Interest on Capital is 10%
Using the information above, the profit & loss appropriation and be completed as follows:
Please fill out the missing figures!!

Hearth and Home

Profit and Loss Appropriation Account for 31 December 2005
Net profit available for appropriation $228,000
Interest on drawings: Rob 4,000
Less: Interest on Capital (10%) Rob ?
John ? ?
Less: Salaries Rob 44,000

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 John 40,000 ?
( )?
Balance of Profits to be shared ?
Share of profits: Rob 50% ?
John 50% ?
?

NB, Interest on drawings is added to the net profit available for appropriation
because it is an additional source of revenue.
The Accounts of a partnership
Each partner has a separate Capital Account, which records the amount of capital contributed by
that partner. Transactions appearing on the capital account record any permanent increases or
decreases in capital, for example when a partner donates cash to the business; the donation
injects capital in the business and also increases the partner’s capital account.

In a double-entry system, the accountant opens a capital account and a current account for each

partner

The capital account shows the capital subscribed and withdrawn

The current account shows salaries, interest on capital, interest on drawings, share
of profit and drawings
These entries correspond with those made in the profit and loss appropriation account and the
balances on these accounts at the end of the accounting period are needed for the balance sheet
Current Account: Rob
Drawings 40,000 Balance b/d 7,000
Interest on Drawings 4,000 Interest on Capital 27,000
31Dec. 2006 Balance c/d 88,000 Salary 44,000
Share of profits 54,000
$132,000 $132,000
1 Jan 2006 Balance b/d 88,000

Current Account: John

Drawings 27,000 Balance b/d 6,000
Interest on Drawings 0 Interest on Capital 13,000
31Dec. 2006 Balance c/d 86,000 Salary 40,000
Share of profits 54,000
$113,000 $113,000
1 Jan 2006 Balance b/d 86,000

The first half of a partnership balance sheet is similar to that of a sole trader, but the second half
shows the closing balances on the partners’ capital and current accounts

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 $
Capital accounts Rob 270,000
John 130,000

Current accounts Rob 88,000

John 86,000

Required
Complete the balance sheet for Hearth & Home

Hearth and Home

Balance sheet as at 31 December 2005
Fixed Assets $000
Premises 300
Fixtures & Fittings 60
Current Assets
Stock 148
Debtors 198
Provision for doubtful debts (2) 196
344
Current Liabilities
Creditors (137)
Bank Overdraft (93)
Working Capital
214
Total Assets
574
Financed by:
Capital Accounts
Rob ?
John ? ?
Current Accounts
Rob ?
John ?
?
?

Admitting a new partner

Reconstitution of a Partnership Firm –Admission of a Partner

Partnership is an agreement between two or more persons (called partners) for sharing
the profits of a business carried on by all or any of them acting for all. Any change in the
existing agreement amounts to reconstitution of the partnership firm. This results in an

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end of the existing agreement and a new agreement comes into being with a changed
relationship among the members of the partnership firm and/or their composition.
However, the firm continues. The partners often resort to reconstitution of the firm in
various ways such as admission of a new partner, change in profit sharing ratio,
retirement of a partner, death or insolvence of a partner.

Reconstitution of a partnership firm usually takes place in any of the following ways:
Admission of a new partner:
A new partner may be admitted when the firm needs additional capital or managerial help.
According to the provisions of Partnership Act, unless it is otherwise provided in the partnership
deed a new partner can be admitted only when the existing partners unanimously agree for it. For
example, Hari and Haqque are partners sharing profits in the ratio of 3:2. On April 1, 2007 they
admitted John as a new partner with 1/6 share in profits of the firm. With this change now there
are three partners of the firm and it stand reconstituted.

Change in the profit sharing ratio among the existing partners:

Sometimes the partners of a firm may decide to change their existing profit sharing ratio. This
may happen an account of a change in the existing partners’ role in the firm. For example, Ram,
Mohan and Sohan are partners in a firm sharing profits in the ratio of 3:2:1. With effect from
April 1,2007 they decided to share profits equally as Sohan brings in additional capital. This
results in a change in the existing agreement leading to reconstitution of the firm.
Retirement of an existing partner:
It means withdrawal by a partner from the business of the firm which may be due to his bad
health, old age or change in business interests. In fact a partner can retire any time if the
partnership is at will. For example, Roy, Ravi and Rao are partners in the firm sharing profits in
the ratio of 2:2:1. On account of illness, Ravi retired from the firm on March 31, 2007. This
results in reconstitution of the firm now having only two partners.
Death of a partner:
Partnership may also stand reconstituted on death of a partner, if the remaining partners decide to
continue the business of the firm as usual. For example, X,Y and Z are partners in a firm sharing
profits in the ratio 3:2:1. X died on March 31, 2007. Y and Z decide to carry on the business
sharing future profits equally. The continuity of business by Y and Z sharing future profits
equally leads to reconstitution of the firm.

Admission of a New Partner

When firm requires additional capital or managerial help or both for the expansion of its business
a new partner may be admitted to supplement its existing resources. According to the Partnership
Act 1932, a new partner can be admitted into the firm only with the consent of all the existing
partners unless otherwise agreed upon. With the admission of a new partner, the partnership firm
is reconstituted and a new agreement is ntered into to carry on the business of the firm.

A newly admitted partner acquires two main rights in the

firm– 1. Right to share the assets of the partnership firm;
and
2. Right to share the profits of the partnership firm.

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For the right to acquire share in the assets and profits of the partnership firm, the partner brings
an agreed amount of capital either in cash or in kind. Moreover, in the case of an established firm
which may be earning more profits than the normal rate of return on its capital the new partner is
required to contribute some additional amount known as premium or goodwill. This is done
primarily to compensate the existing partners for loss of their share in super profits of the firm.

Following are the other important points which require attention at the time of admission of a
new partner:
1. New profit sharing ratio;
2. Sacrificing ratio;
3. Valuation and adjustment of goodwill;
4. Revaluation of assets and Reassessment of liabilities;
5. Distribution of accumulated profits (reserves); and 6. Adjustment of partners’ capitals.

New Profit Sharing Ratio

When new partner is admitted he acquires his share in profits from the old partners. In other
words, on the admission of a new partner, the old partners sacrifice a share of their profit in
favour of the new partner. But, what will be the share of new partner and how he will acquire it
from the existing partners is decided mutually among the old partners and the new partner.
However, if nothing is specified as to how does the new partner acquire his share from the old
partners; it may be assumed that he gets it from them in their profit sharing ratio. In any case, on
admission of a new partner, the profit sharing ratio among the old partners will change keeping
in view their respective contribution to the profit sharing ratio of the incoming partner. Hence,
there is a need to ascertain the new profit sharing ratio among all the partners. This depends upon
how does the new partner acquires his share from the old partners for which there are many
possibilities. Let us understand it with the help of the following illustrations.
Illustration 1
Anil and Vishal are partners sharing profits in the ratio of 3:2. They admitted Sumit as a new
partner for 1/5 share in the future profits of the firm.
Required
Calculate new profit sharing ratio of Anil, Vishal and Sumit.

Solution
Sumit’s share = 1/5 Remaining share = 1-1/5 = 4/5

Anil’s new share = 3/5 of 4/5 = 12/25

Vishal’s new share = 2/5 of 4/5 = 8/25

New profit sharing ratio of Anil, Vishal and Sumit will be 12:8:5. Note: It has been assumed that
the new partner acquired his share from old partners in old ratio.

Illustration 2
Akshay and Bharati are partners sharing profits in the ratio of 3:2.
They admit Dinesh as a new partner for 1/5th share in the future
profits of the firm which he gets equally from Akshay and Bharati.
Calculate new profit sharing ratio of Akshay, Bharati and Dinesh.

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Solution
Dinesh’s share = 1/5 or 2/10

Akshay’s share = 3/5 – 1/10 = 5/10

Bharati’s share = 2/5 –

1/10 = 3/10
New profit sharing ratio between, Akshay, Bharati and Dinesh will be 5:3:2.
Practice Question
Anshu and Nitu are partners sharing profits in the ratio of 3:2. They admitted Jyoti as a new
partner for 3/10 share which she acquired 2/10 from Anshu and 1/10 from Nitu.
Required
Calculate the new profit sharing ratio of Anshu, Nitu and Jyoti.
Goodwill
Goodwill is also one of the special aspects of partnership accounts which requires adjustment
(also valuation if not specified) at the time of reconstitution of a firm viz., a change in the profit
sharing ratio, the admission of a partner or the retirement or death of a partner.
Meaning of Goodwill
Over a period of time, a well-established business develops an advantage of good name,
reputation and wide business connections. This helps the business to earn more profits as
compared to a newly set up business. In accounting, the monetary value of such advantage is
known as “goodwill”. It is regarded as an intangible asset. In other words, goodwill is the value
of the reputation of a firm in respect of the profits expected in future over and above the normal
profits. It is generally observed that when a person pays for goodwill, he/she pays for something,
which places him in the position of being able to earn super profits as compared to the profit
earned by other firms in the same industry.
In simple words, goodwill can be defined as “the present value of a firm’s anticipated excess
earnings” or as “the capitalised value attached to the differential profit capacity of a business”.
Thus, goodwill exists only when the firm earns super profits. Any firm that earns normal profits
or is incurring losses has no goodwill.

Factors Affecting the Value of Goodwill

The main factors affecting the value of goodwill are as follows:
1. Nature of business:
A firm that produces high value added products or having a stable demand is able to earn more
profits and therefore has more goodwill.

2. Location:
If the business is centrally located or is at a place having heavy customer traffic, the goodwill
tends to be high.

3. Efficiency of management:
A well-managed concern usually enjoys the advantage of high productivity and cost efficiency.
This leads to higher profits and so the value of goodwill will also be high.

4. Market situation:

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The monopoly condition or limited competition enables the concern to earn high profits which
leads to higher value of goodwill. 5. Special advantages:
The firm that enjoys special advantages like import licences, low rate and assured supply of
electricity, longterm contracts for supply of materials, well-known collaborators, patents,
trademarks, etc. enjoy higher value of goodwill.

Need for Valuation of Goodwill

Normally, the need for valuation of goodwill arises at the time of sale of a business. But, in the
context of a partnership firm it may also arise in the following circumstances:
1. Change in the profit sharing ratio amongst the existing partners;
2. Admission of new partner;
3. Retirement of a partner;
4. Death of a partner; and
5. Dissolution of a firm involving sale of business as a going concern.
6. Amalgamation of partnership firms.

Methods of Valuation of Goodwill

Since goodwill is an intangible asset it is very difficult to accurately calculate its value. Various
methods have been advocated for the valuation of goodwill of a partnership firm. Goodwill
calculated by one method may differ from the goodwill calculated by another method. Hence,
the method by which goodwill is to be calculated, may be specifically decided between the
existing partners and the incoming partner. The important methods of valuation of goodwill are
as follows:
1. Average Profits Method
2. Supper Profits Method
3. Capitalisation Method

Average Profits Method

Under this method, the goodwill is valued at agreed number of ‘years’ purchase of the average
profits of the past few years. It is based on the assumption that a new business will not be able to
earn any profits during the first few years of its operations. Hence, the person who purchases a
running business must pay in the form of goodwill a sum which is equal to the profits he is likely
to receive for the first few years. The goodwill, therefore, should be calculated by multiplying
the past average profits by the number of years during which the anticipated profits are expected
to accrue.

For example, if the past average profits of a business works out at $ 20,000 and it is expected that
such profits are likely to continue for another three years, the value of goodwill will be $ 60,000
($ 20,000 × 3),

Example
The profit for the last five years of a firm were as follows
Year 2002 $ 4, 00,000
Year 2003 $ 3, 98,000
Year 2004 $ 4, 50,000
Year 2005 $ 4, 45,000
Year 2006 $ 5, 00,000.

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Calculate goodwill of the firm on the basis of 4 years purchase of 5 years average profits.

Solution
Year Profit
($)
2002 4, 00,000
2003 3, 98,000
2004 4, 50,000
2005 4, 45,000
2006 5, 00,000
Total 21, 93,000

Average Profit = Total Profit of Last 5 Years/ No. of years

= 21, 93,000
5
= $ 4, 38,600

Goodwill = Average Profits × No. of years purchased

= $ 4, 38,600 × 4
= $ 17, 54,400

The above calculation of goodwill is based on the assumption that no change in the overall
situation of profits is expected in the future. The above illustration is based on simple average.
Sometimes, if there exists an increasing on decreasing trend, it is considered to be better to give a
higher weightage to the profits to the recent years than those of the earlier years. Hence, it is a
advisable to work out weighted average based on specified weights like 1,2, 3, 4 for respective
year’s profit.

Example
The Profits of firm for the last five years were as follows:
Year Profit
($)
2002 20,000
2003 24,000
2004 30,000
2005 25,000
2006 18,000
Calculate the value of goodwill on the basis of three years’ purchase of weighted average profits
based on weights 1,2,3,4 and 5 respectively to the profits for 2002,2003,2004,2005 and 2006.

Solution
Year Profit Weight Product
(Rs.)
2002 20,000 1 20,000
2003 24,000 2 48,000
2004 30,000 3 90,000
2005 25,000 4 1,00,000

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2006 18,000 5 90,000
15 3,48,000
Weighted Average Profit = 3, 48,000 = $ 23,200

15 Goodwill = $ 23,200 × 3 = $.
69,600
Supper Profits Method
The basic assumption in the average profits (simple or weighted) method of calculating goodwill
is that if a new business is set up, it will not be able to earn any profits during the first few years
of its operations. Hence, the person who purchases an existing business has to pay in the form of
goodwill a sum equal to the total profits he is likely to receive for the first ‘few years’. But it is
contended that the buyer’s real benefit does not lie in total profits; it is limited to such amounts
of profits which are in excess of the normal return on capital employed in similar business.
Therefore, it is desirable to value, goodwill on the basis of the excess profits and not the actual
profits. The excess of actual profits over the normal profits is termed as super profits.

Normal Profit = Capital Employed × Normal Rate of Return

100

Suppose an existing firm earns $18,000 on the capital of $ 1, 50,000 and the normal rate of return
is 10%.
The Normal profits will work out at:
$ 15,000 (1.50, 000 × 10/100).
The super profits in this case will be $ 3,000 ($ 18,000 – $15,000). The goodwill under the super
profit method is ascertained by multiplying the super profits by certain number of years’
purchase. If, in the above example, it is expected that the benefit of super profits is likely to be
available for 5 years in future, the goodwill will be valued at:
$ 15,000 (3,000 × 5).
Thus, the steps involved under the method are:
1. Calculate the average profit,
2. Calculate the normal profit on the capital employed on the basis of the normal rate of return,
3. Calculate the super profits by deducting normal profit from the average profits, and
4. Calculate goodwill by multiplying the super profits by the given number of years’ purchase.
Illustration
The books of a business showed that the capital employed on December 31, 2006, Rs. 5,00,000
and the profits for the last five years were:
1997 – $ 40,000
1998 – $ 50,000
1999 – $ 55,000 2000 – $70,000
2001 – $ 85,000.
You are required to find out the value of goodwill based on 3 years purchase of the super profits
of the business, given that the normal rate of return is 10%.

Solution
Normal Profits = Capital Employed Normal Rate of Return
100

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 = $ 5, 00,000 x 10
100
= $ 50,000
Average Profits:
Year Profit
($)
2002 40,000
2003 50,000
2004 55,000
2005 70,000
2006
Total

Average Profits = $ 3, 00,000/5 = $ 60,000

Super Profit = $ 60,000 – $ 50,000 = $10,000
Goodwill = $ 10,000 3 = $ 30,000
ACCOUNTING ENTRIES ON ADMISSION OF A NEW PARTNER
When a new partner is admitted, a goodwill account is opened so the existing partners can
benefit from the goodwill they have generated
Goodwill is ‘the difference between the value of the separable net assets of an entity and the total
value’. (Total net assets of new partnership less the net assets of the old partnership + capital
invested by the new partner)
Goodwill is either written off immediately or over a period of time
Goodwill and change in ratio
Change in ratio may be due to change in contribution of partners in terms of skills or efforts
Reduce – ill health, old age, busy elsewhere
Increase – increase in skills, education, time contributed
Treatment – (a) open goodwill a/c
(b) adjustment made without goodwill a/c
New partner will pay cash (in addition to capital) for the share of future goodwill and
recompense the old partners for giving the rights to the new partner.
3 ways of paying for that premium
Payment made privately to old partners ( no entries needed)

Cash paid into the business but will then paid out

immediately

Cash paid into the business and retained for the use of the business.
Goodwill should be valued before admitting new partner and should be recorded in old
partners’ capital a/c.
However, goodwill should be eliminated immediately after admitting the new partner.
No Goodwill a/c to be opened, treatment should be just like changes in ratio without
opening Goodwill a/c.
Note:
Equal treatment for retirement and death

15
 Retiring partner has interest in the firm that need to be accounted for
Share of profits
Revaluation of assets
Goodwill
* Calculation of goodwill and revaluation is done solely to ensure that the proper amount which
the business owes to the retiring partner is given back to him/her.
• The purchase of a partnership interest is a personal transaction between the old partner
and new partner.
• No accounting entry is required other than changing the name on the old partners capital
account to the new partners name.
• Interestingly, the old partners can still decide if the new partner should be a partner.
• Many partnership agreements restrict the sale of a partnership interest to parties without
consent of all partners.
Example
• Assume that Howe decides to leave the law practice and retire.
• A new partner Joan Severely, will be admitted to the new partnership and all partners
agree to this arrangement.
• Mr. Howe, upon retirement is entitled to the balance of his capital account. The
Balance sheet prior to Howe’s departure is:
Wee Cheatham & Howe Balance Sheet
Assets
Cash $10,000
Other $50,000
Total $60,000
Liabilities & Equity
Liabilities $ 0
Equity
Wee, capital $10,000
Cheatham, capital $20,000
Howe, capital $30,000
Total $60,000

When Howe leaves the practice the journal entry is:

Dr: Howe, capital $30,000
Cr: Assets $30,000
The Balance sheet now appears as:
Wee Cheatham & Howe Balance Sheet
Assets
Cash $10,000
Other $20,000 Total $30,000
Liabilities & Equity
Liabilities $ 0
Wee, capital $10,000
Cheatham, capital $20,000
Total Equity $30,000

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 When Joan Severely is admitted to the partnership her capital contribution is recorded as
follows: Dr: Cash/Bank $30,000
Cr: Severely, capital $30,000
Joan Severalty’s contribution could be in the form of cash or other
assets The balance sheet now appears as:
Wee Cheatham Severely
Balance
Sheet
Assets
Cash $10,000
Other $50,000 Total $60,000
Liabilities & Equity
Liabilities $ 0
Wee, capital $10,000
Cheatham, capital $20,000
Severely, capital $30,000
Total $60,000

It should be noted that even though Joan Severely’s capital of $30,000 is ½ of the firms
equity it does not entitle her to ½ interest in the partnership That is decided through the new
partnership agreement
Assume that for $30,000 Joan receives a 1/3 interest in the firm
Recall that Wee, capital is $10,000
Cheatham, capital is $20,000
Total $30,000
With the additional $30,000 from Joan total equity is:
Previous balance $30,000
Investment $30,000
Total partnership equity $60,000

1/3 interest (1/3x $60,000) $20,000

• This means Joan’s capital account will be $20,000.
• Joan invests $30,000
• The additional $10,000 is distributed to the prior partners according to their income
sharing arrangement
If we assume for simplicity that income is shared evenly:
Dr: Cash $30,000
Cr: Joan Severely, capital $20,000
Cr: Wee, capital $5,000
Cr: Cheatham, capital $5,000
This example illustrates a bonus to existing partners by the new partner
In practice this is very common
It is also possible to have a bonus to the new partner
• Suppose Joan Severely is offered a ½ interest in the firm for$10,000 The
existing equity of the firm is:
Wee, capital $10,000
Cheathum, capital $20,000

17
 Total $30,000
Additional investment $10,000
Total Equity $40,000

½ interest in the firm should be ½ x $40,000 = $20,000.

However, Joan Severely will receive ½ interest for $10,000.
The additional $10,000 to make Joan Severely capital $20,000 will come from the existing
partners.

The additional $10,000 will come from each partner according to their income sharing
arrangement which is assumed to be 50:50
Dr: Cash $10,000
Dr: Wee, capital $5,000
Dr: Cheathum, capital $5,000
Cr: Joan Severely, capital $20,000
This situation is called a bonus to the new partner. It is not as common as a bonus to existing
partners but does happen. Usually, it is to invite a partner to the firm which the firm believes will
add significantly to their business prospects

Dissolving a partnership
When a partnership is dissolved, a realization account is opened, so that the profit can be
calculated and shred among the partners in their agreed profit-sharing ratios
If the reason for the cessation of the partnership is due to the insolvency of one of the partners,
the rules of Garner v. Murray (1905) apply These require the other partners to bear the loss in
the ratio of their capital accounts.
When a Partnership is liquidated all the assets are turned into cash, the remaining cash, if any, is
distributed to the partners according to their income earning ratios.

Wee Cheatham & Howe

Balance Sheet
Assets
Cost Depreciation Book Value Equipment
Cost $50,000 $10,000 $40,000

Cash $30,000
Other $50,000
$80,000
Total Assets $120,000
Liabilities & Equity
Liabilities $20,000
Equity
Wee, capital $20,000
Cheatham, capital $20,000
Howe, capital $60,000
Total Equity $100,000 Total
Liabilities & Equity $120,000
• Assume that the equipment is sold for $30,000, a loss of $10,000

18
The journal entry to record this is:
Dr: Cash $30,000.
Dr: Accumulated depreciation $10,000.
Dr: Wee, capital. ($10,000 x ¼ ) $2,500.
Dr: Cheathum, capital ($10,000 x ¼ ) $2,500.
Dr: Howe, capital.($10,000 x ½) $5,000.
Cr: Equipment $50,000.
• Notice the loss is immediately recorded to each Partner in their income sharing ratio.
If the investment is sold for $65,000 a gain of $15,000 the journal entry would be:

Dr: Cash $65,000.

Cr: Wee, capital ($15,000 x ¼ ) $3,750.
Cr: Cheathum, capital ($15,000 x ¼ ) $3,750.
Cr: Howe, capital ($15,000 x ½) $7,500.
Cr: Investment $50,000.
The balance sheet will appear as follows:
Wee Cheatham & Howe
Balance Sheet Assets

Cash $125,000
Total $125,000
Liabilities & Equity
Liabilities $20,000
Wee, capital $21,250
Cheatham, capital $21,250
Howe, capital $62,500
Total Equity $105,000
$125,000
After the creditors are paid their will be $105,000 remaining. Each partner will then receive their
capital account balances in cash.

DISSOLUTION OF A PARTNERSHIP FIRM

A firm may come to an end because of dispute among the partners or firm running losses for last
few years or because of order of the court and so on. We can say that the partnership firm is
dissolved. Dissolution of the partnership (owing to retirement, death or insolvency of a partner),
merely involves change in the relation of the partners but it does not end the firm; the partnership
would certainly come to an end but the firm, the reconstituted one might continue under the same
name. Therefore, dissolution of the partnership may or may not include the dissolution of the
firm but the dissolution of the firm necessarily means the dissolution of the partnership.

On dissolution of the firm, the business of the firm ceases to exist since its affairs are would up
by selling the assets and by paying the liabilities and discharging the claims of the partners. The
dissolution of partnership among all partners of a firm is called dissolution of the firm.

19
(i) Dissolution by Agreement: A firm is dissolved in case:
 all the partners give consent or as per the terms partnership agreement .
(ii) Compulsory dissolution : A firm is dissolved compulsorily in the following cases
 When all the partners or all excepting one partner becomes insolvent or of
unsound mind.
 When the business becomes unlawful.
 When all the partners excepting one decide to retire from the firm.
 When all the partners or all excepting one partner die.
 A firm is also dissolved compulsorily if the partnership deed includes any
provision regarding the happening of the following events:
(a) expiry of the period for which the firm was formed,
(b) completion of the specific venture or project for which the firm was
formed.
(iii) Dissolution by notice: In case of a partnership at will, the firm may be dissolved if any
one of the partner gives a notice in writing to the other partners.

(iv) Dissolution by Court: A court may order a partnership firm to be dissolved in the
following cases:
(a) When a partner becomes of unsound mind
(b) When a partner becomes permanently incapable of performing his/her
duties as a partner
(c) When partner deliberately and consistently commits breach of
agreements relating to the management of the firm; (d) when a
partner’s conduct is likely to adversely affect the Business of the
firm;
(e) when a partner transfers his/her interest in the firm to a third
party;
(g) When the court regards dissolution to be just and equitable.

ACCOUNTING ENTRIES TO DISSOLVE A PARTNERSHIP

Dissolution Example (Jennings page 23-23)

E, T and V who are in partnership sharing profits and losses 2:2:1, respectively, decide to
dissolve the partnership on 30th September 2000 at which date their Balance sheet was:

Continued on next page

20
 .
E,T and V
Balance sheet as at 30 September 2000

Fixed Assets Capital accounts

Freehold property 30,000 E 39,000
Equipment 15,000 T 13,000
V 2,000
45,000 54,000
Current Assets Current Accounts
Stock 8,000 E 700
Debtors 4,500 T (300)
Cash at Bank 2,100 V 200
14,600 600
Current Liabilities
Creditors 3,000
Loan- T 2,000

59,000 59,000
The partners were unable to sell the business as a going concern and disposed of the assets
separately for the following sums:
Freehold property $ 31,000
Equipment 4,800
Stock 2,900
Debtors paid in full and creditors gave discounts totaling $100. Dissolution expenses totaled
$800.
Required.
Prepare all the accounts of the partnership on dissolution.

SOLUTION
Freehold Property
Balance B/d $30,000 Realisation $30,000

21
 Equipment
Balance b/d $15,000 Realisation $15,000

Stock
Balance b/d $8,000 Realisation $8,000

Debtors
Balance b/d $4,500 Realisation $4,500

Realisation Account
Freehold Property $30,000 Bank (Freehold property) $31,000
Equipment 15,000 Bank (Equipment) 4,800
Stock 8,000 Bank (Stock) 2,900
Debtors 4,500 Creditors (Discount) 100
Bank-expense 800 Bank (Debtors) 4,500
Share of Loss on Realisation
(15000) E (2/5) 6,000
T (2/5) 6,000
V (1/5) 3,000
58,300 58,300
Creditors
Realisation (discount) $ 100 Balance b/d 3000 Bank
2900

Loan (from T)
Bank $2,000 Balance b/d $2000
Capital Accounts
E T V E T V
Current a/c - 300 - Balances b/d 39,000 13,000 2,000
Realisation loss 6000 6000 3000 Current a/c 700 - 200
Bank (pymt of a sum overdrawn) 800
Bank(final payments) 33,700 6700
39,700 13,000 3000 39700 13000 3000

Current Accounts
E T V E T V
Current a/c - 300 - Balances b/d 700 - 200
Capital a/c transfer 700 - 200 Capital a/c transfer - 300 -

700 300 200 700 300 200

Bank
Balance b/d 2,100 Creditors 2,900
Realisation (freehold P) 31,000 Realisation expenses 800
Realisation (Equipment) 4,800 Loan-T 2,000
Realisation (Stock) 2,900 Capital- E (final payment 33,700

22
Realisation (debtors) 4,500 -T (final payment) 6,700
Capital - V 800
46,000 46,000

CHAPTER 2: COMPANY ACCOUNTS

Anyone who operates a business, alone or with others, may incorporate. A corporation does not
need to be a large business entity; even the owners of home-based businesses may find
incorporation quite advantageous.
What is a Corporation? A corporation is a nonhuman entity. The most important feature of a
corporation is that it exists entirely separate and apart from its owners. Corporations must have at
least one owner, but there is no upper limit. The owners are called shareholders or stockholders.
The ownership interests of the shareholders in a corporation are divided into units called stock,
shares, or shares of stock. The rules governing corporations along with the advantages and
disadvantages apply equally to corporations owned by one or more than one shareholder.
A corporation comes into existence when the prospective shareholders file a paper known as
Articles of Incorporation. Among other things, the Articles of Incorporation require the
prospective shareholders to determine the number of shares the corporation will be authorized to
issue.
The total number of shares a corporation may issue is arbitrary, and there is no upper limit.
However, the corporation must issue at least one share of stock for each shareholder. If the
corporation will have more than one shareholder, the corporation should issue shares to each
stockholder in proportion to their ownership interests. The proportion of the shareholders'
ownership interests may vary from a fraction of one percent to a fraction over ninety-nine
percent, depending on the deal the shareholders make when they decide to go into business
together.
For example, if you are the sole shareholder, it makes no difference whether you own one share
or one million shares. In each case, you own one hundred percent of the corporation. Likewise, if
two people have decided to go into business on a sixty-forty basis, it makes no difference
whether one owns six shares or six million and the other owns four shares or four million. In
each case, their respective interests would be sixty-forty.
How Does a Corporation Conduct Business?
A corporation conducts business through a chain of authorised representatives. The shareholders
are at the top of the chain. The shareholders, however, do not directly manage the corporation's
daily affairs. Instead, the shareholders meet at least once each year to elect a Board of Directors.
Corporations must have at least one director, but there is no upper limit. The directors' job is to
make general business decisions for the corporation. Their decisions are then implemented by the
corporation's officers, who are appointed by the directors at a directors' meeting.
The officers consist of at least the following: Chief Executive Officer (CEO) or managing
director, treasurer, and secretary. The CEO or managing director is responsible for managing the
corporation's daily operations. The treasurer manages the corporation's money, while the
secretary maintains the corporation's nonfinancial books and records. Corporations may also
have one or more top managers reporting to the managing director, and their duties may vary,
depending on the corporation's needs. For example, the corporation may have marketing
manager, operations manager, personnel manager, and so on.

23
The shareholders may elect themselves as the directors. In their capacity as directors, they may
then appoint themselves as one or more of the officers. If you are a sole shareholder, you may
elect yourself as the sole director and, as the sole director, you may appoint yourself as president,
treasurer, and secretary. This arrangement is not considered a conflict of interest.
The law requires the keeping of registers and records eg
1. Minute Book
2. Financial Records
3. Registers of Members
4. Registers of Debenture Holders
5. Registers of charges

General Corporation
This is the most common corporate structure. The corporation is a separate legal entity that is
owned by stockholders. A general corporation may have an unlimited number of stockholders
that, due to the separate legal nature of the corporation, are protected from the creditors of the
business. A stockholder's personal liability is usually limited to the amount of investment in the
corporation and no more.
Advantages
• Owners' personal assets are protected from business debt and liability
• Corporations have unlimited life extending beyond the illness or death of the owners
• Tax free benefits such as insurance, travel, and retirement plan deductions
• Transfer of ownership facilitated by sale of stock
• Change of ownership need not affect management
• Easier to raise capital through sale of stocks and bonds
Disadvantages
• More expensive to form than proprietorship or partnerships
• More legal formality required
• More government rules and regulations
• Stock exchange rules and regulations
• Double taxation. The corporation pays tax on its income and shareholders pay tax on
dividends
• Double tax when selling the corporation. The corporation pays tax on any gain and the
shareholders pay tax on the cash received
The difference between a Private Limited (Pvt. Ltd) and a public limited company
There are lot of differences. The major factor is number of shareholders and shareholding
pattern. In Pvt. Ltd. company the share holders comprise of close group of friends and relatives.
A Pvt. Ltd. company can not make an offer for public to subscribe it's shares. Where as a Ltd.
company can given an advertisement and invite general public to subscribe for it's shares.
Basically a Pvt. Ltd. company is a corporate version of partnership firm where as a Public Ltd.
company is a full fledged corporate body. For a Pvt. Ltd. company minimum 2 shareholders are
required whereas for Public Ltd. company minimum 50 shareholders are required.
A share holder of a Public Ltd. company can transfer his shares freely at the stock exchange
where the shares are listed whereas in a Pvt. Ltd. Company a shareholder can not transfer his
shares without the consent of other shareholders. Also shares of the Pvt. Ltd. company can not be
listed on stock exchanges and hence can not be traded there like shares of a Public Ltd. company.
These are some of the major points of difference.

24
Funding a company
ISSUE OF SHARES AND DEBENTURES

The issuing of shares and debentures is how companies raise capital to finance its operations.
Shares are issued by all companies to their owners at date of incorporation BUT only public
companies can issue shares to the public at a later date. The issuing of shares and debentures
(dollar value and number), and the resulting funds received need to be correctly accounted for in
the companies financial accounts.

What is a share
A company set up to run a business will usually have money (and perhaps other assets) put into it
by the shareholders in return for shares. E.g. A, B and C set up a company and decide that they
will each put in 1,000 as share capital. The simplest way for this to be represented is for the
company to issue 1,000 $1 ordinary shares to each of the three shareholders. The company's
issued share capital will then be 3,000
Nature of shares
Shareholding is a complex system of joint ownership. The shareholders jointly own the
company. At the same time a share is itself an item of property which (subject to the company's
articles) can be transferred by sale or gift.
In return for investing in a company a shareholder gets a bundle of rights in the company which
may vary according to the type of shares acquired. Most companies only have one class of shares
(ordinary shares) but any classes of shares can be created. This is done by setting out the
different rights attached to the various classes (usually in the company's articles). What rights are
attached to the different classes of shares is essentially a matter for the company to determine.
The main rights which usually attach to shares are:
To attend general meeting and vote
Typically shares carry one vote each but there may be nonvoting shares or shares with multiple
votes. Some shares may carry the right to vote only in particular circumstances.
To a share of the company's profits
The distribution of profits is paid by means of a dividend of a certain amount paid on each share.
A dividend may be paid only if the company has made profits and to the extent that it decides to
distribute them.
To a final distribution on winding up
If the company is wound up and all the creditors are paid the remaining assets are available for
division among the members. This may be in two stages: (1) a return of capital; (2) distribution
of surplus capital. Some shares may be given a priority as to one or both of these.
That the company be run lawfully
i.e. in accordance with the Companies Acts, the general law and the company's constitution. In
most circumstances only the members of the company will have the legal right to sue to make
the company act lawfully.
Authorised (or nominal) capital
Under the Companies Act Malawi companies 1984
A company's authorised or nominal capital must be stated in its memorandum of association.
This is the maximum amount of share capital the company can issue (unless it goes through a
procedure to increase the figure). authorised capital is one of the items that must be included in
the memorandum. It must be stated as a sum of money divided into shares of a fixed amount, e.g.
'The company's share capital is 50,000 shares of $ 2 each amounting to $100,000'

25
 Under the 1984 Act. a private company can have an authorised capital of any amount. A public
company in Malawi must have an authored capital of at least _____________________?
The authorised capital is simply an upper limit to the amount of shares the company can issue.
There is no requirement for the company to issue all its authored capital and the figure has no
implication for the liability of the members.
E.g. a company may have an authorised capital of 250,000 shares of $1 each, but only issue,
10,000 shares.
How do people get shares in a company?
Acquisition from the company
When shares are created they are 'allotted' or 'issued' to those people or other companies who
become the company's shareholders.
(The terms 'allot' and 'issue' are often used interchangeably. Allotment, strictly, is the allocation
of the right to certain shares to particular applicants for them. Such 'allottees' may be sent
allotment letters (which may be renounceable in favour of others), and the actual issue of the
shares occurs later. In most private companies allotment and issue will be the same process.)
Allotments are made by the directors, but there are various statutory rules and procedures which
must be complied with, as well as any provisions in the company's memorandum and articles.
In private companies the allotment will be a private arrangement between the company and those
who invest in it. A public company may make the issue through the Stock Exchange or on the
Alternative Investment Market.
Acquisition from an existing shareholder
Subject to such restrictions as appear in the company's memorandum and articles, a shareholder
may sell his or her shares to another person or give them away. A sale or gift will be a transfer of
the shares
If a shareholder dies, there is said to be a 'transmission' of the shares
Pre-emptive rights
Pre-emptive rights (or rights of pre-emption) are any rights shareholders may have to be offered
shares in a company before they are made available to anyone else. They can arise on the
allotment, transfer or transmission of shares. Such rights may be important to ensure that a
shareholder's proportion of the voting and other rights in the company are not diluted.
Can a company buy its own shares?
This used to be completely prohibited. Now it is permitted subject to quite restrictive and
detailed rules.
The problem with companies buying their own shares is that, if completely unrestricted, there is
a danger that creditors (and potential creditors) may be misled as to the size of the company's
capital. This is part of the wider area of maintenance of capital.
1. One way is for the company to create redeemable shares and then redeem them. This has long
been permitted and redeemable preference shares are quite common. Redemption is subject to
the rules on finance mentioned below.
2. Shares may be bought back as part of a reduction of capital sanctioned by the court under
In practice, redeemable shares and off-market purchases by private companies are reasonably
commonplace. The off-market purchase is useful where a director/shareholder of a successful
private company is retiring and selling out his interest, or as a means of buying out a dissenting
shareholder. Purchase by the company is an alternative to purchase by the other shareholders in
the company. The off-market purchase is also used as part of some management buyouts.

SHARE CAPITAL

26
Shareholders
 Owners of a company.
 They have purchased share that the company has issued, either at date of incorporation or
at a later date.
 The founding members of the company are known as ‘subscribers’, and their details
must be recorded in the Register of Members.

Shares can also be purchased when a company issues a ‘Prospectus’

If you wish to purchase shares through the company’s prospectus, the application form and the
payment must be returned to the company.
Share Capital
Refers to the shares issued and paid for by its shareholders.
Is also known as paid up capital ,owners’ equity or share equity.
Issue price of shares
The company directors place a value on the issuing price of the shares based on a number of
factors:- - maximisation of investors wealth
- the market price of the existing shares
- expectation of future profits and dividends
- the desired volume of share to be purchased
It is usual for company’s to have the same type shares issued at various prices.

Uncalled and Paid-Up Capital

When shares are issued there are usually conditions placed on their payment.
Shares can be:
 Issued and paid in full (Paid Up Capital)
 Issued and partly paid, with balance payable in the future
CALLS
- amounts owing are known as CALLS
- amount not required for payment is UNCALLED
PAID UP CAPITAL = SHARES ISSUED X AMOUNT REQUIRED TO BE PAID

Different classes of shares

Companies may have different classes of shares, and this is done for several different reasons.
Any company can create different classes of shares by setting out those classes and the rights
attached to them in the company's articles. If a company has only one class of shares they will be
ordinary shares and will carry equal rights.
Different classes of shares within a company can carry identical rights, but very often have
different voting, dividend and/or capital rights. This is done for different reasons. Sometimes it is
to attract a particular investor, e.g. by giving him or her preference shares. In other cases, shares
are given to family members or employees so that dividends may be paid to them, because in
many cases that is a more tax-efficient means of making payments. In such cases, the owners of
the company may want to restrict the rights attached to such shares, e.g. by making them
nonvoting, and perhaps by making it possible to take the shares back if circumstances change. In
some companies, identical classes of shares are issued to different people, and the articles
provide that the directors may vary the dividends between the different classes.

27
The following are descriptions of some typical classes of shares.
Redeemable non-voting shares (Stock Options)
Widely used to award to employees so that some of their remuneration can be paid as dividends,
which can be more tax-efficient for the company and the employee. In other ways, the shares
may be of limited value. Not only will they be non-voting but the directors are usually
empowered to redeem the shares (take them back) at their nominal value (usually £1 per share) at
any time. This is a useful power if the employee leaves, or if the company is sold.
Preference shares
These will usually have a preferential right to a fixed amount of dividend, expressed as a
percentage of the nominal (par) value of the share, e.g. a 10,000 7% preference shares of $1 each
will carry a dividend of 7cents each year. It is, however, still a dividend and payable only out of
profits. The dividend may be cumulative (i.e. if not paid one year then accumulates to the next
year) or non-cumulative. The presumption is that it is cumulative. The dividend is usually
restricted to a fixed amount, but alternatively the preference share may be participating, in which
case it participates in profits beyond the fixed dividend under some formula.
Preference share are often nonvoting (or nonvoting except when their dividend is in arrears).
They may be given a priority on return of capital. Often they will not be entitled to share in
surplus capital.
Ordinary shares
The holders of ordinary shares must wait until the preference shareholders have been allocated
their dividend before they can receive any share of the profits.
Ordinary shareholders carry voting rights and they are effective owners of the company.

Deferred Shares
These shareholders are usually the last class to receive any dividend payment.

When accounting for the issue of each class of share, it important that they are identified
separately in the company’s accounts.

ACCOUNTING ENTRIES FOR ISSUING SHARE CAPITAL

Share capital issued by prospectus
The accounting for this issue depends on how many shares the directors wish to issue and how
there are to be paid for. The accounting follows the procedure of:-
1. Receipt of Application
[Link] of shares to successful shareholders
3. Refund of any unsuccessful applicants money
4. Record any amounts owing on allotment
5. Receipt of outstanding allotments
6. Record any amounts owing on call
7. Receipt of call amounts
7. Identify and account for any ‘Calls in Arrears’
COSTS ASSOCIATED WITH A SHARE ISSUE
Any costs which are associated directly with the preparation and publication of a prospectus, its
lodgement with the Registrar of Companies in Malawi, as well as the receipting of application
money and the issuing of shares need to separately identified and allocated against share equity.
These costs include:-

28
  Professional advisor fees Underwriting costs.
 Brokerage fees
They can be grouped together in the accounts are known as either:
 Share issue expenses
 Underwriting commission expenses
 Brokerage expenses, or Transaction costs
Debt Instruments: Debentures
Are long term debts instruments used by large companies to obtain funds. it is not secured by any
physical asset. a debenture certificate of acceptance of loans which is given under the company's
stamp and it carries an undertaking that the debenture holder will get a fixed return(fixed on the
basis of interest rates)and the principle amount whenever the debenture matures.

11
TERMINOLOGY
Bookbuilding
Investment bankers solicit bids, or an indication of interest for shares, from institutional investors
prior to pricing an equity issue.
This indication may include a bid for quantity and maximum price for the shares .
The investment banker sets the issue price based on investors indication of interest, supply and
demand for the shares to be issued.

Stapled Securities
Is an arrangement where different securities are quoted jointly.
Joint quotations on stapled securities means that they cannot be traded separately, as the stapled
security is treated as one unit.
Stapled Security may be :
Different classes of security issued by the same
company. Shares issued by a company and units issued
by trust.

Accounting for share issue

Shares payable in full on application
1000 ordinary shares with a nominal value (par) of $4 each are issued by company X.
Applications together with the necessary money are received for exactly 1000 shares. The shares
are then allotted to the applicants. The following are the necessary accounting entries:

Dr Bank Cr
1000 Ordinary shares of $4 each (1) $4000

29
Dr Ordinary Share Application
Cr
Ordinary share capital (2) $4000 Bank (1)
$4000

Dr Ordinary Share Capital

Cr
Ordinary share applications (2)
$4000
(1) Represents the offer by the applicant in terms of sending application money to the company
(2) Is the acceptance of the applications by the company.
Shares issued at a premium
1000 ordinary shares with nominal value of $4 each are to be issued for $10 each. This means a
premium of $6 per share has been charged. Assuming applications and the money are received
for exactly 1000 shares, the following accounting entries are made:
Dr Bank
Cr
1000 Ordinary shares of $4 each (1) $10,000

Ordinary share capital (2) $4000

Bank (1)
Share premium (3) $6000
$10,00
$
10,000 $ 10,00
Dr Ordinary Share Application
Cr
0
0

Dr Ordinary Share Capital

Cr
Ordinary share applications (2)
$6000

Dr Share Premium
Cr
Ordinary share applications (3)
$6000

30
Example
Alpha Ltd was incorporated on 1 July 2005. On this day a prospectus was issued calling for
applications for 75,000 shares at an issue price of $3. The shares were payable $1 on application
and $1 on allotment the balance in two years’ time.
Applications closed on 1 August 2005 with the receipt by the company of $76,000 for 76 000
shares.
1. Receipt Of Cash
Dr Bank 76,000
Cr Application 76.000

The shares were allotted on 15 August, with the $1 000 oversubscription being refunded
to the unsuccessful shareholders.

2. Return Oversubscription
a. Dr Application 1,000
Cr Bank
1,000 b. Dr Application
75,000
Cr Share Capital 75,000

All allotment monies received by 31 August.

4. Receipt Of Allotment
a. Dr Bank 75,000
Cr Allotment
75,000 b. Dr Allotment 75,000
Cr Share Capital 75,000
A call of $1 was made on 1 August 2007. All call money except that payable on 2,000 shares
was received by 30 September except that payable on 2,000 shares
Call
a. Dr Call Account
75,000 Cr Share
Capital 75,000 b. Dr
Bank 73,000
Cr Call Account 73,000
Capital or Finance section of the balance sheet will appear as follows
ALPHA LTD
BALANCE SHEET AS AT XX/XX/XX
SHARE CAPITAL & RESERVES
SHARE CAPITAL
75,000 SHARES called to $3 225,000
LESS- CALLS IN ARREARS 2,000
2,000 Shares @ $1

31
 223,000

Balance sheet extract of a limited company

Net assets 127,000
Financed by:
Share Capital and Reserves
Authorised Share Capital
100,000 Ordinary Shares of $1 each $100,000
20,000 6 % Preference shares of $1 each 20,000
Issued and fully paid:
50,000 Ordinary shares of $1 each 50,000
20,000 6% Preference shares of $1 each 20,000
Reserves
Share premium reserve 12,000 General
reserve 20,000 Retained profit
25,000
127000

Practice question
Jay Jay Limited has an authorised share capital of 120,000 ordinary shares of $1.00 each and
30,000 10% preference shares of $1.00 each. The following balances were extracted from the
books for the year ended 31 March 2002.
Dr Cr
$ $
General reserve 82,200
Issued Shared capital (100,000 ordinary shares) 100,000
30,000 10% Preference Shares 30,000
Salaries & Wages 18,000
General expenses 2,000
Plant & Machinery at cost 80,000
Furniture & Fittings at cost 17,000
Stock at 1 April 2001 35,000
Profit and Loss Account at 1 April 2001 17,000
Accumulated Depreciation
Plant & Machinery 8,000
Furniture and Fittings 3,000
Rates 8,000
Insurance 4,000
Carriage Inwards 600
Purchases 50,000
Sales 160,000
Discount allowed 200
Interim Preference Share Dividend 1500

32
 Interim Ordinary Share dividend 5100
Discount Received 700
Bad debts written off 500
Creditors 27,000
Debtors 28,000
Provision for bad debts 6,000
Freehold land 200,000
Cash in Hand 1,000
Bank overdraft 14,000
Share premium 3,000
Totals 450,000 450,000
Additional Information
a) Stock at 31 March 2002 was $20,000
b) Provision should be made for payment of a final dividend of 20% on ordinary shares and the
balance of the preference share dividend.
c) The general reserve is to be increased to $90,000
d) Provide for depreciation as follows: Plant and equipment 10% on cost, and Furniture and
Fittings 5% on reducing balance.
e) Taxation for the year is $10,000
Required
Prepare a Trading, profit and loss account and a balance sheet for the year ended 31 March 2002

CHAPTER 3: ACCOUNTS FOR SPECIALISED TRANSACTIONS

3.1 Clubs and Societies

Clubs and Societies are categorized as non-trading organisations. They do not exist to make profit, however
they still do keep records of accounting in order to manage their activities. When income is matched against

33
expenditure, the difference is referred to as surplus or deficit rather than profit or loss. The statement
prepared to determine a surplus or deficit is known as income and expenditure account rather than profit and
loss account. The capital or proprietorship of the organisation is referred to as the accumulated fund rather
than the capital account.
Sources of income for the non-trading organisation or club
1. Membership subscriptions, and an initial joining fee
2. Donations
3. An income generating project (“profits” from bar sales)
4. Interest received from an investment
5. Fund raising event
Bar trading account
If a club has a bar or cafeteria , a separate trading account will be prepared for its trading activities. A bar
trading account will consist of:
a. Bar takings
b. Opening stock of goods, purchases, and closing stock of goods ( to give the cost
of bar sales.)
c. Direct expenses of running the bar, resulting in net profit from the bar.
Comparison of items included in financial statements for a profit making entity and a nontrading
organisation such as a church, a sports club.
Profit Making Firm Non-profit Making Firm

1. Cash Book 1. Receipts and Payment Account

2. Trading and Profit and Loss Account 2. Income and Expenditure account
(Sometimes, there is a Trading / Bar trading /
Refreshment account)

3. Net Profit 3. Surplus (of Income Over Expenditure)

4. Net Loss 4. Deficit (Excess of Expenditure over Income)

5. Capital 5. Accumulated Fund

Balance Sheet and adjustments e.g. depreciation, provision for bad debts, accrued / prepaid expenses,
accrued / prepaid income (specifically and usually called subscription in arrears / in advance) remain the
same.
Example
The following trial balance of Haven Golf Club was extracted from the books as on 31 December 2008:
Dr Cr
$ $
Clubhouse 21,000
Equipment 6,809

34
 Profits from raffles 4,980
Subscriptions received 18,760
Wages of bar staff 2,809
Bar stocks (01/01/2008) 1,764
Bar purchases and sales 11,658 17,973
Greenkeeper’s wages 7,698
Golf professional’s salary 6,000
General expenses 580
Cash at bank 1,570
Accumulated Fund (01/01/2008) 18,175
59,888 59,888
Additional information
i. Bar purchases and sales were on a cash basis. Bar stocks at 31 December 2008 were
valued at $989.
ii. Subscriptions paid in advance by members at 31 December 2008 amounted to $180. iii.
A provision is to be made for depreciation of equipment amounting to $760.

Required

a) Draw up the bar trading account for the year ended 31 December 2008
b) Draw up the income and expenditure account for the year ended 31 December 2008, and
a balance sheet as at that date.

Solution

Haven Golf Club Bar Trading Account Year Ended 31 December 2008
$ $
Sales 17,973
COST OF SALES
Opening stock 1,764
Purchases 11,658
13,422
Closing stock ( 989) 12,433
GROSS PROFIT 5,540
Wages of bar staff (2,809)
Profit from Bar (Income & Expenditure) 2731
Haven Golf Club Income and Expenditure Account for the Year Ended 31 December 2008
$ $
INCOME
Subscriptions (18,760 -180) 18,580
Profits from raffles 4,980
Profit from bar 2,731

35
 26,291
EXPENDITURE
Greenkeeper’s wages 7,698
Golf professionals salary 6,000
General expenses 580
Depreciation : Equipment 760 15,038
SURPLUS OF INCOME OVER EXPENDITURE 11,253

Haven Golf Club Balance Sheet as at 31 December 2008

$ $ $
FIXED ASSETS Cost Dep. NBV
Clubhouse 21,000 21,000
Equipment 6,809 760 6,049

27,809 760 27,049

CURRENT ASSETS
Bar stock 989
Bank Balance 1,570

2,559
CURRENT LIABILITIES
Subscriptions received in advance (180)
NET CURRENT ASSETS 2,379
29,428
ACCUMULATED FUND
Balance brought forward 18,175
Surplus of income over expenditure

36
Club Accounts: Income and expenditure Account example

37
 This shows that the same account can be prepared in a more useful vertical format.

Practice question.
Question in Frank Wood page 453:
The following is a summary of the receipts and payments of the Miniville Rotary Club during the year ended
31 July 1999.
Miniville Rotary Club
Receipts and Payments Account for the year ended 31 July 1999

38
 Cash and Bank balance b/d 210 Secretarial expenses 163
Sales of competition tickets 437 Rent 1,402
Members’ subscriptions 1,987 Visiting speakers’ expenses 1,275
Donations 177 Donations to charities 35
Refund of rent 500 Prizes for competitions 270
Balance c/d 13 Stationery and printing 179

$3,324
$3,324
The following are also available:
As at 31 July 1998
1999
$ $
Equipment(original cost $1420) 975 780
Subscriptions in arrears 65 85
Subscriptions in advance 10 37
Owing to suppliers of competition 58 68
prizes
Stocks of competition prizes 38 46
Required
a) Calculate the value of the accumulated fund of the Miniville Rotary Club as at 1 August
1998
b) Prepare the following accounts for the year ended 31 July 1999
-the subscriptions account -the competition prizes account
c) Prepare the income and expenditure account for the Miniville Rotary Club for the year
ended 31 July 1999 and a Balance Sheet as at that date.
3.2 Imprest/petty cash
3.2.1Accounting for Petty cash
The Cash Book became a book of original entry so that all cash and bank transactions could be separated
from the rest of the accounts in the General Ledger. It is for much the same reason that many organisations
use a Petty Cash Book. Every business has a number of transactions of very small value which, were they all
recorded in the Cash Book, would only serve to make it more difficult to identify the important transactions
that businesses need to keep a close eye upon. Just like the Cash Book, the Petty Cash Book is both a book
of original entry and a ledger account.
The advantages of using a Petty Cash Book can be summarised as follows:
 The task of handling and recording small cash payments can be given by the cashier (the person
responsible for recording entries in the Cash Book) to a junior member of staff. This person is known
as the ‘Petty Cashier’. The cashier, who is a more senior and, consequently, higher paid member of
staff would be saved from routine work.
 If small cash payments were entered into the main Cash Book, these items would then need posting
one by one to the ledgers. For example, if travelling expenses were paid to staff on a daily basis, this
could mean approximately 250 postings to the staff travelling expenses account during the year, i.e.
5 days per week × 50 working weeks per year. However, by using a Petty Cash Book, it would only

39
 be the monthly totals for each period that need posting to the General Ledger. If this were done, only
twelve entries would be needed in the staff travelling expenses account instead of approximately
250.
When a petty cashier makes a payment to someone, then that person will have to fill in a voucher showing
exactly what the payment was for. They usually have to attach bills, e.g. for petrol, to the petty cash voucher.
They would sign the voucher to certify that their expenses had been received from the petty cashier.

3.2.2 The imprest system

It is all very well having a Petty Cash Book but, where does the money paid out from it come from? The
imprest system is one where the cashier gives the petty cashier enough cash to meet the petty cash needs for
the following period. Then, at the end of the period, the cashier finds out the amounts spent by the petty
cashier, by looking at the entries in the Petty Cash Book. At the same time, the petty cashier may give the
petty cash vouchers to the cashier so that the entries in the Petty Cash Book may be checked. The cashier
then passes cash to the value of the amount spent on petty cash in the period to the petty cashier. In other
words, the cashier tops up the amount remaining in petty cash to bring it back up to the level it was at when
the period started. This process is the imprest system and this topped-up amount is known as the petty cash
float.

Example1 K
Period 1 The cashier gives the petty cashier 100
The petty cashier pays out in the period ( 78)
Petty cash now in hand 22
The cashier now gives the petty cashier the amount spent 78
petty petty cash in hand at the end of Period 1 100
Period 2 The petty cashier pays out in the period ( 84)
Petty cash now in hand 16
The cashier now gives the petty cashier the amount spent 84
Petty cash in hand at the end of Period 2 100

It may be necessary to increase the petty cash float to be held at the start of each period. In the above case, if
we had wanted to increase the float at the end of the second period to £120, then the cashier would have
given the petty cashier an extra k20, i.e. k84 +k20 =k104. In some small organisations, no Petty Cash Book
is kept. Instead, at the end of each period, the amount left in petty cash is reconciled (i.e. checked and
verified as correct) with the receipts held by the petty cashier. The amount spent is then given to the petty
cashier in order to restore the float to its agreed level. However, this is not an ideal method to adopt.
Businesses need to control the uses of all their resources, including petty cash, and so virtually every
organisation that operates a petty cash float maintains a Petty Cash Book. The most common format adopted
is the ‘analytical petty cash book’.
Illustration of an analytical petty cash book
An analytical petty cash book is shown in Example 1. This example shows one for an elementary school.

Petty Cash Book (page 31)

40
Recei f Date Detail Vouc Tot Motor Staff Posta cleani Ledg Ledge
pts o s her al Expen Travell ges ng er r
l No ses ing folio accou
i expens nts
o es
£ £ £ £ £ £ £ £
300 C Sep 1 Cash 16
B “ 2 Petrol 1 16
1 “ 3 J 2 23 23
9 “ 3 Green 3 12 12
“ 4 Posta 4 32 32
“ 7 ge 5 11 11
“ 9 D 6 21 21
“ 12 davies 7 13 13
“ 14 Cleani 8 23 23
“ 15 ng 9 5 5
“ 16 Petrol 10 11 11
“ 18 K 11 22 22
“ 20 Jones 12 12 12
“ 22 Petrol 13 11 11
“ 24 L 14 7 7
“ 27 Black 15 13 PL1 13
“ 29 Cleani 16 12 12 8
ng 244 82 80 36 33 13
Petrol
Posta
ge
244 “ 30 Cleani GL GL GL GL
“ 30 ng c/d 300 17 29 44 64
544 G 544
300 C Oct 1 Wood b/d
B C
2 Brow
2 n
Posta
ge

Cash
Balan
ce
Balan
ce

41
The Receipts Column is the debit side of the Petty Cash Book. On giving £300 to the petty cashier on 1
September, the credit entry is made in the Cash Book while the debit entry is made in the Petty Cash Book.
A similar entry is made on 30 September for the £244 paid by the headteacher to the petty cashier. As this
amount covers all the expenses paid by the petty cashier, the float is now restored to its earlier level of £300.
The credit side is used to record all the payments made by the petty cashier. The transactions that were
recorded in the Petty Cash Book were:

20X8
Sept £
1 The headteacher gives £300 as float to the petty cashier
Payments out of petty cash during September:
2 Petrol: School bus 16

3 J Green travelling expenses of staff 23

3 Postage 12
4 D Davies travelling expenses of staff 32
7 Cleaning expenses 11
9 Petrol: School bus 21

42
 12 K Jones – travelling expenses of staff 13
14 Petrol: School bus 23
15 L Black – travelling expenses of staff 5
16 Cleaning expenses 11
18 Petrol: School bus 22
20 Postage 12
22 Cleaning expenses 11
24 G Wood – travelling expenses of staff 7
27 Settlement of C Brown’s account in the Purchases Ledger 13
29 Postage 12
30 The headteacher reimburses the petty cashier the amount spent in the month.
The process followed during the period that led to these entries appearing in the Petty Cash Book as shown
in Example 2 is:
1 Enter the date and details of each payment. Put the amount paid in the Total column.
2 Put the same amount in the column for that type of expense.
3 At the end of each period, add up the Total column.
4 Add up each of the expense columns. The total found in step 3 should equal the total of all the expense
columns. In Example 2 this is £244.
5 Enter the amount reimbursed to make up the float in the Receipts column.
6 Balance off the Petty Cash Book, carrying down the petty cash in hand balance to the next period.
To complete the double entry for petty cash expenses paid:
1 The total of each expense column is debited to the appropriate expense account in the General Ledger.
2 The Folio Number of each expense account in the General Ledger is entered under the appropriate expense
column in the Petty Cash Book. (This signifies that the double entry to the ledger account has been made.)
3 The last column in the Petty Cash Book is a Ledger column. It contains entries for items paid out of petty
cash which need posting to a ledger other than the General Ledger. (This might arise, for example, if a
Purchases Ledger account was settled out of petty cash.)
3.2.3Bank/cash book
Nowadays, many businesses have only a small number of sales that are paid for with cash. The rest of the
‘cash’ sales are actually paid using credit cards, cheques, and direct transfers into the business bank account
using systems like Switch. Switch is used in retail transactions and results in the payment being transferred
immediately from the customer’s bank account into the business bank account.
Organisations which have only a small number of sales for cash may use a different form of Cash. If they do,
they will use a Petty Cash Book and a Bank Cash Book. The Bank Cash Book is given this name because all
payments in cash are entered in the Petty Cash Book, and the Bank Cash Book contains only bank columns
and discount columns.

In a Bank Cash Book (it could also be done in an ‘ordinary’ Cash Book), an extra column may be added. The
extra column would show the details of the cheques and direct transfers banked, with just the total of the
banking being shown in the total column

43
 SUMMARY
You should now have learnt:
1That the Petty Cash Book saves (a) the Cash Book and (b) the ledger accounts
from containing a lot of trivial detail.
2That the use of the Petty Cash Book enables the cashier or a senior member of
staff to delegate this type of work to a more junior member of staff.
3That the cashier should periodically check the work performed by the petty cashier.
4That all payments made by the petty cashier should have petty cash vouchers as
evidence of proof of expense.
5How to enter petty cash transactions into the Petty Cash Book.
6How to transfer the totals for each expense recorded in the Petty Cash Book to
the appropriate ledger accounts.
8The difference between a Cash Book and a Bank Cash Book.
9Why some organisations use a Bank Cash Book instead of a Cash Book

3.3 joint ventures

Nature of joint ventures

Sometimes a particular business venture can best be done by two or more businesses joining together to do it
instead of doing it separately. The joining together is for that one venture only, it is not joining together to
make a continuing business. Such projects are known as joint ventures. For instance, a merchant might
provide the capital, the transport to the markets and the selling skills. The farmer grows the produce. The
profits or losses are then shared between them in agreed ratios. It is like a partnership, but only for this one
transaction. There may be several joint ventures between the same businesses, but each one is a separate
venture. The agreements for each venture may be different from each other.
Accounting for large joint ventures
For large-scale or long-term joint ventures, a separate bank account and separate set of books are kept. In
such cases the calculation of profit is not difficult. It is similar to preparing a set of financial statements in an
ordinary business.
Accounting for smaller joint ventures
No separate set of books or separate bank accounts are kept for smaller joint ventures. Each of the parties
will record in their own books only those transactions with which they have been concerned. Exhibit 1 gives
an example of such a joint venture.
Example1

44
White of London and Green of Glasgow enter into a joint venture. White is to supply the goods and pay
some of the expenses. Green is to sell the goods and receive the cash, and pay the remainder of the expenses.
Profits are to be shared equally.
Details of the transactions are as follows:
K
White supplied the goods costing 1,800
White paid wages 200
White paid for storage expenses 160
Green paid transport expenses 120
Green paid selling expenses 320
Green received cash from sales of all the goods 3,200
Stage 1
White and Green will each have entered up their own part of the transactions. White will have opened an
account named ‘Joint Venture with Green’. Similarly, Green will have opened a ‘Joint Venture with White’
account. The double entry to these joint venture accounts will be:
In White’s books:
Payments by White: Debit joint venture with Green
Credit Cash Book
Goods supplied to Green: Debit joint venture with Green
Credit purchases

In Green’s books:
Payments by Green: Debit joint venture with White
Credit Cash Book
Cash received by Green: Debit Cash Book
Credit joint venture with White

At this point the joint venture accounts in each of their books will appear as follows:
White’s books (in London):
Joint Venture with Green

K
Purchases 1,800
Cash: wages 200
Cash: storage expenses 160

Green’s books (in Glasgow):

Joint venture with white

K K
Cash: transport expenses 120 Cash: sales 3200
Cash: selling expenses 320

45
Stage 2
At this stage, White and Green know only the details in their own set of books. They do not yet know what
the details are in the other person’s books. This means that they cannot yet calculate profits, or find out how
much cash has to be paid or received to close the venture. To do this they must each send a copy of their
joint venture accounts to the other person. Each person will then draw up a memorandum joint venture
account, to include all the details from each joint venture account. The memorandum joint venture account is
not a double entry account. It is drawn up only (a) to find out the shares of net profit or loss, and (b) to help
calculate the amounts payable and receivable to close the venture. White and Green’s memorandum joint
venture account is now shown:

White and Green

Memorandum Joint Venture Account

K K K
Purchases 1,80 Sales 3,200
Wages 200
Storage expenses 160
Transport expenses 120
Selling expenses 320
Net profit:White (one-half) 300
Green (one-half) 300 600
3 3,200 0
3,200

Note: The profit is the difference between the two sides of the account. You find out what the balancing
figure is; in this case, it is £600. Then you split it in the profit sharing ratio. In this case, profits are shared
equally. White and Green, therefore, each receive half the profit, £300 each. Now you enter the figures, £300
to White, £300 to Green, and the total of £600, which balances and closes off the account.
Stage 3
The net profit shares for White and Green need to be brought into their own books. This is done as follows:
White’s books:
Debit share of profit to Joint Venture with Green account
Credit White’s profit and loss account
The Joint Venture account in White’s books now looks like this:
White’s books (in London):
Joint venture with green

K
Purchases 1,800
Cash: wages 200
Cash: storage expenses 160
Share of profit transferred to profit
and loss account 300
You then do the same in Green’s books:
46
Green’s books:
Debit share of profit to Joint Venture with White account
Credit Green’s profit and loss account
Green’s books (in Glasgow):
Joint Venture with White

K K
Cash: transport expenses 120 Cash: sales 3,200
Cash: selling expenses 320
Share of profit transferred to profit
and loss account 300

It won’t come as a surprise to see that you have now copied the profit share entries from the Memorandum
Joint Venture account into the Joint Venture accounts held by White and Green. Now you need to balance
off the two Joint Venture accounts:

White’s books (in London):

Joint Venture with Green

K K
Purchases 1,800 Balance c/d 2,460
Cash: wages 200
Cash: storage expenses 160
Share of profit transferred to profit
and loss account 300
2,460 2,460
Balance b/d 2,460

Green’s books (in Glasgow):

Joint Venture with White

K K
Cash: transport expenses 120 Cash: sales 3,200
Cash: selling expenses 320
Share of profit transferred to profit
and loss account 300
Balance c/d 2,460
3,200 3,200
Balance b/d 2,460

Finally, the parties in the joint venture need to settle their debts to each other. They know whether they are to
pay money or receive money when they look at the side of their copy of the joint venture account and see
whether the balance is a debit or a credit:
(a) If the balance brought down is a credit balance, money is owing to the other party in the joint venture. In
this case, Green owes White the amount shown by the credit balance, K2,460.
47
(b) If the balance brought down is a debit balance, money is due from the other party in the joint venture. In
this case White is owed the amount of the balance, K2,460 by Green.
The payment is now made by Green to White and the final entry is made in each of the joint venture
accounts, closing off the accounts.

White’s books (in London):

Joint Venture with Green

K K
Purchases 1,800 Balance c/d 2,460
Cash: wages 200
Cash: storage expenses 160
Share of profit transferred to profit
and loss account 300
2,460 2,460
Balance b/d 2,460 Cash in settlement from Green 2,460

Green’s books (in Glasgow):

Joint Venture with White

K K
Cash: transport expenses 120 Cash: sales 3,200
Cash: selling expenses 320
Share of profit transferred to profit
and loss account 300
Balance c/d 2,460
3,200 3,200
Cash in settlement to White 2,460 Balance b/d 2,460

48
SUMMARY
You should now have learnt:
1That when two or more businesses join together for a particular business
venture, and do not form a permanent business entity, they have entered into a
joint venture.
2That larger and long-term joint ventures operate a separate bank account and
books dedicated to the project.
3That the participants in smaller joint ventures rely on their own bank accounts
and books to run and record their part of the project, using a memorandum joint
venture account to pass the details of their part of the project to the other
participant(s).
4Why separate joint venture accounts are kept by each party to smaller and short term joint
ventures.

49
 Chapter 4: Financial Analysis (Ratios, Horizontal & Vertical)
Financial Statement Analysis
• To make informed decisions about company
• Generally based on comparative financial data
– From one year to the next
– With another company
– With the industry
2
Copyright © 2007 Prentice-Hall. All rights reserved

Horizontal Analysis
• Compares two financial statements to determine dollar and
percentage changes
– Compute dollar changes
– Compute percentage changes = dollar change divided
by base period amount
4
Copyright © 2007 Prentice-Hall. All rights reserved

Horizontal Analysis
2007 2006 Difference
Net sales $430,000 $373,000 $57,000

$57,000 $373,000 = .153 or 15.3%

Charley Theron Taxis, Incorporated

Horizontal Analysis of Comparative Income Statement
Years Ended December 31, 2007 and 2006
Incr.(Decr.)
2007 2006 AMT %
Total revenues $430,000 $373,000 $57,000 15.3%
Expenses:
Cost of goods sold 230000 200000
Selling & gen expenses 100000 50000
Other expenses 50000 25000

50
 Copyright © Total expenses 2007 Prentice-Hall.
All rights Net income reserved 5

Horizontal Analysis Copyright © 2007

Prentice- Hall. All rights
6
reserved

Vertical Analysis
• Shows relationship of each item to a base amount on financial
statements
• Income statement – each item expressed as percentage of net
sales
• Balance sheet – each item expressed as percentage of total
assets
Copyright © 2007 Prentice-Hall. All rights reserved 14

Alpha Graphics, Inc.

Vertical Analysis of
Balance Sheet
December 31, 2006
ASSETS
AMT %
LIABILITIES
$ 42,000 14.8%
207,000 72.9
Total current assets 35,000 12.3
Property, plant, & $284,000 100.0%
equipment, net $ 48,000 16.9%
Other assets 108,000 38.0
Total assets 156,000 54.9
Total current liabilities 128,000 45.1
Long-term debt $284,000 100.0%
Total liabilities 17

STOCKHOLDERS’ EQUITY
Total stockholders’ equity
Total liabilities & stockholders’ equity
Copyright © 2007 Prentice-Hall. All rights reserved
Common-Size Statements
• Reports only percentages
51
 • Useful when benchmarking a company against industry averages
or key competitors
• Benchmarking – comparing a company with other leading
companies
19
Copyright © 2007 Prentice-Hall. All rights reserved

Enchanted Designs, Inc.

Comparative Common-Size Income Statement
Years Ended December 31, 2007 and 2006
2007
2006
Net Sales % % 100.0
Expenses: 50.4
Cost of goods sold 47.0 24.9
Selling and general expenses 22.8 1.1 Vertical Analysis
Other expense 1.6 76.4 What is
Total expense 71.4 Net income 28.6% 23.6% your basis?
Copyright © 2007 Prentice-Hall. All rights 22 Balance Sheet: Total
reserved Assets
Income Statement:
Net Sales (net
revenues)
1998 1997

Assets Amount Percent Amount Percent

Current Assets $ 1,311.2 $ 1,467.7
Plant assets 2,888.8 2,733.3
Other assets 800 16.0 636.6 13.0
$
Total assets 100.0% $4,877.6 100.0%
1998 1997
Amount Percent Amount Percent
Net sales $6,762.1 100.0 $6,830.1 100.0
Cost of goods sold 3,282.6 48.6
3,270.1 47.9
Gross profit 3,479.5 3,560.0
Selling & Admin. 2,513.9
2,366.8
Nonrecurring Chgs 70.5 1.0 184.1 2.7
Income operations 895.1 14.8

52
Limitations of Financial Analysis
1. Estimates: Financial statements are based on estimates, for example allowance for
uncollectible accounts, and provision for depreciation
2. Cost: Financial statements are based on historical cost and are not adjusted for price
changes.
3. Alternative Accounting Methods: One company may use LIFO while another company
in the same industry may use FIFO. If inventory is significant for both companies, it is
unlikely that their current ratios are comparable. Different costing methods also exist in
reporting such items as depreciation.

RATIO ANALYSIS
Liquidity ratios
Liquidity ratios measure the ability of a company to repay its short-term debts and meet
unexpected cash needs.
Current ratio. The current ratio is also called the working capital ratio, as working capital is the
difference between current assets and current liabilities. This ratio measures the ability of a
company to pay its current obligations using current assets. The current ratio is calculated by
dividing current assets by current liabilities.

20X1 20X0

Current assets $38,366 $38,294

Current liabilities 27,945 30,347

Current ratio 1.4 : 1 1.3 : 1

This ratio indicates the company has more current assets than current liabilities. Different
industries have different levels of expected liquidity. Whether the ratio is considered adequate
coverage depends on the type of business, the components of its current assets, and the ability of
the company to generate cash from its receivables and by selling inventory.
Acid-test ratio. The acid-test ratio is also called the quick ratio. Quick assets are defined as
cash, marketable (or short-term) securities, and accounts receivable and notes receivable, net of
the allowances for doubtful accounts. These assets are considered to be very liquid (easy to
obtain cash from the assets) and therefore, available for immediate use to pay obligations. The
acid-test ratio is calculated by dividing quick assets by current liabilities.

53
 20X1 20X0

Cash $6,950 $6,330

Accounts receivable, net 18,567 19,230

Quick Assets $25,517 $25,560

Current Liabilities $27,945 $30,347

aAcid-test ratio .9 : 1 .8 : 1

The traditional rule of thumb for this ratio has been 1:1. Anything below this level requires
further analysis of receivables to understand how often the company turns them into cash. It may
also indicate the company needs to establish a line of credit with a financial institution to ensure
the company has access to cash when it needs to pay its obligations.
Receivables turnover. The receivable turnover ratio calculates the number of times in an
operating cycle (normally one year) the company collects its receivable balance. It is calculated
by dividing net credit sales by the average net receivables. Net credit sales is net sales less cash
sales. If cash sales are unknown, use net sales. Average net receivables is usually the balance of
net receivables at the beginning of the year plus the balance of net receivables at the end of the
year divided by two. If the company is cyclical, an average calculated on a reasonable basis for
the company's operations should be used such as monthly or quarterly.

Calculation of Receivables Turnover

20X1 20X0 20W9

Net credit $129,000 $97,000

sales
Accounts 18,567 19,230 $17,599
receivable

Average (18,567+19,230)/2= (19,230+17,599)/2=

receivables
18,898.5 18,414.5

54
 Receivables $129,00/$18,898.5
$97,00/$18,414.5 =
turnover =
6.8 times 5.3 times

Average collection period. The average collection period (also known as day's sales
outstanding) is a variation of receivables turnover. It calculates the number of days it will take
to collect the average receivables balance. It is often used to evaluate the effectiveness of a
company's credit and collection policies. A rule of thumb is the average collection period should
not be significantly greater than a company's credit term period. The average collection period is
calculated by dividing 365 by the receivables turnover ratio.

20X1 20X0

Receivables Turnover 6.8 times 5.3 times

Average Collection Period 53.7 days 68.9 days

The decrease in the average collection period is favorable. If the credit period is 60 days, the
20X1 average is very good. However, if the credit period is 30 days, the company needs to
review its collection efforts.
Inventory turnover. The inventory turnover ratio measures the number of times the company
sells its inventory during the period. It is calculated by dividing the cost of goods sold by average
inventory. Average inventory is calculated by adding beginning inventory and ending inventory
and dividing by 2. If the company is cyclical, an average calculated on a reasonable basis for the
company's operations should be used such as monthly or quarterly.

Calculation of Inventory Turnover

20X1 20X0 20W9

Cost of $70,950 $59,740

goods
sold
Inventory 12,309 12,202 $12,102

Average (12,309+12,202)/2= (12,202+12,102)/2=

inventory

55
 12,255.5 12,152

Inventory
$70,950/$12,255.5= $59,740/$12,152=
turnover
5.8 times 4.9 times

Day's sales on hand. Day's sales on hand is a variation of the inventory turnover. It calculates
the number of day's sales being carried in inventory. It is calculated by dividing 365 days by the
inventory turnover ratio.

20X1 20X0

Inventory Turnover 5.8 times 4.9 times

Day's Sales on Hand 62.9 days 74.5 days

Profitability ratios
Profitability ratios measure a company's operating efficiency, including its ability to generate
income and therefore, cash flow. Cash flow affects the company's ability to obtain debt and
equity financing.
Profit margin. The profit margin ratio, also known as the operating performance ratio,
measures the company's ability to turn its sales into net income. To evaluate the profit margin, it
must be compared to competitors and industry statistics. It is calculated by dividing net income
by net sales.

20X1 20X0

Net income/(loss) $ 8,130 $(1,400)

Net sales 129,000 97,000

Profit margin 6.3% (1.4%)

56
Asset turnover. The asset turnover ratio measures how efficiently a company is using its
assets. The turnover value varies by industry. It is calculated by dividing net sales by average
total assets.

Calculation of Asset Turnover

20X1 20X0 20W9

Net sales $129,000 $97,000

Total 114,538 118,732 $102,750

assets

Average (114,538+118,732)/2= (118,732+102,750)/2=

total
assets
116,635 110,741

Asset
$129,00/$116,635= $97,00/$110,741 =
turnover
1.1 times .9 times

Return on assets. The return on assets ratio (ROA) is considered an overall measure of
profitability. It measures how much net income was generated for each $1 of assets the company
has. ROA is a combination of the profit margin ratio and the asset turnover ratio. It can be
calculated separately by dividing net income by average total assets or by multiplying the profit
margin ratio times the asset turnover ratio.

The information shown in equation format can also be shown as follows:

20X1 20X0 20X1 20X0

57
 Net income/(loss) $ 8,130 $(1,400) Profit margin 6.3% (1.4%)

Average total assets 116,635 110,741 Asset turnover 1.1 times .9 times

Return on assets 6.97% (1.3%) Return on assets 6.93% * (1.3%)

Return on common stockholders' equity. The return on common stockholders' equity (ROE)
measures how much net income was earned relative to each dollar of common stockholders'
equity. It is calculated by dividing net income by average common stockholders' equity. In a
simple capital structure (only common stock outstanding), average common stockholders' equity
is the average of the beginning and ending stockholders' equity.

Calculation of Return on Common Stockholders' Equity

20X1 20X0 20W9

Net income/(loss) $ 8,130 $ (1,400)

Total stockholders' equity 71,593 65,385 $68,080

Average stockholders' equity (71,593+65,385)/2= (65,385+68,080)/2=

68,489 66,732.5

Return on common
$8,130/$68,489= $(1,400)/$66,732.5=
stockholders' equity
11.9% (2.1%)

In a complex capital structure, net income is adjusted by subtracting the preferred dividend
requirement, and common stockholders' equity is calculated by subtracting the par value (or call
price, if applicable) of the preferred stock from total stockholders' equity.

Earnings per share. Earnings per share (EPS) represents the net income earned for each share of
outstanding common stock. In a simple capital structure, it is calculated by dividing net income
by the number of weighted average common shares outstanding.

58
Assuming The Home Project Company has 50,000,000 shares of common stock outstanding,
EPS is calculated as follows:
20X1 20X0 20W9

Net income/(loss) $ 8,130 $ (1,400)

Share outstanding 50,000 50,000 50,000

Earnings/(loss) per share $0.16 ($0.03)

Calculation notes:
1. If the number of shares of common stock outstanding changes during the year, the
weighted average stock outstanding must be calculated based on shares actually
outstanding during the year. Assuming The Home Project Company had 40,000,000
shares outstanding at the end of 20X0 and issued an additional 10,000,000 shares on July
1, 20X1, the earnings per share using weighted average shares for 20X1 would be $0.18.
The weighted average shares was calculated by 2 because the new shares were issued half
way through the year.

2. If preferred stock is outstanding, preferred dividends declared should be subtracted from

net income before calculating EPS.
Price-earnings ratio. The price-earnings ratio (P/E) is quoted in the financial press daily. It
represents the investors' expectations for the stock. A P/E ratio greater than 15 has historically
been considered high.

If the market price for The Home Project Company was $6.25 at the end of 20X1 and $5.75 at
the end of 20X0, the P/E ratio for 20X1 is 39.1.

59
 20X1 20X0

Marketing price per common share $6.25 $5.75

Earnings per share $0.16 (0.03)

P/E 39.1 N/M

Payout ratio. The payout ratio identifies the percent of net income paid to common
stockholders in the form of cash dividends. It is calculated by dividing cash dividends by net
income.

Cash dividends for The Home Project Company for 20X1 and 20X0 were $1,922,000 and
$1,295,000, respectively, resulting in a payout ratio for 20X1 of 23.6%.
20X1 20X0

Cash dividends $1,922 $1,295

Net income/(loss) 8,130 (1,400)

Payout ratio 23.6% N/M

A more stable and mature company is likely to pay out a higher portion of its earnings as
dividends. Many startup companies and companies in some industries do not pay out dividends.
It is important to understand the company and its strategy when analyzing the payout ratio.
Dividend yield. Another indicator of how a corporation performed is the dividend yield. It
measures the return in cash dividends earned by an investor on one share of the company's stock.
It is calculated by dividing dividends paid per share by the market price of one common share at
the end of the period.

20X1 20X0

Cash dividends per share $ .038 $ .026

Market price per common share $ 6.25 $ 5.75

Dividend yield 0.6% 0.5%

60
A low dividend yield could be a sign of a high growth company that pays little or no dividends
and reinvests earnings in the business or it could be the sign of a downturn in the business. It
should be investigated so the investor knows the reason it is low.
Solvency ratios
Solvency ratios are used to measure long-term risk and are of interest to long-term creditors and
stockholders.
Debt to total assets ratio. The debt to total assets ratio calculates the percent of assets
provided by creditors. It is calculated by dividing total debt by total assets. Total debt is the same
as total liabilities.

20X1 20X0

Current liabilities $27,945 $ 30,347

Long-term debt 15,000 23,000

Total debt $ 42,945 $ 53,347

Total assets $114,538 $118,732

Debt to total assets 37.5% 44.9%

The 20X1 ratio of 37.5% means that creditors have provided 37.5% of the company's financing
for its assets and the stockholders have provided 62.5%.
Times interest earned ratio. The times interest earned ratio is an indicator of the company's
ability to pay interest as it comes due. It is calculated by dividing earnings before interest and
taxes (EBIT) by interest expense.

20X1 20X0

Income before interest expense and income taxes

Income (loss) before taxes $13,550 $(2,295)

Interest expense 1,900 1,500

61
 EBIT $15,450 $ (795)

Interest Expense $ 1,900 $ 1,500

Times interest earned 8.1 times N/M

A times interest earned ratio of 2–3 or more indicates that interest expense should reasonably be
covered. If the times interest earned ratio is less than two it will be difficult to find a bank to loan
money to the business.
Financial Statement Analysis Limitations
Many things can impact the calculation of ratios and make comparisons difficult. The limitations
include:
• The use of estimates in allocating costs to each period. The ratios will be as accurate as
the estimates.
• The cost principle is used to prepare financial statements. Financial data is not adjusted
for price changes or inflation/deflation.
• Companies have a choice of accounting methods (for example, inventory LIFO vs FIFO
and depreciation methods). These differences impact ratios and make it difficult to
compare companies using different methods.
• Companies may have different fiscal year ends making comparison difficult if the
industry is cyclical.
• Diversified companies are difficult to classify for comparison purposes.
• Financial statement analysis does not provide answers to all the users' questions. In fact,
it usually generates more questions!

Unit 6: Cash Flow Statements and Analysis

Review the following financial data from two companies in the same industry. Comment on any
strengths or weaknesses you notice.

Income statements: Company A Company B

Sales .......................................................................................... $ 500,000 $500,000

Expenses .................................................................................... 425,000 425,000 Net income
................................................................................. $ 75,000 $ 75,000

Cash held:
Beginning of year ...................................................................... $ 25,000 $ 25,000
End of year ................................................................................ 25,000 25,000
Increase in cash .......................................................................... $ 0 $ 0

A detailed analysis of the cash account reveals the following cash receipts and payments:

Cash received:

62
 from customers ................................................................. $ 450,000 $
350,000 from sale of fixed assets ................................................... 5,000
60,000 Total cash received .................................................................... $ 455,000
$ 410,000 Cash paid: to suppliers ........................................................................ $
380,000 $ 400,000 for purchase of fixed assets
............................................... 70,000 10,000 for purchase of
investments .............................................. 5,000 0
Total cash paid ........................................................................... $ 455,000 $ 410,000
Increase in cash .......................................................................... $ 0 $ 0

WHY ARE CASH FLOWS IMPORTANT?

Cash is what pays the bills.

You must sell your product and collect cash from your customers in time to:

1. Pay suppliers for merchandise purchases.

2. Pay the bank on any loans.

3. Pay employees their wages.

4. Pay taxes.

5. Purchase new equipment as needed.

Analyzing where a company’s cash is coming from and where it is being spent may assist in
detecting future profit potential and/or future financial problems.

SECTIONS OF THE
STATEMENT OF CASH FLOWS
Cash Flows from Operating Activities
Report cash received and paid in the daily operations of the business, including:

1. Cash received from customers

2. Cash paid to suppliers

Cash Flows from Investing Activities

Report cash received and paid as a result of the sale and purchase of investments. The
investments reported in this section can be divided into two categories:

1. Investments in YOURSELF, for example:

a. Purchase of fixed assets
b. Sale of fixed assets
2. Investments in OTHERS, for example:
a. Purchase of equity or debt securities of another corporation

63
b. Sale of equity or debt securities held as investments
c. Making of a loan to another company
d. Collection of principal payments on a loan made to another company

Cash Flows from Financing Activities

Report cash received and paid as a result of the activities to obtain and repay funds used to
finance the operations of a company. Financing activities can be divided into two categories:
1. EQUITY financing:
a. Issuing shares of stock
b. Retiring shares of stock
c. Purchasing shares of treasury stock
d. Selling shares of treasury stock
e. Paying cash dividends on stock 2. DEBT financing:
a. Borrowing cash
b. Repaying principal on a loan
c. Issuing debentures or bonds

Schedule of Noncash Investing and

Financing Activities
Used to report transactions that are investing and/or financing activities but do not bring in or use
up any cash. These transactions need to be reported because they will affect cash flows in the
future. Examples include the following:
1. Purchasing fixed assets by signing a note payable

2. Purchasing a building through a mortgage loan

3. Exchanging Shares for fixed assets

4. Issuing shares to retire debt

5. Converting preference shares to ordinary shares

Three "Foolers"
The following transactions are reported in the operating activities section of the statement of cash
flows:
1. Interest paid on debt
Justification: The decision to finance the business through debt is a financing activity. Once that
decision has been made, the cash to pay for the interest on debt must come from operating
activities.
2. Interest received on investments 3. Dividends received
on investments
justification: The decision to use cash to purchase equity or debt securities is an investment
decision. Once that decision has been made, the cash received from interest or dividends is
used to operate the business.

64
 CASH FLOWS FROM OPERATING
ACTIVITIES—INDIRECT METHOD
(Also Known as the "Reconciliation Method")
Net income (from Trading, Profit & Loss Account) ............................................................
$ XXX
+ Non-cash expenses (depreciation,
Amortisation, and depletion) ........................................................................................
XXX
+/– Losses or gains on investing or
Financing activities ......................................................................................................
XXX
+/– Changes in current asset and
current liability accounts
related to operating
activities ....................................................................................................................... XXX
Net cash flows from operating activities .............................................................................. $
XXX

Bowling Company
Trading, Profit and Loss Account
For the year Ended 31 December 2004
Sales $1,100,000
Less Cost of goods sold 710,000
Gross profit 390,000
Operating expenses:
Depreciation expense $23,500
Patent amortization 7,000
Other operating expenses 196,000
Total operating expenses 226,500
Income from operations $163,500
Other income:
Gain on sale of $11,000
investments

65
Other expenses:
Interest expense 26,000 (15,000)
Income before tax $148,500
Income tax expense 50,000
Net Income 98,500

66
Bowling Company Comparative Balance Sheet31 December 2004 and 2003

2003

$95,900

102,300
ASSETS 2004 157,900
Cash 260,000
Accounts Receivable/ Debtors $140,350 (58,300) 5,860
Stock 95,300 428,300 84,700
Prepaid expenses 165,200 (138,000) 90,000
Long-term Investment 6,240
Land 35,700 201,700
Buildings 75,000
Accumulated depreciation 375,000 290,300
Machinery and Equipment (71,300) 303,700 65,000
Accumulated depreciation 428,300 $1,093,660
Patents (148,500) 279,800
Total Assets 58,000
Liabilities and Shareholders’ $1,159,290 $46,700
Equity 12,500
Creditors / Accounts payable $43,500 8,400
Accrued expenses 14,000 10,000
Income taxes payable 7,900 0
Dividends payable 14,000 250,000
Note payable, due 2004 40,000 375,000
Bonds payable 150,000
Ordinary Shares of $30 par 450,000 41,250
Share premium 66,250
Retained earnings 373,640 349,810
Total Liabilities & Equity $1,159,290 $1,093,660

Additional information applicable to 2004

a. Land costing $15,000 was sold for $15,000.
b. A loan or note was issued for $40,000.
c. A building costing $115,000 was constructed.
d. 2,500 ordinary shares were issued at 40 in exchange for bonds payable
e. Cash dividends were $74,670

67
Required
Prepare a statement of cash flows using the indirect method.

Solution

Bowling Company
Statement of Cash Flows-Indirect Method
For the year ended 31 December 2004
Cash flows from operating activities:
Net income per income statement $98 500
Add: Depreciation $23 500
Amortisation of patents 7 000
Decrease in debtors 7 000
Increase in accrued expense 1 500 39 000
137 500
Deduct: Increase in stock 7 300
Increase in prepaid expenses 380
Decrease in Creditors 3 200
Decrease in income tax 500
payable
Gain on sale of investment 1 100 22 380
Net Cash flow from operating $115,120
activities
Cash flow from investing activities
Cash received form sale of $60,000
investment
Cash received from sale of land 15,000
Less cash paid for building (115,000)
construction
Net cash flow from investing (40,000)
activities
Cash flows from financing activities
Cash received from issuing note $40,000
payable
(70,670)
Less cash paid for dividends
Net cash flow from financing (30,670)
activities
$44,450
Increase in cash
95,900
Cash at the beginning of the year
$140,350
Cash at the end of the year

Schedule of non-cash investing and financing activities:

68
 Issued Ordinary shares to retire bond payable……………………..$100,000

Chapter 5: Single Entry and Incomplete Records

5.0 LEARNING OBJECTIVES
At the end of this chapter, students are expected to construct final accounts from any set
of accounting records which fall short of complete double entry. Since in extreme cases
there may be no any records whatever of the day-to-day transactions, it is expected that
the students shall be able to build up accounts largely from estimates. In other instances,
books may have been kept by ‘single entry’ or data may be available by means of which
double entry can be constructed.

5.1APPROACH TO BE ADOPTED
In order to prepare the Statement of Profit and Loss and Comprehensive Income and the Statement
of Financial Position, the following procedure is recommended:
Stage 1
Construct a statement of the financial condition at the beginning of the period. This requires assets and
liabilities to be determined.
The values of any non-current assets can be obtained from such details as the trader is able to supply
of their cost and the dates upon which they were acquired, provision for depreciation from the date
of acquisition to the commencement of the current period being deducted. The trader must provide
an estimate of the value of his inventories and particulars of any book debts and liabilities. Accounts
should be opened, and estimated asset values posted to the debit side. Total of the book debts should
be debited to total trade receivables account, and the total of the liabilities credited to a total trade
payables account. This is illustrated in a later section. The excess of the aggregate of the assets over
the liabilities may be taken to represent the amount of the trader’s capital at the commencement of
the period and should be credited to his/her capital account.
Stage 2
A careful analysis should be made of the bank statement, and a cash summary (which may take a
form of receipts and payments account). For this purpose, analysis columns should be prepared for
each of the principal headings of receipts and payments. For example, the lodgments into the bank
may be analysed under the heading of cash takings, income from investments, the sale of assets, new
capital paid in and private income of the trader. Payments from the bank should be analysed as
between payments for goods purchased, rent, rates, insurances and other business expenses, cheques
cashed for wages, petty cash and personal expenditure, and cheques drawn for the trader’s private
purposes.
Stage 3
Ascertain the amounts of any cash takings which have not been paid into the bank, but have been
used by the trader for the payment of business expenses, goods purchased for cash and personal
expenses. An estimate should also be obtained of the value of any inventory which may have been
withdrawn by the trader for his own personal use or for that of his/her family.

Stage 4
On completion of the above analysis, postings will be made as follows:
(1) From the debit side of the cash summary:

69
 (i) cash takings to the credit side of the total trade receivables account;
(ii) income from investments (if any) to the credit of income from investments account;
(iii) proceeds of sale of assets (if any) to the credit of the appropriate asset accounts;
(iv) other items to the credit of the respective accounts.
If a profit or loss on the sale of assets is disclosed, this should be transferred either to Income
Statement (the Statement of Profit and Loss and Comprehensive Income) or the proprietor’s capital
account.
(2) From the credit side of the cash summary:
(i) payments for goods purchased to the debit of total trade payables account;
(ii) payments of expenses to the debit of the relevant nominal account;
(iii) cheques drawn for petty cash to the debit of petty cash account;
(iv) the proprietor’s personal drawings to the debit of his current account;
(v) the purchase of assets (if any) to the debit of the respective assets accounts.
Stage 5
The amount of any cash takings used for business or private purposes should be noted, the
appropriate account debited and the appropriate receivables (trade or other) account credited. Note,
however, that in incomplete record situations, private drawings may need to be calculated as a
balancing figure.
Stage 6
This involves calculating year-end adjustments and balances.
A schedule should be compiled of the book debts outstanding, the total of which should be carried
down in the total trade receivables account. The balance of this account will now represent the total
sales for the period and should be transferred to the credit of trading account.
Similarly, s schedule should be made of liabilities outstanding trade and other payables. The total
should be carried down in the total trade payables account. The balance of this account will now
represent the total purchase for the period and should be transferred to the debit of trading account.
Accruals and prepayments will be carried down as closing balances in the relevant expenses accounts.

Stage 7
The whole of the transactions will now be recorded in total double entry form and it will be possible
to extract a Statement of Profit and Loss and Comprehensive Income as well as a Statement of
Financial Position in the usual way.
5.2 RELIABILITY OF INFORMATION
The gross profit percentage revealed by the trading account may afford some indication as to the
accuracy or otherwise of the data and estimates used in compiling the accounts. If it is found that
this percentage is substantially lower than the percentage of gross profit normally earned in the
particular trade, doubt would be thrown on the accuracy of the amounts of the opening and closing
inventories, purchases or sales. Further enquiry would therefore be necessary. In particular,
information should be elicited as to the style in which the trader lives. It will often be found that the
amount of cash takings alleged to be withdrawn for private use is wholly incompatible with the size
and character of the trader’s domestic establishment and mode of life. A re-estimation of the amount
of personal drawings might thus be necessary. See section x.5 on Use of the Gross Profit Percentage
for further comments.
5.3 ILLUSTRATION 1
(note: the amounts used are for demonstration purpose only)
A is the proprietor of a grocery and general store. He has not previously engaged an accountant. He
has informed you that this year the Commissioner of Taxes has refused to accept the account which
A has supplied of his trading results for the year ended March 31 2013. That account is as follows:
70
 K K
Payment for goods 9,495 Takings 10,930
Payment for expenses 1,130
Profits 305
- 10,930 10,930
He instructs you to examine his records and prepare accounts.
From your examination of the records and from interviews with your client, you ascertain the following
information:
(1) The takings are kept in a drawer under the counter; at the end of each day the cash is
counted and recorded on a scrap of paper; at irregular intervals Mrs A transcribes the
figures into a notebook; a batch of slips of paper was inadvertently destroyed before the
figures had been written into the note book, but Mr and Mrs A carefully estimated their
takings for that period, and the estimated figure is included in the total of K10,930.
(2) The following balances can be accepted:

March 31
2012 2013
K K
Cash in hand 45 87
Balance at bank 156 219
Book debts 458 491
Payables for purchases of inventory 279 243
Inventory at cost 1,950 1,900
(3) Debts costing K356 were abandoned during the year as bad; the takings included K25
recovered in respect of an old debt abandoned in the previous year.
(4) A rents the shop and living accommodation on a weekly tenancy for K3 per week including
rates; the rent is included in expenses of K1,130. The living accommodation may be
regarded as one-third of the whole.
(5) The expenses total also includes:
(i) K35 running expenses of A’s private car.
(ii) K60 for exterior decoration of the whole premises, the landlord having refused to have this
done.
(iii) K160 for alterations to the premises to enlarge the
storage accommodation,
(6) A takes K10 per week from the business and hands it over to his wife, who pays all the
household and personal expenses except those referred to below.
(7) A pays for his own cigarettes and beer with cash taken from the drawer; this is estimated
at K1.50 per week.
(8) A competed in a football pool for 30 weeks of the year, staking K1 each week, buying a
postal order with cash taken from the drawer; his winnings totalled K59.
(9) During the year A bought a second hand car (not used for business) from a friend; the price
agreed was K350, but as the friend owed A K67 for goods supplied from the business the
matter was settled by a cheque for the difference.
(10) An insurance policy for A’s life matured and realized K641.
(11) A cashed a cheque for K100 for a friend; the cheque was dishonored and the friend is
repaying the K100 by instalments. He had paid K40 by March 2013.
(12) Other private payments by cheque totalled K96 plus a further sum of K110 for income tax.
(13) You are to provide K42 for accountancy fees.

71
 You are required to prepare:
(a) A Statement of Financial Position of the business as at March 31 2012;
(b) A Statement of Profit and Loss and Comprehensive Income for the year ended March 31 2013;
and
(c) A Statement of Financial Position of the business as at March 31 2013.
SOLUTIONS
(a) A Statement of Financial Position of the business as at March 31 2012
Current assets K
Inventory 1,950
Receivables 458
Cash at bank 156
Cash in hand 45
2,609
Less payables 279
2,330
=====
(b) A Statement of Profit and Loss and Comprehensive Income for the year ended
March 31 2013
K K
Sales 11,638
Opening inventory 1,950
Purchases 9,459
11,409
Less Closing inventory 1,900
Cost of sales 9,509
Gross profit 2,129
Rent and rates (2/3 x K3 x 52 weeks) 104
Sundry expenses 719
Cost of enlarging storage accommodation 160
Repairs (2/3 x K60) 40
Bad debts (356 – 25) 331
Accountancy fees 42
1,396
Net profit for the year 733
Note: the cost of enlarging storage accommodation could be capitalized but it has been written
off in the year in which incurred on prudence grounds.
(c) A Statement of Financial Position of the business as at March 31 2013.
Current assets K K
Inventory 1,900
Receivables 491
Cash at bank 219
Cash in hand 87

268 2,697
Less current liabilities
Trade payables 243
Accountancy fees 42
285
72
 2,412
======

Capital account of A
Balance at 1 April 2012 2,330
Net profit 733
3,063
Less drawings 651
2,412
======
Workings
CASH SUMMARY
K K
Balance 1/4/12 (cash K45; Expenses 1,130
Bank K156) 201 Purchases 9,495
Bad debt recovered 25 Cash drawings 520
Football pool winnings 59 Personal cigarettes etc 78
Insurance policy 641 Football pools 30
Repaid by friend 40 Car (K350 - K67) 283
Balance cash takings carried Loan to friend 100
To total receivables account 11,182 Drawings by cheque 96
Income tax 110
Balance 31/3/13 (cash K87;
Bank K219) 306
12,148 12,148
====== ======
TOTAL RECEIVABLES
K K
Trade receivables 1/4/12 458 Cash takings 11,182
Balance = sales 11,638 Friend re car 67
Bad debts w/o 356
Trade receivables 31/3/13 491
12,096 12,096
======= ======
TOTAL PAYABLES
K K
Cash 9,495 Trade payables 1/4/12 279
Trade payables 31/3/13 243 Balance = purchases 9,459
9,738 9,738
====== =====
SUNDRY EXPENSES
K K
Cash 1,130 Rent 156
Car expenses 35
Repairs to premises 60
Alterations 160
Balance = sundry expenses 719
1,130 1,130
73
 ====== =====
181
DRAWINGS
K K
Cash 520 Football pool winnings 59
Cheques 96 Life policy money 641
Rent (private element) 52 Repayments by friend 40
Private car expenses 35 Balance = net drawings 651
Decorations (house(one-
Third of K60) 20
Purchase of car 350
Cash paid to friend 100
Cigarettes etc 78
Football pools 30
Income tax 110 _____
1,391 1,391
===== =====
5.4USE OF THE GROSS PROFIT PERCENTAGE
In the above illustration there was sufficient information to enable the sales figure of K11,638 to be
calculated from total trade receivables account.
In some questions, however, such information is not always readily available. In cases such as these,
it may be possible to calculate sales indirectly as long as a gross profit percentage is provided.
The approach is quite simple:
(1) Calculate cost of sales:
Opening inventory + purchases – closing inventory;
(2) Convert cost of sales to sales:
eg if gross profit percentage is 20%, sales = 100/80 x cost of sales.
Once sales for the year have been estimated, and opening and closing trade receivables taken into
account, the figure of cash takings can be calculated as a balancing figure in the total trade
receivables account.
5.5 DEFICIENT ACCOUNTING RECORDS
Where the available records are so deficient that it is impossible to compile a reasonably complete
cash summary, the only method of estimating the profit or loss for the period is to prepare statements
of affairs showing the ‘net worth’ of the business at the beginning and at the end of the period
respectively.
A statement of affairs for this purpose is a document in the form of a Statement of Financial Position,
showing on one side the estimated amounts of the various assets, and on the other the liabilities, the
difference between the two sides representing the proprietor’s ‘net worth’ or capital at the date of
the statement.
If a statement of affairs has been drawn up at the end of the preceding period, the opening capital
for the current period would be shown thereby. It would then be necessary to prepare a similar
statement at the end of the current period, and to find the difference between the opening and closing
figures of capital, the amount of which, after adding back any sums withdrawn, and deducting any
new capital introduced, would represent the profit or loss for the period.

5.6ILLUSTRATION 2
J’s last statement of affairs prepared at January 1 was:
STATEMENT OF AFFAIRS
74
 January 1 K K
Payables 6,000 Office furniture 500
Bills payable 500 Inventories 2,000 Capital
account – being Trade receivables 4,500
excess of assets over Bills receivable 1,000
liabilities at this date 3,000 Cash 1,500
9,500 9,500
===== =====
On December 31 he finds his liabilities to be: trade payables K4,500, bills payable K700; and his
assets: office furniture K450, inventory K1,500, trade receivables K5,300, bills receivable K700,
cash K800. His drawings during the period have amounted to K450. What profit has he made?
STATEMENT OF AFFAIRS
December 31
K K
Trade payables 4,500 Office furniture 450
Bills payable 700 Inventories 1,500

Capital account – being Trade receivables 5,300 excess

of assets over Bills receivable 700 liabilities at this
date 3,550 Cash 800
8,750 8,750
===== =====
K
Calculation of profit
Capital, December 31 3,550
Drawings for the year 450 Capital,
January 1 (3000)
Estimated net profit for the year 1,000
=====
No great difficulty should be experienced in estimating values of the assets and liabilities at the end
of the period under review, provided that the work of preparing the statement is undertaken shortly
after that date, since the necessary material for the valuation will probably be still accessible. The
preparation of earlier statements may present more difficulty, and the most searching enquiries may
have to be made. Needless to say, this method of ascertaining results is most unsatisfactory, and the
trader should be advised to install double entry book-keeping without delay.
Incomplete records and missing figures. In practice, part of the information relating to cash receipts
or payments is often missing. If the missing information is in respect of one type of payment, then
it is normal to assume that the missing figure is the amount required to make both totals agree in the
cashcolumn of the cash and bank summary. (This does not happen with bank items owing to the
fact that another copy of the bank statement can always be obtained from the bank.) receipts and
payments is available:
Cash Bank
£ £
Cash paid into the bank during the year 35,500

75
 Receipts from debtors 47,250 46,800
Paid to suppliers 1,320 44,930
Drawings during the year ? –

Expenses paid 150 3,900

Balances at 1.1.20X4 235 11,200
Balances at 31.12.20X4 250 44,670
Cash Bank Cash Bank
£ £ £ £ £
Balances 1.1.20X4 235 11,200 Bankings ¢ (contra entry) 5,500
Received from debtors 47,250 46,800 Suppliers 1,320 44,930
Bankings ¢ (contra entry) 35,500 Expenses 150 3,900
Drawings ?
Balances 31.12.20X 4 250 44,670
4 7,485 93,500 47,485 93,500
The amount needed to make the two sides of the cash columns agree is £10,265i.e. £47,485 minus
£ (35,500 +1,320 +150 +250). This is the figure for drawings.

5.7 incomprete record And missing figures

In practice, part of the information relating to cash receipts or payments is often missing. If the missing
information is in respect of one type of payment, then it is normal to assume that the missing figure is the
amount required to make both totals agree in the cash column of the cash and bank summary. (This does not
happen with bank items owing to the fact that another copy of the bank statement can always be obtained from
the bank.). an example where the figure for Drawings is unknown. This example also shows the contra entry
made in the cash book when cash receipts are banked.

Information on cash and bank transactions is available as follows

)Cash paid into the bank during the year 35,500 Receipts from debtors 47,250 46,800 Paid to suppliers 1,320
44,930 Drawings during the year ? – Expenses paid 150 3,900 Balances at 1.1.20X4 235 11,200 Balances at
31.12.20X4 250 44,670

Now, you need to enter this information in a cash book account

Balances 1.1.20X4 235 11,200 Bankings ¢ (contra entry) 35,500 Received from debtors 47,250 46,800
Suppliers 1,320 44,930 Bankings ¢ (contra entry) 35,500 Expenses 150 3,900 Drawings ? Balances
31.12.20X4 250 44,670 47,485 93,500 47,485 93,[Link] will be shown as follows;

76
 Cash Bank

£ £

Cash paid into the bank during the year 35,500

Receipts from debtors 47,250 46,800

Paid to suppliers 1,320 44,930

Drawings during the year ? –

77
Expenses paid 150 3,900

Balances at 1.1.20X4 235 11,200

Balances at 31.12.20X4 250 44,670

Cash Bank Cash Bank

K K k K K

Balances 1.1.20X4 235 11,200 Bankings ¢ (contra entry) 5,500

Received from debtors 47,250 46,800 Suppliers 1,320 44,930

78
 Bankings ¢ (contra entry) 35,500 Expenses 150 3,900

Drawings ?

Balances 31.12.20X 4 250 44,670

47,485 93,500 47,485 93,500

The amount needed to make the two sides of the cash columns agree is £10,265 i.e. £47,485 minus £(35,500
+1,320 +150 +250). This is the figure for drawing

shows an example where the amount of cash received from debtors is unknown. Information on cash and
bank transactions is available as follows

2) Cash Ban k: Receipts from debtors ? 78,080 Cash withdrawn from the bank for business use (this is the
amount which is used besides cash receipts from debtors to pay drawings and expenses) 10,920 Paid to
suppliers – 65,800 Expenses paid 640 2,230 Drawings 21,180 315 Balances at 1.1.20X7 40 1,560 Balances at
31.12.20X7 70 375

Cash and Bank: Cash Bank Balances 1.1.20X7 40 1,560 Suppliers 65,800 Received from debtors ? 78,080
Expenses 640 2,230 Withdrawn from Bank ¢ 10,920 Withdrawn from Bank ¢ 10,920 Drawings 21,180 315
Balances 31.12.20X7 70 375 21,890 79,640 21,890 79,640s it is the only missing item, receipts from debtors
is, therefore, the amount needed to make each side of the cash column agree, £10,930 i.e. £21,890 minus
£(10,920 + 40).

79
Note: It must be emphasised that the use of balancing figures is acceptable only when all the other figures
have been verified. Should, for instance, a cash expense be omitted when cash received from debtors is
being calculated, this would result in an understatement not only of expenses but also, ultimately, of sales

5.8Where there are two missing pieces of information

Quite often, the only cash expense item for which there is some doubt is drawings. Receipts will normally
have been retained for all the others. If both cash drawings and cash receipts from debtors (or from cash sales)
were not known, it would not be possible to deduce both of these figures separately. The only course available
would be to estimate whichever figure was more capable of being accurately assessed, use this as a ‘known’
figure, then deduce the other figure. However, this is a most unsatisfactory position as both of the figures are
estimates, the accuracy of each one relying entirely upon the accuracy of the [Link] the end of this chapter,
students are expected to construct final accounts from any set of accounting records which fall short of
complete double entry. Since in extreme cases there may be no any records whatever of the day-to-day
transactions, it is expected that the students shall be able to build up accounts largely from estimates. In other
instances, books may have been kept by ‘single entry’ or data may be available by means of which double
entry can be constructed.

SUMMARY OF THE CHAPTER- The chapter explained how accounts may be prepared
from incomplete records. There are different situations where this approach may be appropriate.
However, reliability of the information may be brought into question at times since the amounts
used are mainly based on estimates.

END OF CHAPTER QUESTION

Q1 The following information is relevant to the calculation of the sales figure for Spencer, a sole
trader who does not keep full accounting records but has opted to maintain all financial records in
hard currency:
K
Opening receivables 29,100
Cash received from credit customers and 381,600
paid into the bank
Expenses paid out of cash received from 6,800
credit customers before banking
Irrecoverable debts written off 7,200
Discounts allowed to credit customers 9,400
Cash sales 112,900
Closing receivables 38,600

What figure should appear in Spencer’s trading account for sales?

EXAMINATION TYPE QUESTIONS
Question 1
You are provided with the following information for a receivables account of customer Liwiro:
Liwiro

80
 2013 K 2013 K
May 1 Sales 20,500 May 17 Bank 30,000
May 14 Sales 36,000 May 28 Returns 5,000
May 31 Sales 18,000
Required:
Establish the balance on this account at 31st May 2013 1 Marks
184
Question 2
(a) You are given the following figures for the year 2013 for Tayamba Kick Starters, a new
business venture.
MK
st
Inventories at 01 January 2013 400,000
st
Inventories at 31 December 2013 600,000
Purchases 5,200,000
A uniform rate of mark-up of 20% is applied.
Required:
Calculate the Cost of Goods Sold, Sales and Gross Profit figures for the business for the year
ended 31st December 2013. Show all your workings. Prove your answer by preparing a trading
account for the (8 marks)
(b) Scott Tabeledwa had the whole of his stock stolen from his warehouse on the night of 20
August 2013. Also destroyed were his sales and purchases journals, but the sales and
purchases ledgers were salvaged. The following facts are known:
i. The amount for inventories was known at the last Statement of Financial Position
date, 31st March 2013, to be MK1,248,000 at cost.
ii. Receipts from debtors during the period 01st April 2013 to 20th August 2013 amounted
to MK3,174,500. Trade receivables at 31st March 2013 were MK1,427,800, at 20th
August 2013 they were MK1,233,300
iii. Payments to creditors during the period 01st April 2013 to 20th August 2013 amounted
to MK1,727,000. Trade payables at 31st March 2013 were MK763,300 and at 20th
August 2013 they were MK628,900.
iv. The gross profit margin on all sales had been constant at 25%.
Required:
Construct a trading account for Scott Tabeledwa for the period ended 20th August 2013. You are
expected to show the flow of all your workings.
(12 marks)
[TOTAL 20MARKS

81
CHAPTER 6: control accounts
6.1 BACK GROUND INFORMATION

To ensure financial soundness of a business, managers of the business must put in place measures
to ensure that the business’s assets and resources are controlled. Such measures are known as
internal controls. It is imperative that that every system of transactions undertaken in the
business has internal controls to ensure

of accounting records, control accounts are prepared for a particular system (say a purchase
system). The control accounts record the same information that is recorded in the sales ledger (for
a sales system) or the purchase ledger (for a purchase system) and at the end the information in
the control is compared to that in the ledger concerned. This is done to check the arithmetical
accuracy as well as proper entries in the records.

A control account is an account in the general ledger which keeps a record of a total number of
similar individual items. For large entities, the control account forms part of the double entry
system.

6.2 THE RECEIVABLES/ SALES LEDGER CONTROL ACCOUNT

This is an account which keeps a record of all trade receivables in total. A business can have
numerous trade receivables and each of them will have his/her account in the sales ledger. One
special account will be needed to control the entries in all the trade receivables accounts, that is,
the receivables control account.

The amount that is transferred to the receivables control account is the total in the sales day
book. Remember that the total in the sales day book is transferred to the sales account in the
general ledger. If control accounts are being used, this total has to be transferred to the
receivables control account as well.

Any item that is recorded in one or more receivables’ accounts in the sales ledger is also recorded in
total in the receivables control account. It is important to know on which sideof the control account,
entries will be made. For instance, the following items will have to be totaled and entered in the
receivables control account on the debit side:

i. Total of credit sales from the sales day book

ii. Total of customers’ dishonored cheques and refunds made to customers
iii. Total of any interests charged on overdue accounts of customers.

The following items will have to be totaled and entered in the receivables control account on the
credit side:

82
 i. Total of cash /cheques received from customers
ii. Total of cash discounts allowed to customers
iii. Total of sales returns made by customers
iv. Total of debts that have been written off as irrecoverable.

6.3 TRADE PAYABLES/PURCHASES CONTROL ACCOUNT

This is an account which keeps a record of all trade payables in total. A business can have
numerous trade payables and each of them will have his/her account in the purchases ledger.
One special account will be needed to control the entries in all the trade payables’ accounts, that
is, the payables/purchases ledger control account.

The amount that is transferred to the payables control account is the total in the purchases day
book. Remember also that the total in the purchases day book is transferred to the purchases
account in the general ledger. If control accounts are being used, this total has to be transferred
to the payables control account as well.

Any item that is recorded in one or more payables’ accounts in the purchases ledger is also
recorded in total in the payables control account. For instance, the following items will have to be
totaled and entered in the payables control account on the debit side:

x Total of cash/cheques paid to suppliers x Total of

purchases returns made to suppliers x Total of any
discounts received from suppliers.

The following items will have to be totaled and entered in the receivables control account on the
credit side: x Total of credit purchases from suppliers
x Total of any interests charged by suppliers on overdue accounts

6.4 CONTRA ENTRIES

In a situation where one person/entity becomes both a customer and a supplier, for the purposes
of control accounts, the balances in the two ledgers, that is the sales and purchases ledger, are
off set to come up with one balance in the control account. The double entries required for the
set offs are:

Dr Payables Control account Cr

Receivables Control account
With the amount involved.

83
Example 1

The following are the opening ledger balances and totals for the month of January 2012
Opening balances
Debit Credit
MK MK
Receivablesledger(MK) 46,217
Payablesledger(MK) 23,993
Totals for the month to 31 January 2012

MK
Purchases 76,474
Sales 126,024
Purchasesreturns 2,154
Receivablesaccountssettledbycontraaccountswithpayables 455
Irrecoverabledebtswrittenoff 1,253
Discountsandallowancestocustomers 746
Cashreceivedfromcustomers 120,464
Cashdiscountsreceived 1,942
Cashpaidtosuppliers 70,476
Cashpaidtocustomers(Refunds) 52
Required:
i. Prepare receivables ledger control account ii.
Prepare payables ledger control account

Solution

Receivables control account will be drawn up as shown below :

Receivables Control
______________________________________________________
Balance b/f 46,217

84
Contra 455 Sales 126,024 Discounts allowed 746
Refunds 52 Irrecoverable debts 1,253
Cash 120,464
Balance c/d 49,375
172,293 172,293 Using the above

information, we can also prepare a payables control account.

Payables Control

Returns 2,154 Bal b/d 23,993

Contra 455 Purchases 76,474
Discount received 1,942
Payments 70,476
Balance c/d 25,440
100,467 100,467

6.5 IMPORTANCE OF CONTROL ACCOUNTS

You have learnt how the receivables and payables control accounts. But why do we need to prepare
control accounts? Control accounts are important for the following reasons:

a) Provide a check on the accuracy of entries made in the personal accounts in the sales and
purchases ledger.
b) Assist in location of errors
c) Provide an internal check where there is segregation of duties
d) Assist in extracting closing receivables, and payables ledger balances for use in the trial
balance and statement of financial position.

6.6 CONTROL ACCOUNT RECONCILIATION AND THE LEDGER

At the end of a specified period, the balance on the control account must be checked and
compared with the sum of the balances from the individual accounts in the sales or purchases

85
ledger. In normal circumstances, the two totals must agree. However, if the balances do not
agree, we should reconcile the two balances to ensure that all errors are discovered and any
fraud, if any, is detected.

When reconciling the control account balance to the sum of balances of the accounts in the
ledger, the following procedures should be followed:

i. Update the control account. This is achieved by bringing into the control account any
item which has not been included in it but is supposed to be included; as well as
removing from the control account any item which has been included in it but it is not
supposed to be included. The end result is that the control account will have a new
closing balance.

ii. Adjust the updated control account balance with any errors or omissions that have been
made in the individual accounts in the ledger.

If all errors and omissions have been discovered and dealt with accordingly, the final amount
arrived at after the second stage above must be equal to the sum of the balances in the
accounts in the ledger. This is illustrated below:

i. Reconciliation of the Receivables Control Account with the Sales Ledger

K Updated balance in the Receivables control account

X
Add:
Items to be credited but have not been credited
in the sales ledger accounts, e.g. irrecoverable debts X
X
Less:
Items to be debited but have not been debited in the sales ledger accounts, e.g.
correction of under cast of sales (X)
Balance from sum of trade receivables accounts X

86
 143
ii. Reconciliation of the Payables Control Account with the Purchases Ledger

K
Updated balance in the Payables control account X
Add:

Items to be debited but have not been debited in ledger accounts X

X
Less:
Items to be credited but have not been credited in ledger accounts (X)
Balance from sum of Trade payables accounts X

SUMMARY OF THE CHAPTER

In this chapter you have learnt that business prepare control accounts as part of internal
controls. You have looked at the purposes of control accounts and how the receivables
and payables control accounts are prepared. You have also learnt why periodic
reconciliations between control accounts and ledger accounts are important. This ensures
that causes of differences have been identified. Once this is done they can now be
rectified.

END OF CHAPTER QUESTIONS

Q1
Explain the purposes of control accounts.

Q2
Explain how the following items are reflected in the receivables and payables
control accounts :

Receipts from customers

Payments to suppliers
Discount allowed
Discount received
Dishonored cheques
Returns inwards and outwards
Q3

The following transactions relate to receivable and payable controls for G Motors for the month of
September 2010:

87
 144
K
Balance b/f - Receivables 140,000
- Payables 90,000

Credit sales 600,000

Cash sales 180,000
Credit purchases 400,000
Cash purchases 50,000
Returns inwards from customers 10,000
Carriage inward for purchases 40,000
Interest on receivable 4,000
Bad debts 12,000
Provision for doubtful debts 16,000
Contra account (purchases) 25,000
Return outward to credit supplier 14,000
Cash from receivables 380,000
Payment to credit suppliers 250,000
Discount allowed to credit customers 17,000
Discount received from credit suppliers 10,000
Returns inward from credit customers 11,000
Dishonored cheque from a credit customer 8,000
Required:

(a) Prepare the receivable and payable control accounts for the month of
September 2010.
17 Marks

(b) Outline three items which may result in differences between the amount of payables
in ledger accounts and that on the supplier’s statement.
3 Marks

88
 CHAPTER7: BANK RECONCILIATION
7.1 THE NEED FOR BANK RECONCILIATION STATEMENTS
In financial accounting 1 you looked at how to prepare a cash book. You will recall that the cash books columns
for cash and bank transactions. The bank columns are for all the transactions which go through an entity’s
bank account. In this case, the transactions which have been recorded in the bank columns of the cash book
should be the same as the bank records for the business, which are being maintained by the bank. The records
prepared by the bank will be in a form of a bank statement. However, there are times when the two sets of
records are different. This calls for the preparation of a bank reconciliation statement.
7.2 BANK STATEMENT AND CASH BOOK BALANCES
Any transaction the business undertakes with the bank is recorded by both the business and the bank. One
would expect that that the balance in the cash book of the business must be equal to that in the bank’s books
because the records of the two parties are the same. However, this is unlikely to be the case for the following
reasons:
i. Bank Charges: Banks charge for the services they offer to their customer and these charges are directly
recorded (debited)into the customer’s account. The balance shown by the bank will therefore be different from
that of the cash book of the business because the cash book will not record this charge made by the bank.
ii. Bank Interests: Just as bank charges, a bank may give interest to the customers directly through the bank
accounts or may charge interests on overdraft balances directly. This may bring about the differences in the
balances reported by the two entities. iii. Standing Orders: These are orders customers give the bank to make
regular payments at stated dates to persons or companies. The bank simply obeys the command and the
payment is only reflected in the books of the bank and not the business’ books, hence a cause of the
disagreements between the two balances.
iv. Direct Debits: This where an instruction is given to the business’ creditors, (not the bank), to obtain the
money directly from the business’ bank account.
v. Credit Transfers/Bank Giro Credits: These are the amounts that the business’ customers pay directly into
the business’ bank account. The receipt will therefore be recorded in the books of the bank alone hence the
difference arises between the two balances.
vi. Unpresented Cheques: These are cheques that have been issued by the business to its payables but have not
been presented to the bank to effect payment. This will be recorded in the business’ cash book but the bank
will not record this payment until the payables have actually presented the cheques to the bank.
vii. Outstanding Bank Lodgements: These are the amounts or cheques that the business has deposited at the
bank but the bank has not yet cleared them. They are also called uncredited cheques. These will be recorded
by the business in its cash book but the bank will record these only when they are cleared.
viii. Errors: In chapter 18 you noted that accounts personnel are bound to make errors. These errors may be
committed when dealing with bank transactions. For example an error may be made when balancing the cash
book and so the resulting balance might not be correct. Such an error will not appear in the bank’s records.
The implication is that there will be a difference between the balance shown by the cash book and that shown
by the bank’s records.
ix. Dishonored cheques (or R/D cheques). These are cheques that the bank has denied to clear for various
reasons. This cheque had been recorded initially in the business’ books and when the bank denies payment, it

89
won’t be recorded in the bank’s records. Until the business reverses the transaction involving that dishonored
cheque, there will be a difference between the balance in the cash book and that in the bank statement.

When the cash book balance and the bank balance are not equal, we need to find out why the balances are not
equal. This is achieved through the reconciliation process. The reconciliation process is a control measure to
detect cash fraud.
7.3 FREQUENCY AND PURPOSES OF BANK RECONCILIATION
Bank reconciliation is an accounting procedure for agreeing the balance as per bank statement with the balance
as per cash book. It is good practice to reconcile the bank balance with the cashbook balance as frequent as
possible say at least once a month. How frequent the bank reconciliation statement may be prepared will
depend on the following factors:
i. Frequency and volume of transactions :The likelihood of error is greater where there are more transactions
ii. Other controls: If there are very few other checks on cash, the greater the need for bank reconciliation. iii.
Cash flows: If the company has to keep a very close watch on its cash position, then the reconciliation should
be performed as often as the information on cash balance is required. iv. Number of bank accounts: The more
the bank accounts are operated, the more difficult it becomes to perform regular reconciliation.
The bank reconciliation serves the following purposes:
i. Analysing the difference between the cashbook and the bank statement. ii. Detecting and correcting errors
committed by the bank or cash office iii. Detecting possible misappropriation of funds iv. Recognising or
identifying appropriate expenditures or receipts made directly by the bank. v. Ensuring that Commercial
Bank’s claims for reimbursement are not duplicated.
7.4 BANK RECONCILIATION PROCESS
To reconcile the two balances the following procedures are to be followed:
a) Update the cash book by taking into it some amounts that appear in the bank statement but not appearing in
the cash book. If the cash book contained some errors, the update should include correcting such errors. For
instance, bank charges will always be recorded in the bank statement and not in the cash book. The updated
cash book should therefore include this item.
b) Identify any unpresented cheques. You noted that Unpresented cheques represent any amount shown by the
cash book as a payment but has not been reflected as a debit in the bank statement
c) Identify any outstanding bank lodgements. Bank lodgements are amounts that have been recorded in the
cash book as receipts but are not reflected as a credit in the bank statement.
Once the above procedures have been undertaken, we can now prepare the reconciliation statement.
The bank reconciliation is done using two options as following:-

Option A

90
 BANK RECONCILIATION

Cash Balance on Bank Statement Cash Balance on Depositor’s Records

+ Deposits not recorded by Bank + Collections made by Bank

– Checks that have not been cleared – Not Sufficient Funds checks

– Service charges

+/– Bank errors –\+ Depositor's errors

Adjusted balance* Adjusted balance*

*These should agree.

Option B
This would entail first updating the cash book then doing the actual reconciliation following the stages shown
on the right side of the above chart.

EXAMPLE
BANK RECONCILIATION
Prepare a bank reconciliation for Cartwright Company as of October 31, using the following
information:
Cash balance on October 31 bank statement .................................................... $10,410
Cash account balance in general ledger ............................................................. 9,890
Deposit made on October 31, not recorded on bank statement ....................... 1,865
Note collected by bank ($1,200 plus $60 in interest) ......................................... 1,260
Outstanding checks: No. 567, $800; No. 569, $452............................................ 1,252
Debit memorandum from bank for a NSF check written by J. Lane in payment of his
account ............................................................................................................ 100
In addition, Cartwright recorded Check No. 548 written for $152 in payment of the October utility bill
as $125 in the cash payments journal.

OPTION A

BANK RECONCILIATION

Cash balance on bank statement ................................................. $10,410

Add Oct. 31 deposit ....................................................................... 1,865

$12,275
Deduct outstanding checks:
No. 567 ...................................................................... $800
No. 569 ...................................................................... 452 1,252

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 Adjusted balance (A) .................................................................... $11,023

Cash balance on depositor's

records ..................................................................................... $ 9,890
Add note collected by bank .......................................................... 1,260

$11,150
Deduct: NSF check ......................................................... $100
Error—Check No. 548 .................................... 27 127

Adjusted balance (B)………………….. $11,023

NOTE:- as you can see from above adjusted balance (A) and adjusted balance (B) are the same. Thus our bank
reconciliation has balanced.
OPTION B
PREPARING AN UPDATED CASH BOOK
Debit Credit
Date Details Amount Date Details Amount
31/10 Balance b/d 9 890 31/10 NSF – J Lane 100
31/10 Note collected by 1 260 31/10 Error Cheque No. 27
Bank 548
31/10 Adjusted Balance c/d 11 023
11 150 11 150
01/11 Adjusted Balance b/d 11 023

BANK RECONCILIATION STATEMENT

Balance on Bank Statement 10 410

Add Deposits not on Bank Statement (31/10) 1 865
12 275
Less/Deduct Outstanding Cheques No. 567 800
No. 569 452 1 252

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 Adjusted Balance 11 023

Practice
The cash account for wonder Co. at November 30, 2003 indicated a balance of $16,190.95.
The bank statement indicated a balance of $21,016.30 on November 30, 2003.
Records revealed the following items:
a. Checks outstanding totaled $5,169.75
b. A deposit of $4,189.40 representing receipts of November 30, had been made too late to appear on the
bank statement.
c. The bank had collected $4,500 on a note left for collection. The face of the note was $4,000
d. A check for $2,850 returned with the statement had been incorrectly recorded by Wonder Co. as $2,580.
The check was for the payment of an obligation to Kizer Co. for the purchase of office equipment on
account.
e. A check drawn for $1,375 had been erroneously charged by the bank as $1,735.
f. Bank service charges for November amounted to $25
Required
Prepare a bank reconciliation statement.

Solution
WONDER CO.
Bank Reconciliation
November 30, 2003
Cash balance according to bank statement .................................... $21,016.30
Add: Deposit of November 30, not recorded by bank $4,189.40
Bank error in charging check as $1,735 instead of
$1,375...................................................................... 360.00 4,549.40
$25,565.70
Deduct outstanding checks ............................................................ 5,169.75
Adjusted balance ......................................................................... $20,395.95

Cash balance according to depositor’s records .............................. $16,190.95

Add proceeds of note collected by bank, including
$500 interest ........................................................................... 4,500.00
$20,690.95
Deduct: Error in recording check ................................... $270.00
Bank service charge .............................................. 25.00 295.00
Adjusted balance ............................................................................ $20,395.95

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According to the procedures given above the reconciliation can also be presented as follows statement will be
presented as follows:

Bank Reconciliation Statement as at ………………………………. K Updated cash book balance

X
Add unpresented cheques X
x
Less bank lodgements (X)
Balance per Bank Statement X
Alternatively we can start with the balance as per the bank statement in which case the statement will be as
follows:
Balance per bank statement X
Add Bank lodgements X
X
Less Unpresented cheques (X)
Balance per updated cash book X
Regardless of the method used, the differences between the cash book balance and the balance on the bank
statement will be explained. Let us now look at a practical example.

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Example 1
From the following cash book and bank statement, draw up a statement reconciling the two balances:
Cash book

Dec 1. Balance b/d 3,480 Dec 8 A. Dalitso 698

7. P.J. Malumbo 176 15 R. Matemba 66
22. J. Elenda 146 28. G. Samalani 230 31. K. Wanda 498
Balance c/d 3,662 31. M. Balendo 356
4,656 4,656

Bank statement

Dr Cr Balance
Dec 1. Balance B/f 1,740
7. Cheque 176 1,828
11 A. Dalitso 698 1,479
20 R. Matemba 66 1,446
22 Cheque 146 1,519
31 Credit transfer, J. Wadada 108 1,573
31 Bank charges 44 1,551

Solution
i. Entries in the cash book and on the bank statement are not recorded on the same side. A debit entry in the
cash book would be reflected on the bank statement as a credit entry and the other way round.
ii. Let us spot any amounts appearing in the bank statement which do not appear in the cash book. We will
then use these amounts to update the cash book. A credit transfer of K108 from J. Wadada and bank charges
of K44 have not been recorded in the cash book and should be included in the cash book. In this way the cash
book will be up to date.
Therefore, the updated cash book will be:

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balance b/d 3,662 Bank charges 44
J. Wadada 108 Balance c/d 3,726
3,770 3,770

iii. We could have re-written the whole cash book but this may be time consuming. For examination purposes
it is good to start with the balance which has been brought down (K3,726) as marks are not awarded for the
original entries in the cash book.
iv. From the cash book and the bank statement, K330 paid to G. Samalani has not been presented to the bank
for payment as at the date the reconciliation is being made. This is an unpresented cheque. Cheques from K.
Wanda and M Balendo of K498 and K356 respectively have not been cleared by the bank. As a result they are
not reflecting on the business’ bank statement. The two cheques are bank lodgements as at 31 december 2012

Bank Reconciliation Statement as at 31 December 2012

K K
Balance as per updatedcashbook 3,726
Add :Unpresented cheques 330
4056 Less: Bank lodgements
[Link] 498
[Link] 356 (854)
Balance as per bank statement 3,202
Alternatively the bank reconciliation statement may also be prepared as follows:
Bank Reconciliation Statement as at 31 December 2012
K K
Balance as per bank statement 3,202
Add: Bank lodgements
[Link] 498
[Link] 356 854
4,056
Less :Unpresentedcheques (330)
Balance as per updated cashbook 3,726

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OVERDRAFTS
An overdraft occurs when a business or a person draws from the bank more money than the money that it or
he has in the bank. In this case, the bank becomes a liability to the business and the business an asset to the
bank. We still need to check if the balances in the cash book and on the bank statement are equal. When
overdraft balances are involved in the reconciliation processes, the presentation changes as follows in order to
take care of the negative balances:
Bank reconciliation statement
K
Updated cash book overdraft balance X
Add bank lodgements X
X
Less Unpresented cheques (X)
Overdrafts per Bank statement X
OR
Overdraft per bank Statement X
Add Unpresented cheques X
X
Less: bank lodgements (X)
You will note that the items in the reconciliation statements are the same. You should be able to reconcile
whether a business has an overdraft or not.
SUMMARY OF THE CHAPTER
In this chapter you have learnt that ideally the balance in the cash book and the balance on the bank statement
should be equal. However, sometimes the balances are not equal. In this case you need to prepare a bank
reconciliation account in order to identify the causes of the differences between the two balances. You have
noted that it is good practice to prepare the bank reconciliation statements periodically.
END OF CHAPTER QUESTIONS
Q1 Explain the importance of the bank reconciliations.
Q2 Mention possible factors which may make the cash book balance to be different from the balance on the
bank statement.

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 BLANTYRE INTERNATIONAL UNIVERSITY

FINANCIAL ACCOUNTING II

Jan -june Semester 2018 Assignment 1

Lecturer: Miss Nellie Kishombe
Email: nelliekishombe31@[Link]
Due Date: 21st march 2018 and 21st April for the second assignment
NB: Only Students on Distance learning mode are allowed to submit assignments
via email.

INSTRUCTIONS FOR ASSISGNEMT 1&2

 Make sure that your name, registration number, programme and academic year appear on the
cover page
 Marks are awarded for depth and application of knowledge, flow of your ideas and referencing to
other academic and credible sources( sites like Wikipedia are not academic)
 You are required to use citations for the questions that need citations (not the ones they require
calculations). Use the Harvard style of referencing, you must have separate page of your references
at the end of your assignment and you are required to have no less than five references
 Do not copy assignments from classmates, plagiarism will not be tolerated
 Late assignments will not be marked.

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The following trial balance was extracted from the books of Thendo ndovi on 30 June2014:

Dr Cr
K’000 K’000
Capital 4,500
Drawings 200
Sales 6,080
Inventory at 1 July 2013 590
Purchases 2,800
Carriage inwards 80
Rent 745
Wages and salaries 1,850
Office salaries 1,690
General expenses 195
Sundry expenses 250
Insurance 375
Advertising 140
Carriage outwards 103
Plant and machinery 700
Motor vehicles 880
Bank overdraft 120
Cash-in-hand 32
Receivables 670
Payables _____ 600
11,300 11,300

Inventory at 30 June 2014 was K520,000.

Required:

(i) Prepare an income statement for Thendo Ndovi for the year ended 30 June 2014.
(4 Marks)

(ii) Prepare a statement of financial position for Thendo Ndovi as at 30 June 2014.
(5 Marks)

X, Y and Z are three brothers trading under a partnership known as Excellence Bazaars without any
partnership agreement.

Required:

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 (a) Explain how the partnership will be governed in the absence of a partnership agreement and
mention any three accounting arrangements that will govern the partnership.
(4 Marks

(b) Assuming that the partners decide to change their trading arrangement on 31 May 2009 to affect
the partners profit-sharing ratios as follows:

X on half
Y one quarter
Z one quarter
Explain briefly three possible reasons for the change in the profit and loss sharing ratios.
(4 marks)

The following trial balance comes from the accounting records of a partnership a, b and c Trial
Balance as at 31 March 2002

K K
Sales 227,238
Purchases 129,876
Selling expenses 23,987
Distribution expenses 19,888
Administration expenses 16,780
Debtors and prepayments 36,270
Creditors and accruals 23,750
Cash in hand 1,460
Cash at bank 3,458
Opening stock 17,773
Equipment – cost 100,500
– accumulated dep. Partners’
24,100

current accounts
– A 214
– B 114
– c 212

Partners’ drawings
–a 12,785
–b 11,444
–c 7,007

Partners’ capital
–a 38,000
–b 34,850

100
 –c 32,750
———— ———
381,228 381,228
———— ————
Additional information:

1. The stock at 31 March 2002 was valued at cost of K21,782.

2. The partnership agreement provides that interest on partners’ capital accounts
should be allowed at the rate of 10% per annum. a, b and c are to be appropriated annual
salaries out of profits of K3,000, K2,000 and K1,000 respectively. The balance of profits
is to be shared in the ratio a40%, b 40% and c 20%.

Required:

(a) Prepare the trading and profit and loss account and appropriation account for the year
ended 31 March 2002. Show how the current account balances are determined
(10 marks)

b) Prepare the balance sheet as at 31 March 2002. (8 marks)

4. On 1 January 2008 The chinyama Golf Club had the following assets:
K
Cash at bank 20,000
Snack bar stocks 80,000
Club house buildings 1,250,000

During the year to 31 December 2008 the Club received and paid the following amounts:

Receipts K Payments K
Subscriptions 2008 350,000 Rent and rates 150,000
Subscriptions 2009 38,000 Extension to club house 800,000
Snack bar income 600,000 Snack bar purchases 375,000
Visitors‟ fees 65,000 Secretarial expenses 24,000
Loan from bank 550,000 Interest on loan 26,000
Competition fees 82,000 Snack bar expenses 60,000
Games equipment 200,000

Notes: The snack bar stock on 31 December 2008 was K90,000. The games
equipment should be depreciated by 20%.

Required:

(i) Draw up the bar trading account, income and expenditure account for the year ended 31 December 2008,
clearly showing the snack bar profit or loss. (8 m arks)

(ii) Prepare a balance sheet as at 31 December 2008. (5 marks)

101
(ii) How would entrance fees collected from members usually be treated in the preparation of accounts for a
club like The Chinyama’s? ( 2 marks)

TOTAL MARKS (50 MARKS)

Financial Accounting 11 : Assignment 2

(a) Give and briefly explain any two reasons for the use of control accounts in accounting. (2 marks)

(b) Your organization has provided you with the following information for the month of March 2014:

102
 K
Purchases ledger
Balance at 1 March (Cr) 222,000
Cheques paid to suppliers during the month 778,000
Credit purchases during the month 583,000

Sales ledger
Balance at 1 March (Dr) 379,206
Credit sales during the month 603,345
Cash received from customers during the month 418,987

Required: Complete the sales ledger control account (or receivables ledger control account)
and the purchases ledger control account (or payables ledger control account) for the month of
March 2014, carrying down the balances at the end of the month.
(8 Marks)

(c) You are provided with the following information for a trade receivables account customer, John
Banda:

John Banda
2014 K K
February 4 Sales 205,000 February 17 Bank 300,000
February 15 Sales 360,000 February 28 Returns 50,000
February 27 Sales 180,000

Required:
Establish the balance on this account at 28 February 2014. (3 Marks)

Wilson Ltd has been trading for a number of years as outdoor clothing

manufacturers. In 2002 a decrease in holidays abroad has led to an increase in

demand for local outdoor holidays and outdoor clothing. The summarised balance

sheets for the last two years are given below.

Year to 31 Dec. 2002 Year to 31 Dec.

2001
k,000 k'000 k,000 k,000
Fixed Assets
Intangible assets 20 35
Tangible assets
Property 681 318
plant/equipment 196 171

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 –––– ––––
897 524
Current Assets
¤ Stock 502 121
Debtors 397 164
Investments 6 140
Cash at bank 11 136
–––– ––––
916 561
Current Liabilities
Creditors (521) (260)
Accruals (106) 289 (38) 263
––––– ––––– ––––– –––––
1,186 787
Long Term Liabilities
8% debentures (170) –
––––– –––––
Net Assets 1,016 787
––––– –––––
Financed by:
Ordinary share capital 360 270
Revaluation reserve 40 –
Profit and loss account 616 517
––––– –––––
1,016 787
––––– –––––
The sales for 2002 and 2001 respectively were k2,150,000 and k1,602,000. The cost of goods
sold for 2002 and 2001 respectively was k1,610,000 and k1,085,000.
Required:
(a) Calculate the following accounting ratios:
(i) Gross profit percentage
(ii) Quick (or Acid test) ratio
(iii) Working capital (current) ratio
(iv) Debtors collection period (days)
(v) Stock turnover (10marks)
(b) Comment on each of the ratios you have calculated in
(a). (5marks)

(c) State three comparisons that can be made with the

ratios. (3marks)

3. You are given the following information for Chikumbutso:

(1) On 31 December 2012 the bank column of Chikumbuso’s cash book showed a
debit balance of K15,000.

104
 (2) The monthly bank statement written up to 31 December 2012 showed a credit
balance of K29,500.

On checking the cash book against the bank statement, it was discovered that the
following transactions had not been entered in the cash book:

(3) Dividends of K2,400 had been paid directly to the bank.

(4) A credit transfer – Malawi Revenue Authority VAT refund of K2,600 – had
been collected by the bank.
(5) Bank charges of K300 had been recovered by the bank.
(6) A direct debit of K700 for professional membership subscription had been paid
by the bank.
(7) A standing order of K2,000 for Chikumbutso’s loan repayment had been paid
by the bank.
(8) Chikumbutso’s deposit account balance of K14,000 was transferred into his
bank current account.

A further check revealed the following items:

(9) Two cheques drawn in favour of chosaziwa for K2,500 and Fanizo for K2,900
had been entered in the cashbook but had not been presented for payment.
(10) Cash and cheques amounting to K6,900 had been paid into the bank on 31
December 2012 but were not credited by the bank until 2 January 2013.

Required:
(i) Starting with the debit balance of K15,000, bring Chikumbutso’s cashbook (bank
columns) up to date and then balance the bank account. 8 Marks

(ii)Prepare a bank reconciliation statement for Chikumbutso as at 31 December

2012. 6 Marks

(TOTAL: 50 MARKS)

105