THE INSTITUTE OF CAT L2.1 FINANCIAL ACCOUNTING Study Manual
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Page 0 Page 0 BLANK 1 INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS OF RWANDA Level 2 L2.1 FINANCIAL ACCOUNTING First Edition 2012 This study manual has been fully revised and updated in accordance with the current syllabus. It has been developed in consultation with experienced lecturers. © iCPAR All rights reserved. The text of this publication, or any part thereof, may not be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, storage in an information retrieval system, or otherwise, without prior permission of the publisher. Whilst every effort has been made to ensure that the contents of this book are accurate, no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the publisher or authors. In addition to this, the authors and publishers accept no legal responsibility or liability for any errors or omissions in relation to the contents of this book. Page 1 BLANK Page 2 Contents Study Unit Title Page Introduction to the Course SECTION 1: 9 GENERAL FRAMEWORK OF ACCOUNTING 1 General Framework of Accounting Introduction The Objective of Financial Statements Users of Financial Statements Stewardship and Economic Decisions The Qualitative Characteristics of Financial Information Components of Financial Statements The Statement of Financial Position The Statement of Comprehensive Income The Statement of Changes in Equity The Cash Flow Statement Elements of Financial Statements Recognition in Financial Statements Measurement in Financial Statements The Historical Cost Convention/System The Accounting Profession and the Role of the Accountant Internal and External Auditors Internal Control Systems 13 14 14 14 16 17 18 18 18 18 19 19 20 20 21 21 23 25 2 Regulatory & Non Regulatory Framework Generally Accepted Accounting Policies (GAAP) The Regulatory Framework – Non Statutory The Regulatory Framework – Statutory 29 30 30 38 SECTION 2: 3 BOOK-KEEPING Double Entry, Trial Balance, Statement of Financial Position Books of Original Entry Nominal Ledger Double Entry The Accounting Equation The Statement of Comprehensive Income The Statement of Financial Position The Effects of Transaction on a Statement of Financial Position Capital Expenditure and Revenue Expenditure Questions / Solutions Page 3 41 42 47 49 49 50 52 53 62 63 Study Unit Title Page 4 Accruals and Prepayment Accruals and Prepayments Questions / Solutions 81 82 85 5 Trade Receivables, Bad Debts and Provisions Provisions Trade Receivables, Bad Debts, Bad Debts Recovered and Provisions Other Provisions Provisions for Discounts Allowed Provisions for Discounts Received Questions / Solutions 89 90 90 94 95 96 99 6 Control Accounts Control Accounts Trade Receivables Control Account Trade Payables Control Account Questions / Solutions Accounting for VAT 103 104 105 107 108 114 7 Bank Reconciliation Statements The Cash Book and Bank reconciliation Statement Bank Reconciliations Questions / Solutions Questions / Solutions 121 122 125 127 8 Suspense Accounts Suspense Accounts Example Errors not affecting the Trial Balance Questions / Solutions The Journal Questions / Solutions 133 134 134 135 135 137 139 SECTION 3: ACCOUNTING TREATMENT OF IDENTIFIED IAS’S 9 IAS 1 – Presentation of Financial Statements Objective Purpose of Financial Statements Components of Financial Statements Financial Review by Management Structure, Content and Reporting Definitions Statement of Financial Position Format Example 1 – Statement of Financial Position The Statement of Comprehensive Income Function of Expenditure Method Page 4 145 147 147 147 147 148 148 148 150 151 151 Study Unit Title Page Nature of Expenditure Method Changes in Inventories of Finished Goods and Work in Progress Raw Materials and Consumables Used Information to be presented either on the face of the Statement of Comprehensive Income or in the notes Statement of Changes in Equity Statement of Recognised Income and Expense Disclosure of Significant Accounting Policies Questions / Solutions 151 152 152 153 10 IAS 2 – Inventories Introduction - Inventories Definitions Measurement Disclosure Methods of Costing 163 164 164 165 165 166 11 IAS 8 – Accounting Policies, Changes in Accounting Estimates & Errors Introduction Definitions Accounting Policies Changes in Accounting Policies Disclosure – Change in Accounting Policies Changes in Accounting Estimates Disclosure – Changes in Accounting Estimates Errors Disclosure – Prior Period Errors 169 12 IAS 10 – Events after the Reporting Period Objective Definitions Recognition & Measurement Dividends Going Concern Disclosure 175 176 176 176 177 177 177 13 IAS 16 – Property, Plant and Equipment Objective Definitions Depreciation Accounting for Depreciation Disposal of Property, Plant and Equipment Ledger Accounts and Journal Entries Recognition & Measurement Disclosure 179 180 180 180 181 185 185 188 190 Page 5 155 156 156 157 170 170 170 171 171 172 172 172 173 Study Unit Title Page Examples 190 14 IAS 18 - Revenue Objective Definitions Recognition & Measurement Sale of Goods Rendering of Services Interest, Royalties and Dividends Disclosure 195 196 196 196 197 197 197 197 15 IAS 20 – Government Grants Objective Basic Concepts Definitions Types of Grant Available Accounting Treatment Disclosure Repayment of Grants Grant Recognition 199 200 200 200 201 201 203 203 204 16 IAS 37 – Provisions, Contingent Liabilities and Contingent Assets Objective Definition Recognition Measurement Changes in Provisions Uses of Provisions Application of Recognition and Measurement Rules Disclosure Examples – Recognition 205 206 206 207 207 208 208 208 209 210 17 IAS 12 – Income Taxes Objective Definition Recognition and Presentation Disclosure 213 214 214 214 214 18 IAS 17 – Leases Objective Classification of Leases Accounting by Lessees Disclosure: Lessees – Finance Leases Disclosure: Lessees – Operating Leases 217 218 218 219 219 220 Page 6 Study Unit Title Page SECTION 4: PREPARATION OF FINANCIAL STATEMENTS FOR DIFFERENT FORMS OF BUSINESS ENTITY 19 Sole Traders Preparing Financial Statements for Different Forms of Business Entity Sole Trader Accounts - Introduction Two Approaches in Preparing Accounts Double Entry Approach Question / Solution Single Entry Approach Question / Solution Use of Ratios Question / Solution 221 222 223 224 224 228 231 231 233 234 20 Company Accounts 1 Introduction – Statement of Comprehensive Income Dividends Transfer to Reserve Statement of Financial Position Share Capital Corporation Tax / Income Tax Expense Issue of Shares Ultra Vires Returns, Statutory Books, Director’s Reports, Notices, Resolutions and Accounts to be Filed Ethical Obligations of Company Directors 239 240 241 241 241 241 242 243 249 250 21 Company Accounts Introduction Preparation of Limited Company Accounts Sample Questions / Solutions Questions / Solutions 255 256 269 270 275 22 Income and Expenditure Introduction – Income and Expenditure Accounts Sources of Income Expenditure Statement of Financial Position Question / Solution 291 292 292 295 295 295 Page 7 254 Study Unit Title Page SECTION 5: INTERPRETATION OF FINANCIAL STATEMENTS 23 IAS 7 – Cash Flow Statements Cash Management Objective Operating Activities Investing Activities Financing Activities Reporting Cash Flows from Operating Activities Worked Examples Disposal of a Tangible Net Asset Taxation Dividends Worked Example 299 300 300 300 301 301 301 304 310 311 311 311 24 Ratio Analysis & Interpretation of Financial Statement General Ratios on Return on Capital Ratios of Profitability Ratios of Activity Ratios of Leverage / Gearing Ratios of Liquidity Limitations of Ratio Analysis Summary Checklist 315 316 317 317 319 322 323 325 325 326 25 Manufacturing Accounts General Divisions of Costs Worked Example 329 330 330 331 26 IPSAS – International Public Sector Accounting Standards Introduction IPSAS 1 IPSAS 2 IPSAS 12 IPSAS 3 IPSAS 14 IPSAS 17 IPSAS 31 IPSAS 16 IPSAS 19 IPSAS 9 & 23 335 336 338 339 340 341 342 343 346 347 348 349 Page 8 Page 9 INTRODUCTION TO THE COURSE Stage: Subject Title: Level 2 L2.1 Financial Accounting Aim The aim of this subject is to ensure that students understand how role, function and basic principles of financial accounting and to prepare accounts for basic reporting entities in accordance with International Financial Reporting standards (IFRSs) Students should have an ability to analyse and interpret financial statements. Learning Outcomes On successful completion of this subject students should be able to: • • • • • An understanding of the influence of legislation and accounting together with the standard setting process. Be able to recognise and comment on relevant ethical issues relevant to business owners, managers and accountants. The ability to prepare accounts from incomplete records, partnerships, limited companies, together with an understanding of the importance of cash to a business and to prepare cash flow statements for limited companies. The ability to use ratio analysis as a technique in decision making and performance evaluation. The ability to analyse and interpret financial statements Page 10 Syllabus: • • • • • 1. Conceptual and regulatory framework Influence of legislation and accounting standards on the production of published accounting information for organisations Impact of legislation on the preparation and reporting of financial statements Roles of the International Accounting Standards Board, The Standards Advisory Council and the International Financial Reporting Interpretations Committee Application of International Accounting Standards and International Financial Reporting Standards to the preparation and presentation of financial statements Framework for the Preparation and Presentation of Financial Statements - • The objective of financial statements Underlying Assumptions Qualitative characteristics of financial statements Elements of financial statements Standard setting process - Standard setting process - Accounting standards and the law on Published Accounts - The role of the stock exchange • Internal and external auditors and ethical issues for the Accounting Technician - Role and duties of internal and external auditors - Internal control systems - Ethical issues and responsibilities accruing • • • Content and application of specified accounting standards - Presentation of Financial Statements - Inventories - Cash Flow Statements - Accounting policies, change in accounting estimates and errors - Events after the Reporting Period - Income taxes (excluding deferred tax) - Property, Plant and Equipment - Leases (Lessee accounting only) - Accounting for Government Grants and Disclosure of Government Assistance - Provisions, Contingent Liabilities and Contingent Assets Professional ethical issues relevant to business owners, managers and accountants - Understanding and application of ethical issues Government accounting - General Introduction to Government Accounting - The IPSAS regime and the public sector Page 11 • • 2. Financial statements Financial statements for limited companies for internal and external purposes - Preparation of financial statements for limited companies - Differences between a sole trader and a limited company - Accounting records of a limited company - Capital structure of a limited company - Share premium account - Dividends - Reserves - Practical application of IAS/IFRS requirements Disclosure and filing requirements for limited companies - - • • • 3. • Cash flow statements for limited companies and an understanding of the importance of cash to the business entity - Preparation of cash flow statements in accordance with the IFRS regime - Importance of cash to a business entity - Preparation of reports on the interpretation of a Cash flow statement The accounts of manufacturing businesses - Classification of costs - Work in Progress - Preparation of the manufacturing account Preparation of accounts from incomplete records - Incomplete records - Preparation of accounts from incomplete records Interpretation of financial statements Ratio Analysis of accounting information - • Broad categories of ratios Profitability and return on capital employed Long term solvency and stability Short term solvency and liquidity Efficiency Shareholders' investment ratios Interpretation of Financial Statements and explanation of ratios used - • Format and filing requirements Wording and layout of a Statement of Comprehensive Income (Statement of Comprehensive Income) and Statement of financial Position (Statement of Financial Position) Size criteria for companies Disclosure Requirements Split of turnover Details regarding staff numbers and remuneration Movement in non-current assets Details of taxes owing Interpretation of Financial Statements Explanation of information provided by ratios Limitations of ratio analysis Preparation of reports for the users of accounting information as a tool in the decision making process - Preparation of reports in a professional manner Ratio analysis in the decision making process Page 12 BLANK Page 13 Study Unit 1 The General Framework of Accounting Contents A. Introduction B. The Objective of Financial Statements C. Users of Financial Statements D. Stewardship and Economic Decisions E. The Qualitative Characteristics of Financial Information F. Components of Financial Statements G. The Statement of Financial Position H. The Statement of Comprehensive Income I. The Statement of Changes in Equity J. The Cash Flow Statement K. Elements of Financial Statement L. Recognition in Financial Statements M. Measurement in Financial Statements N. The Historical Cost Convention/System O. The Accounting Profession and the Role of the Accountant Page 14 A. INTRODUCTION Financial accounting is a branch of economics. It involves gathering, recording, summarising and presenting information to the various users of financial information. B. THE OBJECTIVE OF FINANCIAL STATEMENTS The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. Financial position reveals information about the economic resources that an entity controls, its financial structure, its liquidity and solvency and its ability to change. This information is contained in the Statement of Financial Position. Changes in financial position are revealed in a Cash Flow Statement. Financial Performance means the return obtained on the resources which the entity controls. This information can be extracted from the profit and loss account. In International Accounting the profit and loss account is referred to as the Statement of Comprehensive Income. The Reporting Entity Financial Statements report on all of the activities and resources under the control of the entity that has prepared them whether it is a sole trader, a club or society or a limited company. C. USERS OF FINANCIAL STATEMENTS Users of financial statements include the following: (a) Existing and potential shareholders Information is required in relation to profit, dividends, trends and prospects in connection with share price. (b) Loan Creditors Information is required in relation to liquidity and to highlight the risk of non-payment. (c) Business Contact Group i.e. suppliers, customers, competitors and merger/acquisition situations. Information is required to ensure ability to pay debts, continuity of supply and trade information. (d) Analysts and investors Information on performance, trends and prospects is required for clients (e) Government Information is required as a base for taxation and to ensure compliance with company law (f) Employees Information about employment security and to assist with collective pay bargaining (g) Public Page 15 Any member of the public may require details of the contribution to the local and national economy made by the company and the environmental impact. Creditors Government Employers Users of Financial Statements Investors Employees Public The objective of accounting is to provide sufficient information to meet the needs of the various users at the lowest possible cost. There are two branches of accounting, that reflect the internal and external users of accounting information. Management accounting is concerned with the provision of information to people within the organisation to help them make better decisions and improve the efficiency and effectiveness of existing operations, whereas financial accounting is concerned with the provision of information to external parties outside the organisation. As such, management accounting could be called internal accounting and financial accounting could be called external accounting. Differences between management accounting and financial accounting The major differences between these two branches of accounting are: • Legal requirements. There is a statutory requirement for public limited companies to produce annual financial accounts regardless of whether or not management regards this information as useful. Management accounting is entirely optional and information should only be produced if it is considered that the benefits from the use of the information by management exceed the cost of collecting it. • Focus on individual parts or segments of the business. Financial accounting reports describe the whole of the business whereas management accounting focuses on small parts of the organisation i.e. profitability of products, services etc. Management accounting information measures the economic performance of decentralised operating units, such as divisions and departments • Generally accepted accounting principles. Financial accounting statements must be prepared to conform with the legal requirements and the generally accepted accounting principles established by the regulatory bodies. These requirements are essential to ensure the uniformity and consistency that is needed for external financial statements. Outside users need assurance that external statements are prepared in accordance with generally accepted accounting principles so that the inter-company and historical comparisons are possible. In contrast, management accountants are not Page 16 • • required to adhere to generally accepted accounting principles when providing managerial information for internal purposes. Instead, the focus is on the serving management’s needs and providing information that is useful to managers relating to their decision-making, planning and control functions. Time dimension. Financial accounting reports what has happened in the past in an organisation, whereas management accounting is concerned with future information as well as past information. Decisions are concerned with future events and management therefore requires details of expected future costs and revenues. Report frequency. A detailed set of financial accounts is published annually and less detailed accounts are published semi-annually. Management requires information quickly. Consequently, management accounting reports on various activities may be prepared at daily, weekly or monthly intervals. D. STEWARDSHIP AND ECONOMIC DECISIONS Stewardship entails the safekeeping and proper use of an entity’s resources and their efficient and profitable use. Existing investors assess management’s stewardship in order to decide whether to seek a change in management or to change the level of their shareholding in the entity. Ethical Issues for Management Ethical behaviour is an important element of stewardship. Increased accountability and legal frameworks across the globe now require that businesses take stock of their actions. Ethical debates in business are not new, however, and the area is large and often hard to quantify. Business ethics are moral principles that guide how a business behaves and they are the foundation of lasting business success. When a business practices ethical decision-making they are practising the values of a democratic society within the workplace. Therefore a business that places emphasis on ethics provides an environment that promotes honest working practices. This is especially important in a world that has recently witnessed mass corporate failures and questionable accounting practices. It is therefore important that businesses apply appropriate values, ethics and attitudes. Businesses or other corporate structures will usually have their own statement of business principles or a code, which sets out their core values and standards. This statement of principle or code enables the application of a common code of basic values that all persons within the organisation can agree on. It forces employers and companies to adhere to high standards of performance by not only following company law legislation but also by “doing the right thing.” A business ethical code emphasises the importance of applying moral values to company decisions. It is also important to realise that a code will apply to all members of the organisation regardless of their position in the company. However, a higher expectation is placed on qualified professionals such as accountants, who are held in a position of trust which is damaged by unscrupulous behaviour or poor practice. Page 17 The advantages of ethical behaviour include: Higher revenues – demand from positive consumer support • Improved brand and business awareness and recognition • Better employee motivation and recruitment • New sources of finance – e.g. from ethical investors The disadvantages claimed for ethical business include: • Higher costs – e.g. sourcing from Fairtrade suppliers rather than lowest price • Higher overheads – e.g. training & communication of ethical policy • A danger of building up false expectations E. THE QUALITATIVE INFORMATION CHARACTERISTICS OF FINANCIAL In deciding what information should be included in financial statements, when it should be included and how it should be presented, the aim is to ensure that financial statements yield useful information. Financial information is useful if it is: Relevant - If it has the ability to influence the economic decisions of users and is provided in time to influence those decisions Reliable - Reliability is characterised by: Comparable - • Faithful representation • Substance over form recognition of the economic substance of a transaction over its legal form • Neutrality - free from bias • Prudence - a degree of caution in making estimates in conditions of uncertainty • Completeness - an omission can cause information to be false or misleading It enables users to discern and evaluate similarities in, and differences between, the nature and effects of transactions and other events over time and across different reporting entities. Understandable - Its significance can be perceived by users who have a reasonable knowledge of business and economic activities and accounting and a willingness to study with reasonable diligence the information provided. If a conflict arises between these characteristics, a trade-off needs to be found that still enables the objective of financial statements to be met. For example, if the information that is the most relevant is not the most reliable and vice versa, it will usually be appropriate to use the item of information that is the most relevant of those that are reliable. Financial information with the above characteristics will be most useful to the users of financial statements. In deciding whether to present financial information separately in the financial statements the accountant must assess the information’s ability to influence Page 18 economic decisions it is considered to be material and should be presented separately in the financial statements. F. COMPONENTS OF FINANCIAL STATEMENTS The primary financial statements are currently: (a) Trading Profit and Loss Account/the Statement of Comprehensive Income (b) A Statement of Changes in Equity (c) The Statement of Financial Position (d) The Cash Flow Statement Notes to these primary financial statements are used to amplify and explain the primary statements. The notes on primary financial statements form an integral part of the financial statements. G. THE STATEMENT OF FINANCIAL POSITION This is a financial statement of the assets, liabilities and ownership interests drawn up at a particular point in time. This point in time for the annual financial statement is referred to as the entity’s year end. H. THE STATEMENT OF COMPREHENSIVE INCOME (PROFIT & LOSS) The Statement of Comprehensive Income details the trading results for the period. It details the Revenue earned and the expenses incurred. I. THE STATEMENT OF CHANGES IN EQUITY A statement of changes in equity shows the following items: • Net profit/loss for the period • Gains/losses recognised directly in equity e.g. surplus on revaluation of land and buildings • Cumulative effect of changes in accounting policy and the correction of fundamental errors (per IAS 8, which will be dealt with in a later chapter) • Capital transactions with owners, for example, dividend payments share issue. • Accumulated profit/loss • − At start of the year − Movement for year − At end of year Reconciliation between carrying amount at the start and end of the year for: Page 19 J. − Each class of equity − Share premium − Each reserve THE CASH FLOW STATEMENT This statement shows the increase or decrease in the amount of cash/cash equivalents the entity has generated since the previous year end. K. ELEMENTS OF FINANCIAL STATEMENTS Financial statements need to reflect the effects of transactions and other events on the reporting entity’s financial performance and financial position. This involves a high degree of classification and aggregation. Order is imposed on this process by specifying and defining the classes of items – the elements – that encapsulate the key aspects of the effects of those transactions and other events. The main elements and their definitions are as follows: • Assets – a resource controlled by an entity as a result of past events from which future economic benefits are expected to flow. Assets are broken down between current assets and non-current assets (formerly known as fixed assets). • Liabilities – present obligations of the entity arising from past events, settlement of which is expected to result in an outflow of resources embodying economic benefits. Liabilities are broken down between current liabilities and non-current liabilities. • Equity – the residual interest in the assets of the entity after deducting all its liabilities. • Income – increases in economic benefits in the form of inflows of assets or decreases of liabilities that result in increases in equity. • Expenses – decreases in economic benefits in the form of outflows of assets or incurrence of liabilities that result in decreases in equity. Assets Future Economic Benefits – If an item does not generate future economic benefits it is not an asset. There must be evidence that cash will be received in the future. Controlled by an Entity – Though ownership is not essential control is a vital element. Control means the ability to restrict use. Past Transactions or Events – The transaction or event must be in the past before an asset can arise. Access to economic benefits obtained after the Statement of Financial Position date cannot constitute an asset. Liabilities Obligations – These may be legal or constructive. A legal obligation derives from a contract, legislation or other operation of law. A constructive obligation derives from the entity’s actions e.g. refunds to dis-satisfied customers. Page 20 Transfer of Economic Benefits – This normally represents a transfer of cash but could involve the exchange of an asset e.g. trade in of a motor vehicle. Obligations that are not expected to result in a transfer of economic benefits e.g. the guarantee of a loan, are referred to as contingent liabilities Past Transactions or Events – The transaction or event must be in the past. L. RECOGNITION IN FINANCIAL STATEMENTS The objective of financial statements is achieved to a large extent by showing in the primary financial statements, in words and by a monetary amount, the effects that transactions and other events have on the elements. This process is known as recognition. For example, if the effect of a transaction is to create a new asset or liability or to add to an existing asset or liability, that new asset or liability or addition will be recognised in the Statement of Financial Position if there is sufficient evidence that it exists and it can be measured reliably enough as a monetary amount. A gain or loss will be recognised at the same time, unless there has been no change in the total net assets or the whole of the change is the result of capital contributions or distributions. M. MEASUREMENT IN FINANCIAL STATEMENTS In order that an asset or liability can be recognised, it needs to be assigned a monetary carrying amount. Two measurement bases could be used for this purpose: • Historical Cost – which is the lower of cost and recoverable amount (as defined below) Or • Current Value – which is the lower amount of replacement cost and recoverable amount. Most assets and liabilities arise from arm’s length transactions. In such circumstances and regardless of the measurement basis used, the carrying amount assigned on initial recognition will be the transaction cost. The carrying amounts derived from the two bases will usually change after initial recognition, making it necessary to decide which basis to use. The approach adopted by many entities involves measuring some Statement of Financial Position categories at historical cost and some at current value. Although this is often referred to as the modified historical cost basis, it is more accurately referred to as the mixed measurement system. It is envisaged that the measurement basis used for a category of assets or liabilities will be determined by reference to factors such as the objective of financial statements, the nature of the assets or liabilities concerned and the particular circumstances involved. It is also envisaged that a separate decision as to the appropriate measurement basis will be taken for each Statement of Financial Position category. That decision will need to be kept under review as accounting thought, access to markets, and circumstances change. Page 21 Whatever the measurement base chosen, the carrying amount may need to be changed from time to time. This process is known as re-measurement. • When historical cost measure is used, re-measurements are necessary to ensure that items are stated at the lower of cost and recoverable amount. • When a current value is used, re-measurements are necessary to ensure that items are stated at up to date current value. Re-measurements will be recognised only if there is sufficient evidence that the monetary amount has changed and the new amount can be measured with sufficient reliability. Recoverable amount is the higher of realisable value and value in use. Realisable value is the amount that could be obtained by selling the asset in an orderly disposal. Value in use is the present discounted value of the future cash flows obtainable as a result of an asset’s continued use, including those resulting from its ultimate disposal. N. THE HISTORICAL CONVENTION/SYSTEM Conventionally, financial accounts are based on historical cost – which is assets/liabilities recorded in the Statement of Financial Position at their cost of acquisition. Expenses are charged against revenues in determining profit based upon historic cost of assets used in generation of the revenues. Advantages of Historical Cost Accounting: (a) Consistent with fundamental accounting concepts (b) Objective and the information it produces is easily verified. (c) Simple and inexpensive to record the information. (d) Easily understood by the users of financial statements. Disadvantages of Historical Cost Accounting: (a) Assets values unrealistic, in particular land and buildings. (b) Comparisons over time meaningless. (c) Maintenance of the physical substance of business ignored. O. THE ACCOUNTING PROFESSION AND THE ROLE OF THE ACCOUNTANT Professional independence is a concept fundamental to the accountancy profession. It is essentially an attitude of mind characterised by integrity and an objective approach to professional work. A practising member should both be and appear to be, in each professional assignment he undertakes, free of any interest, which might be regarded, whatever its actual effect, as being incompatible with objectivity. The fact that this is selfevident in the exercise of the reporting function must not obscure its relevance in respect of other professional work. Accountants cannot avoid external pressures on their integrity and objectivity in the course of their professional work, but they are expected to resist these pressures. They must, in fact, retain their integrity and objectivity in all phases of their Page 22 practice and, when expressing "opinions" on financial statements avoid involvement in situations that would impair the credibility of their independence in the minds of reasonable people familiar with the facts. The accountancy profession exists to ensure that all interested parties entitled to knowledge of certain facts have those facts presented objectively. That is the essence of high professional standards and is as appropriate to the accountant in commerce and industry as to the accountant in public practice. Anything, which tends to impair or might appear to impair objectivity, in relation to any particular assignment or client must cast grave doubt on the propriety of the accountant acting in the assignment for the client in question. Examples of undesirable financial involvement are • An accountant should not make a loan to a client or guarantee a client’s overdraft • A loan should not be accepted from a client • An accountant should not give advice to a client, where such advice, if acted upon would result in receipt of commission by the accountant, unless the client is made aware of the receipt of such commission It is undesirable that a practice should derive too great a part of its professional income from one client or group of connected clients. A practice, therefore, should endeavour to ensure that the recurring fees paid by one client or group of connected clients do not exceed 10% of the gross fees of the practice or, in the case of a member practising parttime, 10% of his gross earned income. It is recognised that a new practice seeking to establish itself or an old practice running itself down may well not, in the short term, be able to comply with this criterion. If a member is dependent for his income on the profits of any one office within a practice and the gross income of that office is regularly dependent on one client or a group of connected clients for more than 10% of its gross fees, a partner from another office of the practice should take final responsibility for any report made by the practice on the affairs of that client. The conduct towards which an accountant should strive is embodied in six broad principles stated as affirmative Ethical Principles:1. 2. 3. Independence, Integrity and Objectivity An accountant should maintain his/her integrity and objectivity and, when engaged in the practice of public accounting, be independent of those he/she serves Competence and Technical Standards An accountant should observe the profession's technical standards and strive continually to improve this competence and the quality of his/her services Responsibilities to Clients An accountant should be fair and candid with his/her clients and serve them to the best of his/her ability, with professional concern for their best interests, consistent with his/her responsibilities to the public 4. Responsibilities to Colleagues An accountant should conduct himself/herself in a manner, which will promote cooperation and good relations among members of the profession 5. Other Responsibilities and Practice Page 23 An accountant should conduct himself/herself in a manner, which will enhance the stature of the profession and its ability to serve the public 6. Responsibility of Members Not In Practice An accountant not in practice must uphold the standards and etiquette of the profession The foregoing Ethical Principles are intended as a broad guideline. They constitute the philosophical foundation upon which the professional conduct of accountants is based. P. INTERNAL AND EXERNAL AUDITORS The role and function of external auditors Financial statements are used for a variety of purposes and decisions. For example, financial statements are used by owners to evaluate management’s stewardship, by investors for making decisions about whether to buy or sell securities, by credit rating services for making decisions about credit worthiness of entities, and by bankers for making decisions about whether to lend money. Effective use of financial statements requires that the reader understand the roles of those responsible for preparing and auditing financial statements. Financial statements are the representations of management. When using management’s statements, the reader must recognize that the preparation of these statements requires management to make significant accounting estimates and judgments, as well as to determine from among several alternative accounting principles and methods those that are most appropriate within the framework of generally accepted accounting standards. In contrast, the auditor’s responsibility is to express an opinion on whether management has fairly presented the information in the financial statements. In an audit, the financial statements are evaluated by the auditor, who is objective and knowledgeable about auditing, accounting, and financial reporting matters. During the audit, the auditor collects evidence to obtain reasonable assurance that the amounts and disclosures in the financial statements are free of material misstatement. However, the characteristics of evaluating evidence on a test basis, the fact that accounting estimates are inherently imprecise, and the difficulties associated with detecting misstatements hidden by collusion and careful forgery, prevent the auditor from finding every error or irregularity that may affect a user’s decision. The auditor also evaluates whether audit evidence raises doubt about the ability of the client to continue as a going concern in the foreseeable future. However, readers should recognize that future business performance is uncertain, and an auditor cannot guarantee business success. Through the audit process, the auditor adds credibility to management’s financial statements, which allows owners, investors, bankers, and other creditors to use them with greater confidence. Page 24 The auditor expresses his assurance on the financial statements in an auditor’s report. The report, which contains standard words and phrases that have a specific meaning, conveys the auditor’s opinion related to whether the financial statements fairly present the entity’s financial position and results of operations. If the auditor has reservations about amounts or disclosures in the statements, he modifies the report to describe the reservations. The auditor’s report and management’s financial statements are only useful to those who make the effort to understand them. Auditor’s duties Auditors duties include:• Duty to provide an Audit Report – report to the members of the company on the financial statements examined by them. The auditors’ report must be read at the general meeting and should be made available to every member of the company. • Duty to report failure to maintain proper books of account – where auditors form the opinion that the company being audited is disobeying, or has disobeyed its obligations to maintain proper books of account, they are obliged to serve notice on the company informing it of that opinion. The auditors may report this to the Office of the Registrar General (ORG) • Duty to exercise Professional Integrity – Auditor is under a duty to carry out the audit with professional integrity. In preparing their report, they must exercise skill, car and caution of a reasonably competent, careful and cautious auditor. Duties and responsibilities of Internal Auditor Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organisation’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes. Independence is established by the organisational and reporting structure. Objectivity is achieved by an appropriate mind-set. The internal audit activity evaluates risk exposures relating to the organization's governance, operations and information systems, in relation to: Effectiveness and efficiency of operations. Reliability and integrity of financial and operational information. Safeguarding of assets. Compliance with laws, regulations, and contracts. Based on the results of the risk assessment, the internal auditors evaluate the adequacy and effectiveness of how risks are identified and managed in the above areas. They also assess other aspects such as ethics and values within the organisation, performance management, communication of risk and control information within the organization in order to facilitate a good governance process. Page 25 The internal auditors are expected to provide recommendations for improvement in those areas where opportunities or deficiencies are identified. While management is responsible for internal controls, the internal audit activity provides assurance to management and the audit committee that internal controls are effective and working as intended. An effective internal audit activity is a valuable resource for management and the board or its equivalent, and the audit committee due to its understanding of the organisation and its culture, operations, and risk profile. The objectivity, skills, and knowledge of competent internal auditors can significantly add value to an organization's internal control, risk management, and governance processes. Similarly an effective internal audit activity can provide assurance to other stakeholders such as regulators, employees, providers of finance, and shareholders. Q. INTERNAL CONTROL SYSTEMS Internal control systems are control procedures put in place by the management of an organisation to ensure efficient and effective operation of its activities, so as to meet the organisation's objectives. The importance of internal control and risk management A company’s system of internal control has a key role in the management of risks that are significant to the fulfilment of its business objectives. A sound system of internal control contributes to safeguarding the shareholders’ investment and the company’s assets. Internal control facilitates the effectiveness and efficiency of operations, helps ensure the reliability of internal and external reporting and assists compliance with laws and regulations. Effective financial controls, including the maintenance of proper accounting records, are an important element of internal control. They help ensure that the company is not unnecessarily exposed to avoidable financial risks and that financial information used within the business and for publication is reliable. They also contribute to the safeguarding of assets, including the prevention and detection of fraud. A company’s objectives, its internal organisation and the environment in which it operates are continually evolving and, as a result, the risks it faces are continually changing. A sound system of internal control therefore depends on a thorough and regular evaluation of the nature and extent of the risks to which the company is exposed. Since profits are, in part, the reward for successful risk-taking in business, the purpose of internal control is to help manage and control risk appropriately rather than to eliminate it. Page 26 Maintaining a sound system of internal control Responsibilities The board of directors is responsible for the company’s system of internal control. It should set appropriate policies on internal control and seek regular assurance that will enable it to satisfy itself that the system is functioning effectively. The board must further ensure that the system of internal control is effective in managing risks in the manner which it has approved. In determining its policies with regard to internal control, and thereby assessing what constitutes a sound system of internal control in the particular circumstances of the company, the board’s deliberations should include consideration of the following factors: the nature and extent of the risks facing the company; the extent and categories of risk which it regards as acceptable for the company to bear; the likelihood of the risks concerned materialising; the company’s ability to reduce the incidence and impact on the business of risks that do materialise; and the costs of operating particular controls relative to the benefit thereby obtained in managing the related risks. It is the role of management to implement board policies on risk and control. In fulfilling its responsibilities, management should identify and evaluate the risks faced by the company for consideration by the board and design, operate and monitor a suitable system of internal control which implements the policies adopted by the board. All employees have some responsibility for internal control as part of their accountability for achieving objectives. They, collectively, should have the necessary knowledge, skills, information and authority to establish, operate and monitor the system of internal control. This will require an understanding of the company, its objectives, the industries and markets in which it operates, and the risks it faces. Elements of a sound system of internal control An internal control system encompasses the policies, processes, tasks, behaviours and other aspects of a company that, taken together: facilitate its effective and efficient operation by enabling it to respond appropriately to significant business, operational, financial, compliance and other risks to achieving the company’s objectives. Page 27 This includes: safeguarding of assets from inappropriate use or from loss and fraud, and ensuring that liabilities are identified and managed; ensuring the quality of internal and external reporting. This requires the maintenance of proper records and processes that generate a flow of timely, relevant and reliable information from within and outside the organisation; ensuring compliance with applicable laws and regulations, and also with internal policies with respect to the conduct of business. A company’s system of internal control will reflect its control environment which encompasses its organisational structure. The system will include: control activities; information and communications processes; and processes for monitoring the continuing effectiveness of the system of internal control. The system of internal control should: be embedded in the operations of the company and form part of its culture; be capable of responding quickly to evolving risks to the business arising from factors within the company and to changes in the business environment; and include procedures for reporting immediately to appropriate levels of management any significant control failings or weaknesses that are identified together with details of corrective action being undertaken. A sound system of internal control reduces, but cannot eliminate, the possibility of poor judgement in decision-making; human error; control processes being deliberately circumvented by employees and others; management overriding controls; and the occurrence of unforeseeable circumstances. A sound system of internal control therefore provides reasonable, but not absolute, assurance that a company will not be hindered in achieving its business objectives, or in the orderly and legitimate conduct of its business, by circumstances which may reasonably be foreseen. A system of internal control cannot, however, provide protection with certainty against a company failing to meet its business objectives or all material errors, losses, fraud, or breaches of laws or regulations. Reviewing the effectiveness of internal control Page 28 Responsibilities Reviewing the effectiveness of internal control is an essential part of the board’s responsibilities. The board will need to form its own view on effectiveness after due and careful enquiry based on the information and assurances provided to it. Management is accountable to the board for monitoring the system of internal control and for providing assurance to the board that it has done so. The role of board committees in the review process, including that of the audit committee, is for the board to decide and will depend upon factors such as the size and composition of the board; the scale, diversity and complexity of the company’s operations; and the nature of the significant risks that the company faces. To the extent that designated board committees carry out, on behalf of the board, tasks that are attributed in this guidance document to the board, the results of the relevant committees’ work should be reported to, and considered by, the board. The board takes responsibility for the disclosures on internal control in the annual report and accounts. Page 29 Study Unit 2 Regulatory & Non-Regulatory Framework Contents A. Generally Accepted Accounting Principles (GAAP) B. The Regulatory Framework – Non Statutory C. The Regulatory Framework – Statutory Page 30 A. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) The phrase Generally Accepted Accounting Principles is a technical accounting term that encompasses the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. It includes not only broad guidelines of general application, but also detailed practices and procedures. These conventions, rules and procedures provide a standard by which to measure financial presentations. GAAP includes the requirements of the Companies Acts and accounting standards. It also includes acceptable accounting treatments whether or not they are set out in law and accounting standards. Sources of GAAP The main sources of GAAP are: (a) Company Law (b) International and Local Accounting Standards (c) Stock Exchange Requirements (d) The International Framework for the preparation and presentation of financial statements. (e) Any other generally accepted concepts and principles e.g. the money measurement concept. B. THE REGULATORY FRAMEWORK – NON STATUTORY Accounting rules and regulations in certain jurisdictions for example (Ireland, UK) are governed by a Financial Reporting Council (FRC). The FRC (UK & Ireland) has two divisions – the Accounting Standards Board (ASB) and the Review Panel. There are 25 members on the council plus some observers, comprising a chairman and three deputy chairmen. Member representation is from both users and preparers and from auditors and drawn from three broad establishments – the accountancy profession, the financial community and the world of business and administration at large. The council meets approximately three times a year. The main functions of a Financial Reporting Council (FRC) are to: • Provide funding for its two divisions – the ASB and the Review Panel. • Enforce compliance with standards currently in issue and in particular to the Review Panel – it is the FRC which takes companies to court to enforce changes to accounts where a company has refused to make changes recommended by the review panel. • Set a general work programme for the ASB. • Give guidance to the ASB and the Review Panel to ensure their work is carried out efficiently and economically. • Provide a forum for public debate and support of accounting standards. Prior to the creation of the FRC (UK & Ireland) accounting rules and regulations were governed by the Accounting Standards Committee (ASC). In total the ASC issued 25 Page 31 Statements of Standard Accounting Practice (SSAP) covering such areas as stocks and long term contracts research and development and post Statement of Financial Position events. In Rwanda: The Companies Act, Law No 7/2009 of 27/4/2009 Relating to Companies (Article 254 and others) mandates the application of International Accounting Standards with regard to financial reporting by the registered companies. At present, the banks and other financial institutions are required by the National Bank of Rwanda to follow IFRS. The newly established ICPAR has been legally mandated to prepare accounting and auditing standards consistent with IFRS and ISA respectively. International Accounting Standards Board (IASB): In April 2001 the International Accounting Standards Board was formed to take over the work of the International Accounting Standards Committee (IASC). The International Accounting Standards Committee was set up in 1973. The role of this body was to formulate and publish accounting standards to be observed in the presentation of financial statements and to promote their world-wide acceptance and observance and to work for the improvement and harmonisation of regulations, accounting standards and procedures relating to the presentation of financial reporting. Objectives of the IASB The objectives of the IASB are set out in its mission statement: • “To develop, in the public interest a single set of high quality, understandable and enforceable global accounting standards that require high quality transparent and comparable information in financial statements.” • To promote the use of rigorous application of these standards. • To work actively with actual standard-setters to achieve conveyance of accounting standards around the world. Structure IASC Foundation 19 Trustees Standards Advisory Council (SAC) IASB 14 Members International financial Reporting Interpretations Committee (IFRIC) Foundation Trustees These are 19 individuals from different geographical and functional backgrounds. Among their functions are the appointment of the Council, The Board and The Interpretation Committee. Also they monitor the effectiveness of the IASB, secure funding and approve budgets and have responsibility for constitutional change. Page 32 IASB This comprises 14 members (12 full time) who are appointed by the trustees for an initial term of three to five years. The Board’s responsibilities include: • Develop and publish discussion documents for public comment • Prepare and issue exposure drafts • Setting up procedures for reviewing comments received on documents published for comment • Preparation and issue of International Accounting Standards Standards Advisory Council (SAC) About 45 members make up the Standards Advisory Council. It meets in public at least three times a year with the Board. It advises the Board on agenda decisions and priorities. International Financial Reporting Interpretations Committee (IFRIC) The committee is made up of accounting experts from different countries. The objective of IFRIC is to develop conceptually sound and practicable interpretations of International Accounting Standards to be applied on a global basis. These interpretations are developed for financial reporting issues not specifically addressed by the International Accounting Standard and where unsatisfactory conflicting interpretations of a standard have developed. These pronouncements have the same force as an International Accounting Standard. Discussion Documents The IASB develops and publishes discussion documents. These represent a study of a financial reporting issue. They present alternative solutions to the issue under consideration and set out arrangements and implications relative to each. Following the receipt of comments IASB develops and publishes on Exposure Draft. Exposure Draft An exposure draft is a proposed accounting standard. The IASB invites comments thereon. After a reasonable time period, normally 120 days, an accounting standard is produced. International Accounting Standards/International Financial Reporting Standards The International Accounting Standards Committee (IASC) produced accounting standards called International Accounting Standards (IAS). It has published 41 International Accounting Standards some of which are no longer in force. The International Accounting Standards Board, which took over from the IASC produces accounting standards called International Financial Reporting Standards IFRS. To date it has produced five of these. Rwandan Stock Exchange Public limited companies (Ltd) are required to observe requirements as set by the Rwandan Stock Exchange. Most of its requirements are covered by compliance with company law. Statements of Recommended Practice (SORPs) Statements of Recommended Practice are developed in the public interest and set out current best accounting practice. The primary aims in issuing SORPs are to narrow the areas of Page 33 difference and variety in the accounting treatment of the matters with which they deal and to enhance the usefulness of published accounting information. SORPs are issued on subjects on which it is not considered appropriate to issue an accounting standard at the time. SORPs may be developed and issued by the Accounting Standards Board or they may be developed and issued by an "industry" group which is representative of the industry concerned for the purpose of the developing SORPs specific to that industry and is recognised as such by the ASR. Such SORPs are sent for approval and franking by the ASB and are referred to as "franked SORPs". Before approving and franking a franked SORP, the ASB will review the proposed statement and the procedures involved in its development. Although SORPs are not mandatory, entities falling within their scope are encouraged to follow them and to state in their accounts that they have done so. They are also encouraged to disclose any departure from the recommendations and the reasons for it. The provisions need not be applied to immaterial items. Advantages of Standards (a) Provide the accounting profession with a manual of useful working rules (b) Forces improvements in the quality of the work of the accountant (c) Strengthen the accountant's resistance against pressure from directors to use an accounting policy which may be suspect (d) Ensure that the users of financial statements get more complete and clearer information on a consistent basis from period to period (e) Help in the comparison users may make between the financial statements of one organisation and another (f) Direct financial statements towards establishing the economic truth of the entity's performance Disadvantages of Standards (a) The working rules are bureaucratic and lead to rigidity (b) The quality of the work is restricted because firms and industries differ and change, as do the environments within which they operate. Standards, which are based on averages, lead to rigidity and reduce the scope for professional judgements. (c) Official acceptance reduces the accountant's strength to resist the application of an inappropriate standard when the directors wish to follow it (d) Users are likely to think that the financial statements produced using accounting standards are infallible (e) Although providing formulae, standards are still low for the figures used as inputs are selected with some subjectivity, which reduces the possible benefits of comparison between firms, when the input base may not be known (f) They have been derived through social or political pressures which may reduce the freedom and lead to manipulation of the profession (g) They impair the development of critical thought (h) The more standards there are the more costly the financial statements are to produce Page 34 True and Fair True relates to the correctness of an item in the financial statements. Fair is a judgmental characteristic relating to the description and measurement of an item in the financial statements. Consider the following sentence: A motor vehicle cost RWF15,000,000 and its expected useful life is five years, the cost of RWF15,000,000 can be verified, it is true, however the useful life of five years is an estimate which can be regarded as fair. If the expected life was stated as 50 years this would not be regarded as fair. Compliance with accounting standards is taken as the best indication that the financial statements show a true and fair view. Framework for the Presentation and Preparation of Financial Statements An accounting standard-setter’s conceptual framework or statement of principles describes the accounting model that it uses as the conceptual underpinning for its work. The Statement describes the standard-setter’s views on: • The activities that should be reported on in financial statements • The aspects of those activities that should be highlighted • The attributes that information needs to have if it is to be included in the financial statements • How information should be presented in those financial statements The Purpose of the Framework The framework documents can have a variety of roles. The main role of the Framework is to provide conceptual input into the IASB’s work on the preparation and appraisal of accounting standards. The Framework is not, therefore, an accounting standard, nor does it contain any requirements on how financial statements are to be prepared. A number of the principles in the Framework play fundamental roles in existing accounting standards, for example, several draw on the statement’s definitions of assets and liabilities; IAS 37: Provisions, Contingent Liabilities and Contingent Assets. The Framework therefore plays a very important role in the standard-setting process, although it is only one of the factors that the ASB takes into account when setting standards. Other factors include legal requirements, cost-benefit considerations, industry-specific issues, and the desirability of evolutionary change and implementation issues. The six stages of standard setting International Financial Reporting Standards (IFRSs) are developed through an international consultation process, the "due process", which involves interested individuals and organisations from around the world. The due process comprises six stages, with the Trustees having the opportunity to ensure compliance at various points throughout: Stage 1: Setting the agenda Page 35 The IASB, by developing high quality accounting standards, seeks to address a demand for better-quality information that is of value to all users of financial statements. Better–quality information will also be of value to preparers of financial statements. The IASB evaluates the merits of adding a potential item to its agenda mainly by reference to the needs of investors. The IASB considers: the relevance to users of the information and the reliability of information that could be provided whether existing guidance available the possibility of increasing convergence the quality of the standard to be developed resource constraints To help the IASB in considering its future agenda, its staff are asked to identify, review and raise issues that might warrant the IASB’s attention. New issues may also arise from a change in the IASB’s conceptual framework. In addition, the IASB raises and discusses potential agenda items in the light of comments from other standard-setters and other interested parties, the IFRS Advisory Council and the IFRS Interpretations Committee, and staff research and other recommendations. The IASB receives requests from constituents to interpret, review or amend existing publications. The staff consider all such requests, summarise major or common issues raised, and present them to the IASB from time to time as candidates for when the IASB is next considering its agenda. IASB meetings The IASB’s discussions of potential projects and its decisions to adopt new projects take place in public IASB meetings. Before reaching such decisions the IASB consults the IFRS Advisory Council and accounting standard-setting bodies on proposed agenda items and setting priorities. In making decisions regarding its agenda priorities, the IASB also considers factors related to its convergence initiatives with accounting standard-setters. The IASB’s approval to add agenda items, as well as its decisions on their priority, is by a simple majority vote at an IASB meeting. Stage 2: Project planning When adding an item to its active agenda, the IASB also decides whether to: conduct the project alone, or jointly with another standard-setter Page 36 Similar due process is followed under both approaches. After considering the nature of the issues and the level of interest among constituents, the IASB may establish a working group at this stage. A team is selected for the project by the two most senior members of the technical staff: The Director of Technical Activities; and The Director of Research The project manager draws up a project plan under the supervision of those Directors. The team may also include members of staff from other accounting standard-setters, as deemed appropriate by the IASB. Stage 3: Development and publication Although a discussion paper is not mandatory, the IASB normally publishes it as its first publication on any major new topic to explain the issue and solicit early comment from constituents. If the IASB decides to omit this step, it will state why. Typically, a discussion paper includes: a comprehensive overview of the issue; possible approaches in addressing the issue; the preliminary views of its authors or the IASB; and an invitation to comment This approach may differ if another accounting standard-setter develops the research paper. Discussion papers may result either from: a research project being conducted by another accounting standard-setter; or as the first stage of an active agenda project carried out by the IASB In the first case, the discussion paper is drafted by another standard-setter and published by the IASB. Issues related to the discussion paper are discussed in IASB meetings, and publication of such a paper requires a simple majority vote by the IASB. If the discussion paper includes the preliminary views of other authors, the IASB reviews the draft discussion paper to ensure that its analysis is an appropriate basis on which to invite public comments. For discussion papers on agenda items that are under the IASB’s direction, or include its preliminary views, the IASB develops the paper or its views on the basis of analysis drawn from staff research and recommendations, as well as suggestions made by the IFRS Advisory Council, working groups and standard-setters and presentations from invited parties. All discussions of technical issues related to the draft paper take place in public sessions. Stage 4: Development and publication of an exposure draft Page 37 Publication of an exposure draft is a mandatory step in due process. Irrespective of whether the IASB has published a discussion paper, an exposure draft is the IASB’s main vehicle for consulting the public. Unlike a discussion paper, an exposure draft sets out a specific proposal in the form of a proposed standard (or amendment to an existing standard) The development of an exposure draft begins with the IASB considering: issues on the basis of staff research and recommendations; comments received on any discussion paper; and suggestions made by the IFRS Advisory Council, working groups and accounting standard-setters, and arising from public education sessions After resolving issues at its meetings, the IASB instructs the staff to draft the exposure draft. When the draft has been completed, and the IASB has balloted on it, the IASB publishes it for public comment. Stage 5: Development and publication of an IFRS The development of an IFRS is carried out during IASB meetings, when the IASB considers the comments received on the exposure draft. After resolving issues arising from the exposure draft, the IASB considers whether it should expose its revised proposals for public comment, for example by publishing a second exposure draft. In considering the need for re-exposure, the IASB: identifies substantial issues that emerged during the comment period on the exposure draft that it had not previously considered assesses the evidence that it has considered evaluates whether it has sufficiently understood the issues and actively sought the views of constituents considers whether the various viewpoints were aired in the exposure draft and adequately discussed and reviewed in the basis for conclusions. Stage 6: Drafting the IFRS The IASB’s decision on whether to publish its revised proposals for another round of comment is made in an IASB meeting. If the IASB decides that re-exposure is necessary, the due process to be followed is the same as for the first exposure draft. When the IASB is satisfied that it has reached a conclusion on the issues arising from the exposure draft, it instructs the staff to draft the IFRS. Pre-ballot draft Page 38 A pre-ballot draft is usually subject to external review, normally by the IFRIC. Shortly before the IASB ballots the standard, a near-final draft is posted on eIFRS. Finally, after the due process is completed, all outstanding issues are resolved, and the IASB members have balloted in favour of publication, the IFRS is issued. Procedures after an IFRS is issued After an IFRS is issued, the staff and the IASB members hold regular meetings with interested parties, including other standard-setting bodies, to help understand unanticipated issues related to the practical implementation and potential impact of its proposals. The IFRS Foundation also fosters educational activities to ensure consistency in the application of IFRSs. After a suitable time, the IASB may consider initiating studies in the light of: its review of the IFRS’s application, changes in the financial reporting environment and regulatory requirements, and comments by the IFRS Advisory Council, the IFRS Interpretations Committee, standard-setters and constituents about the quality of the IFRS Those studies may result in items being added to the IASB’s agenda. C. THE REGULATORY FRAMEWORK – STATUTORY Company Law The main law governing financial statements is the Companies Act Law no. 7/2009 of 27/4/2009 relating to companies. 1. It applies to companies both private and public. 2. All companies should file accounts with the Office of Registrar General. 3. All accounts must show a true and fair view. 4. IFRS and IASB standards must be adhered to. CONCEPTS Prior to the introduction of the Framework the following accounting concepts were used: Going Concern Continuity of the entity in its present form for the foreseeable future/there is no intention to put the company into liquidation or to drastically cut back the scale of operations Prudence Cautious presentation of the entity's financial position. Profits are recognised only when realised while losses are provided for as soon as they are foreseen Accruals Revenue earned in the period matched with costs incurred in Page 39 earning it, not as money is received or paid Consistency There is similar accounting treatment of like items within each accounting period and from one period to the next Entity That the accounts recognise the business as a distinct separate entity from its owners Money Measurement Accounts only deal with those items to which a monetary value can be attributed Materiality If omission, misstatement or non-disclosure affects the view given, the item is material and disclosure is required Substance Form over Legal Recognises economic substance from legal form e.g. assets acquired on hire purchase Stable Monetary Unit That the value of the monetary unit used is consistent over time Accounting Periods Accounts are prepared for discrete time periods Page 40 BLANK Page 41 Study Unit 3 Double Entry, Trial Balance, Statement of Financial Position Contents __________________________________________________________________________________ A. Books of Original Entry ___________________________________________________________________________ B. Nominal Ledger ___________________________________________________________________________ C. Double Entry ___________________________________________________________________________ D. The Accounting Equation ___________________________________________________________________________ E. The Statement of Comprehensive Income ___________________________________________________________________________ F. The Statement of Financial Position ___________________________________________________________________________ G. The Effects of Transactions on a Statement of Financial Position ___________________________________________________________________________ H. Capital Expenditure and Revenue Expenditure ___________________________________________________________________________ I. Questions/Solutions ___________________________________________________________________________ Page 42 A. BOOKS OF ORIGINAL ENTRY/BOOKS ENTRY/BOOKS OF FIRST ENTRY OF PRIME In order to extract a trial balance, a Statement of Comprehensive Income and Statement of Financial Position, the information must be posted to the accounting books. These accounting books are known by a number of names - the books of original entry, the books of prime entry or the books of first entry. The books of original entry comprise the following books: • Sales Book • Sales Return Book • Cash Receipts Book • Debtors (Trade Receivables)Ledger • Purchases Book • Purchases Return Book • Cheque Payment Book • Creditors (Trade Payables) Ledger • Petty Cash Book SALES BOOK: Written from Sales Invoice Each sales invoice should be entered in the sales book as follows: (a) Date of invoice (b) Customers name (c) Invoice number - all sales invoices should be sequentially numbered at the printers (d) Total amount of invoice (e) Trade Receivables ledger account (f) Cash sale amount - if not a credit sale (g) Analysis columns appropriate to the various different types of sales including VAT analysis columns - showing net goods and VAT for the respective rates and then the analysis excluding VAT. Analysis columns can be specifically tailored to the nature of the entity's business and transactions type. Analysis headings should only be set up for items, which are expected to recur regularly. All other items should be analysed under a sundry column with a brief narrative as to their nature beside that item. The sales book should be totalled and ruled off monthly. The total should agree with the cross tot of the analysis columns. Each month should be commenced on a new page. A separate section should be opened in the sales book for all sales credit notes issued and these should be dealt with in the same fashion as above in relation to recording sales invoices. This can be a separate book, if required, known as the sales returns book. Page 43 A sales summary may be prepared at the back of the sales book by entering the totals of both invoices and credit notes for each month. Example Layout of Sales Day Book: Sales Day Book Date Details Folio No. Total VAT NET CASH RECEIPTS BOOK This book should record all monies received and lodged to the bank accounts. Each receipt will be entered into the cash receipt book as follows: (a) Date received (b) Details of receipt i.e. from whom received (c) The amount of the receipt (d) Analysis of receipts i.e. debtors receipt, cash sales receipt and miscellaneous receipts. Miscellaneous receipts should have a written narrative beside such receipts for identification purposes e.g. VAT refunds etc. These miscellaneous receipts will have no corresponding entry in the debtors’ ledger. Cash sales will be analysed in the sales book both for the type of transaction and VAT analysis (e) Lodgement column - This should be the last column and should record all lodgements made to the bank The total of all the analysis columns at the end of each month should be equal to the total column - excluding the lodgement column. The total column ought to agree with the total of the lodgement column, provided daily lodgements are being made. The cash receipts book should be totalled and ruled off monthly and each month should be commenced on a new page. Bank stamped lodgement slips should be retained and kept on a special file. Example Layout of Cash Receipt Book: Cash Receipt Book Date Details Sundry Receipts Total Receipts A/C Ref From DRS Page 44 VAT Analysis of Col. PURCHASES BOOK On receipt of a purchase invoice, the invoice should be assigned an internal sequential number. This number has no relevance to the supplier but it is a method of filing and retrieving it, if required. All calculations, additions and extensions on the purchase invoice should be checked. It is also a means to check that all invoices are entered into the “books”. I.e. numbers should be sequential and it is easier to check if any are missing from the relevant books and analysis sheets. Each invoice should be entered in the purchase book detailing the following: (a) Date of invoice - i.e. date received and entered (b) Supplier's name (c) Internal sequential number of invoice (d) Total amount (e) Creditor’s ledger amount - if applicable (f) Analysis columns for purchase of materials by category e.g. capital expenditure, subcontract work, travel, entertainment, sundry, etc. including VAT analysis columns. The analysis columns should show net goods and VAT at the respective rates and the analysis excluding VAT. The VAT analysis columns will be split between items for resale and non-re-sale items and any further analysis required for the annual VAT returns. Analysis columns will be specifically tailored to the nature of the entity's business and the transactions type. Analysis headings should only be set up for items which are expected to recur regularly. All other items should be analysed under a sundry column and a brief narrative as to their nature beside that item. The purchase book should be totalled and ruled off monthly. The total column must agree with the cross total of the analysis columns plus the VAT column. Each month should be commenced on a new page. A separate section should be opened in the purchases book for all purchases credit notes received and these should be dealt with in the same fashion as noted above related to recording purchase invoices. This can be kept as a separate book, if necessary and called the purchase returns book. A purchase summary should be prepared at the back of the purchases book by entering the total of the invoices and credit notes for each month. Example Layout of Purchases Day Book: Purchases Day Book Date Details No. Total Page 45 VAT NET CHEQUE PAYMENTS BOOK This records all payments made through the bank accounts. Each payment amount will be entered into the cheque payments book as follows: (a) Date of cheque (b) Details of payment i.e. to whom payable and for what (c) Cheque number (d) Cheque total (e) Analysis of payment i.e. creditors payments, salaries, wages, motor expenses, etc. Apart from payment to creditors, other payments will be made directly by cheque i.e. no corresponding entry will exist in the purchase book or creditors ledger. The exact analysis of items other than payments processed through the payments relating to purchases book and the creditors’ ledger will be dependent on the nature of the company's business and transactions. Analysis headings should only be set up for items, which are expected to recur regularly. All other times should be analysed under a sundry column with a brief narrative as to their nature beside that item. It is essential that when cheques are being presented for signature that they must be accompanied by the supporting documentation i.e. invoice, goods received note and/or supplier’s statement. On payment, the supporting documentation should be stamped "Paid" and initialled by the cheque signatory in order to prevent re-payment. All cheques should be crossed "Account Payee only - non-negotiable". Suppliers’ statements should be agreed with invoices to hand and if applicable, the creditors’ ledger balances. The total of all the analysis columns at the end of the month should be equal to the total column. The cheque payments should be totalled and ruled off monthly and each month should be commenced on a new page. Example Layout of Cheque Payments Book: Cheque Payments Book Date Ch. No. Payee Total Payments Payments to Creditors A/C Wages Bank Other Ref Interest Analysis Charges Columns DEBTORS (Trade Receivables) LEDGER/SALES LEDGER A debtors’ (trade receivables) ledger is used to keep a record of all amounts due to the company in respect of sales made. A loose-leaf type ledger would be the appropriate form to operate. An account should be maintained for each debtor (trade receivables) - including debtors (trade receivables) in foreign currencies, if any. An index at the front of the ledger can record the debtors’ name. All sales to customers should be posted from the sales book to the DEBIT side of the individual accounts involved. Each entry should show the date, the description i.e. goods or services, the invoice number, the sales book reference and the amount - including VAT. Page 46 All returns from customers should be posted from the sales return book on the CREDIT side of the individual accounts involved. Each entry should show the date, the description, the credit note number, the sales returns book reference and the amount, including VAT. Any receipts from debtors (trade receivables) should be posted from the debtors’ (trade receivables) columns in the cash receipts book on the CREDIT side of the individual accounts involved. Each entry should show the date received, description i.e. cash or cheque, the cash receipts book reference and the amount received. A list of balances should be maintained periodically and this list should show the amount due by debtors (trade receivables) to the company at that date. A control account should be maintained at the front of the ledger to which the total sales, total credits and total receipts for each month should be posted. The balance on this control account at the end of every month should agree with the total of the debtors’(trade receivables) balances at that date. CREDITORS (Trade Payables) LEDGER/PURCHASES LEDGER A creditors’ (trade payables) ledger is used to keep a record of all amounts due by the company in respect of purchases made. Initially, a creditor’s ledger account should only be opened where the amounts involved are relatively large or for a supplier where transactions are expected to recur on a regular basis. At a later date, when the overall volume of transactions increases, to maintain a control, all purchases may be processed through the creditors’ (trade payables) ledger whether for cash/cheque or credit. A Creditor’s Ledger is useful to analyse from whom purchase are made, how often and how much A loose-leaf type ledger would be the appropriate form to operate. An account should be maintained for each creditor - including foreign currency creditors. An index at the front of the ledger can record the creditors’ (trade payables) name. All purchases from suppliers should be posted from the purchase book to the CREDIT side of the individual account involved. Each entry should show the date of the purchase, the description i.e. goods or services, the internal reference number, the purchase book reference and the amount, including VAT. All returns to customers should be posted from the purchases returns book on the DEBIT side of the individual accounts involved. Each entry should show the date, the description, the credit note number, the purchases returns book reference and the amount, including VAT. Any payments to creditors (trade payables) should be posted from the creditor columns in the cheque payments book on the DEBIT side of the individual accounts involved. Each entry should show the date paid, description i.e. cash or cheque, the cheque number, the cheque payments book reference and the amount paid. A list of balances should be maintained periodically and this list should show the amount due to creditors by the company at that date. A control account should be maintained at the front of the ledger to which the total purchases, total credits and total payments for each month should be posted. The balance on Page 47 this control account at the end of every month should agree with the total of the creditors (trade payables) balance at that date. PETTY CASH BOOK or PETTY CASH ACCOUNT This should record all cheques drawn to fund petty cash. These should be recorded as receipts in the petty cash book. Furthermore, a full record should be kept, with supporting documentation, of all disbursements made out of petty cash. These disbursements should be analysed under appropriate columns as follows: (a) Date (b) Narrative (c) Petty cash docket reference number (d) Total amount (e) VAT analysis split between items for re-sale and non-re-sale items recording the net goods and VAT amount for each rate of VAT (f) The analysis of the nature of the disbursements will be the amount exclusive of VAT and all probably cover headings such as postage, entertainment, travel, publications, office requisitions, etc. and a sundry column. The sundry column is for items, which are not expected to recur regularly and each entry in this column should have a brief narrative as to the nature of transaction. It is preferable that an imprest petty cash system be operated whereby a pre-set amount of cash be introduced into petty cash, i.e. RWF100,000 and this would be topped up to the preset amount at the end of each week, or when required. The exact amount to be put into petty cash will be determined by the volume of transaction processed through petty cash and the amount of the individual transactions. It would be preferable to establish a maximum amount that may be processed for any transaction through petty cash i.e. RWF10,000. Thereafter, any amounts in excess of that amount are paid by cheque. B. NOMINAL LEDGER The information to prepare a Statement of Comprehensive Income and Statement of Financial Position is extracted from the NOMINAL LEDGER. The NOMINAL LEDGER is a book/record containing what are referred to as LEDGER ACCOUNTS. An individual LEDGER ACCOUNT shows details of transactions in relation to the various ASSETS, LIABILITIES, EXPENSES and REVENUE. Each account is given a separate page. The page is divided into two halves. The left-hand side of the page is called the debit side while the right hand side of the page is called the credit side. The title of the account is shown across the top of the account at the centre. EXAMPLE Capital of RWF10,000 introduced into business and lodged to the Bank Account Page 48 BANK ACCOUNT Debit Side 1 Jan Capital Account Credit Side RWF 10,000 RWF CAPITAL ACCOUNT Debit Side Credit Side RWF 1 Jan Bank Account RWF 10,000 DOUBLE ENTRY The method of bookkeeping in use is called the double entry method. It was invented in the 15th century by Luca Pacioli 1. For every debit entry, there is an equal and corresponding credit entry. 2. For every credit entry, there is an equal and corresponding debit entry. TRIAL BALANCE All the items recorded in all the accounts on the debit side should equal in total all the items recorded on the credit side. In accounting terminology to see if the two sides of the NOMINAL LEDGER agree, a TRIAL BALANCE is drawn up. EXAMPLE Trial Balance Debit RWF 5,800 5,000 400 500 5,500 1,000 Bank Premises Furniture Van Inventory Trade Receivables Capital Loan Trade Payables Profit & Loss 18,200 Page 49 Credit RWF 10,000 4,000 3,250 950 18,200 C. DOUBLE ENTRY Accounting involves the systematic interpretation of economic transactions and activities and the communication of the results to the decision-makers. The two basic rules relating to double entry bookkeeping are: (a) Debits are to the LEFT while credits are to the RIGHT in a standard ledger account. (b) Every DEBIT must have a CREDIT – or more specifically, the value of entries posted to the DEBIT side must equal the value of entries posted to the CREDIT side i.e. both sides should be equal and balance at all times. Ledger Account Debit Side Credit Side Following these rules, as the value of the total debits must be equal to the value of the credit, then Assets = Liabilities and Capital D. THE ACCOUNTING EQUATION The resources of a firm are known as ASSETS. Someone must have supplied these resources. The total amount supplied by the owner of the business is known as CAPITAL. Therefore, if all the resources of the business are supplied by the owner, the following must be true: ASSETS = CAPITAL However, some of the assets normally have been provided by some other person than the owner. This indebtedness of a firm is referred to as LIABILITIES. Therefore, the equation is now referred to as ASSETS = CAPITAL + LIABILITIES or ASSETS - LIABILITIES = CAPITAL This equality of assets with the total of capital and liabilities will always hold true. ASSETS are made up of items such as PREMISES, PLANT and MACHINERY, MOTOR VEHICLES, FIXTURES and FITTINGS, etc. LIABILITIES are made up of money owing for goods purchased, for expenses incurred and loans received by the firm, etc. CAPITAL refers to the owners’ EQUITY or NET WORTH. Page 50 EXERCISE T. Chahine. starts a business. Before he actually starts to sell anything he has bought the following: Fixtures RWF2,000, Motor Vehicle RWF5,000 and stock of RWF3,500. Although he has paid in full for the fixtures and motor vehicle, he still owes RWF1,400 for some of the goods. J. Ayim. has lent him RWF3,000, which is payable within 1 year. T. Chahine., after the above, has RWF2,800 in the business bank account and RWF100 cash in hand. You are required to prepare a Statement of Financial Position of the business. T. Chahine. Statement of Financial Position As At … RWF Non-current Assets Fixtures Motor Vehicle RWF 2,000 5,000 7,000 Current Assets Stock Bank Cash 3,500 2,800 100 6,400 13,400 9,000 Capital (Balancing Figure) Current Liabilities Trade Payables Loan 1,400 3,000 4,400 13,400 E. THE STATEMENT OF COMPREHENSIVE INCOME The Statement of Comprehensive Income shows details how the PROFIT or LOSS of a period has been made. THERE ARE TWO COMPONENTS PARTS: • THE TRADING ACCOUNT: This shows the GROSS PROFIT for the account period. The GROSS PROFIT is the difference between: SALES and COST OF GOODS SOLD • THE PROFIT AND LOSS ACCOUNT: This shows the NET PROFIT for the period. NET PROFIT = GROSS PROFIT plus INCOME FROM OTHER SOURCES less EXPENSES Page 51 EXAMPLE HORIZONTAL FORMAT Statement of Comprehensive Income for year ended 31st December 20X0 RWF 11,300 29,100 20,300 60,700 Opening Inventory Purchases Gross Profit RWF 50,000 10,700 Sales Closing Inventory 60,700 Statement of Comprehensive Income for year ended 31st December, 20X0 RWF Administration Expenses: Salaries/Wages Rent and Rates Depreciation RWF 20,300 Gross Profit 8,300 3,200 1,100 Financial Expenses: Bad Debts Selling & Distribution Expenses: Travelling Advertising NET PROFIT RWF 12,600 200 210 1,000 1,210 6,290 20,300 20,300 EXAMPLE VERTICAL FORMAT Statement of Comprehensive Income for year ended 31st December, 20X0 RWF Sales Opening Inventory Purchases RWF 50,000 11,300 29,100 40,400 (10,700) Closing Inventory Cost of Sales Gross Profit Expenses: Administration Expenses: Salaries and Wages Rent and Rates Depreciation RWF (29,700) 20,300 8,300 3,200 1,100 Page 52 12,600 Financial Expenses: Bad Debts Selling & Distribution Expenses: Travelling Expenses Advertising 200 200 210 1,000 1,210 (14,010) 6,290 Net Profit EXERCISE: PLB LIMITED Statement of Comprehensive Income: Basic The following list of balances has been extracted from the ledger of PLB Ltd as at 31st December 20X2 RWF 32,279 1,978 3,271 242 785 8,437 125 16,346 Sales Bank Interest paid Rent and Rates Postage and Stationery Advertising Salaries and Wages Repairs and Renewals Cost of Sales Required: Prepare the Statement of Comprehensive Income for the year ended 31st December, 20X2 PLB Limited Statement of Comprehensive Income for the Year Ended 31st December 20X2 RWF Sales Cost of Sales Gross Profit Expenses: Rent and Rates Bank Interest Postage and Stationery Advertising Salaries Repairs 3,271 1,978 242 785 8,437 125 14,838 1,095 Net Profit F. RWF 32,279 (16,346) 15,933 THE STATEMENT OF FINANCIAL POSITION This is simply a list of all the ASSETS CONTROLLED and all LIABILITIES OWED by the business at a particular date. It is a snapshot of the financial position of the business at a given moment in time. In the Statement of Financial Position, assets and liabilities are subdivided into: Page 53 Non-current Assets An asset with a LONG LIFE acquired FOR USE IN THE BUSINESS and NOT PURCHASED FOR RESALE (i) INTANGIBLE e.g. Goodwill (ii) TANGIBLE (iii) FINANCIAL e.g. Plant and machinery e.g. Investments Current Assets An asset owned by the business with the INTENTION OF CONVERSION INTO CASH within ONE YEAR. These are shown in order of LIQUIDITY – Inventory (stock, finished and unfinished goods), Trade Receivables, Prepaid Expenses, Bank and Cash (the more liquid, the lower down the list). Current Liabilities Amounts PAYABLE WITHIN ONE YEAR - Examples: Trade Payables, Accrued Expenses Long-Term Liabilities Amounts PAYABLE AFTER MORE THAN ONE YEAR - Examples: Debentures, Loans Capital This is a special type of LIABILITY, representing what is owed by THE BUSINESS to ITS OWNERS i.e. the proprietors claim against the business. In non-commercial entities, this is often referred to as an accumulated fund. G. THE EFFECT OF TRANSACTIONS ON A STATEMENT OF FINANCIAL POSITION Any transaction completed by the owner/employees of the business will affect the business Statement of Financial Position. The reason for this is because at all times, the golden rule is being applied i.e. every DEBIT has a CREDIT or more precisely, the value of the DEBITS is equal to the value of the CREDITS. For example, if the owner buys an asset with cash, the cash balance decreases (Credit) while the non-current assets increase (Debit). The Statement of Financial Position may be presented in one of two ways: Horizontal Format Example Limited Statement of Financial Position as at 31 December 20XX Non-current Assets Current Assets: Inventory Trade Receivables 1,400 4,800 RWF 8,800 Capital: Share Capital Reserves 6,200 Shareholders’ Funds Loan Capital Current Liabilities Trade Payables Taxation Page 54 RWF 3,500 3,000 6,500 3,000 3,500 2,000 5,500 15,000 15,000 Vertical Format Example Limited Statement of Financial Position as at 31 December 20XX RWF Non-current Assets Current Assets Inventory Trade Receivables RWF 8,800 RWF 1,400 4,800 6,200 15,000 3,500 3,000 6,500 3,000 Share Capital Reserves Shareholders Non-current Liabilities Current Liabilities Trade Payables Tax Payable 3,500 2,000 5,500 15,000 Complete the following business transactions in the pro forma Statement of Financial Position set out below: (The solutions are set out further in this unit) 1. The Introduction of Capital: G. Sarr. sets himself up in business on 1 January by paying RWF10,000 into a business bank account Statement of Financial Position of G. Sarr. as at 1 January ASSETS LIABILITIES RWF RWF 2. The Purchase of an Asset by Cheque and the Incurring of a Liability: January 2 - Purchase of premises for RWF5,000 satisfied by cheque RWF1,000 and mortgage RWF4,000 Statement of Financial Position of G. Sarr. as at 2 January ASSETS LIABILITIES RWF RWF Page 55 3. Purchase of Assets for Credit and for Cash: January 3 - Purchase of van RWF500, on credit and office furniture RWF400 for cash Statement of Financial Position of G. Sarr. as at 3 January ASSETS LIABILITIES RWF RWF 4. Purchase of asset for cash: January 4 - Purchase of Inventory for cash RWF4,000 Statement of Financial Position of G, Sarr, as at 4 January ASSETS LIABILITIES RWF RWF 5. Sale of an Asset on Credit at a Profit: January 5 - Sale of Inventory, which cost RWF1,500, for RWF2,500 on credit Statement of Financial Position of G. Sarr. as at 5 January ASSETS LIABILITIES RWF RWF 6. The Payment of a Liability by Cheque: January 6 - RWF250, being half the cost of the van, is paid by cheque Statement of Financial Position of G. Sarr. as at 6 January ASSETS LIABILITIES RWF RWF 7. The Payment of an Expense by Cheque: January 7 - Electricity bill paid, RWF50 Statement of Financial Position of G. Sarr. as at 7 January ASSETS LIABILITIES RWF RWF Page 56 8. Purchase of an Asset on Credit: January 8 - Further Inventory purchased on credit at a cost of RWF3,000 Statement of Financial Position of G. Sarr. as at 8 January ASSETS RWF 9. LIABILITIES RWF Collection of an Asset: January 9 - RWF1,500 is received in part settlement of the original debt for RWF2,500 Statement of Financial Position of G. Sarr. as at 9 January ASSETS RWF LIABILITIES RWF Solutions 1. The Statement of Financial Position of G Sarr Statement of Financial Position of G. S.arr as at 1 January Cash at Bank ASSETS RWF 10,000 Capital LIABILITIES RWF 10,000 10,000 10,000 The business is separate from G. arr. as an individual. Therefore, the business has an asset of RWF10,000 and a liability, i.e. an amount owing to a person, of RWF10,000. In this case, the amount is owing to the proprietor, G. Sarr., and by convention is called Capital, i.e. the amount the individual has invested in the business. 2. Statement of Financial Position as at 2 January Statement of Financial Position of G. Sarr. as at 2 January RWF Non-current Assets: Premises 5,000 Capital Current Assets: Non-current Liabilities Cash at Bank 9,000 Mortgage 14,000 RWF 10,000 4,000 14,000 The business has acquired an additional source of finance - a mortgage loan. There are now two types of asset, fixed and current and it is important to distinguish between them. Note that fixed or non-current assets are recorded first. Page 57 3. Statement of Financial Position as at 3 January Statement of Financial Position of G. Sarr. as at 3 January RWF Non-current Assets: Premises 5,000 Capital Furniture 400 Non-current Liabilities Van 500 Mortgage 5,900 Current Liability: Trade Payables Current Assets: Cash at Bank 8,600 14,500 RWF 10,000 4,000 500 14,500 A further source of finance has arisen – Creditors (Trade Payables). As it is of a shortterm nature, it is classified separately from the other sources of finance. The assets acquired are non-current assets and are listed in order of permanence under the heading. A sub-total of non-current assets is always made. 4. Statement of Financial Position as at 4 January Statement of Financial Position of G. Sarr. as at 4 January RWF Non-current Assets: Premises 5,000 Capital Furniture 400 Non-current Liabilities Van 500 Mortgage 5,900 Current Liability: Trade Payables Current Assets: Inventory 4,000 Cash at Bank 4,600 14,500 RWF 10,000 4,000 500 14,500 There is no change in the sources of finance; only the assets have been deployed differently. In the current assets, there are now two categories. (Note that the two items are listed in reverse order for ease of convertibility to cash). The grand totals of the Statement of Financial Position are shown on the same line. 5. Statement of Financial Position as at 5 January Statement of Financial Position of G. Sarr. as at 5 January RWF Non-current Assets: Premises 5,000 Capital Furniture 400 Profit to date Van 500 5,900 Non-current Liabilities Mortgage Current Assets: Inventory 2,500 Current Liability: Trade Receivables 2,500 Trade Payables Page 58 RWF 10,000 1,000 11,000 4,000 500 Cash at Bank 4,600 15,500 15,500 An additional source of finance has been found. The profit on the transaction has been in the business. It belongs to the proprietor and is added to his Capital Account. The inventory has cost RWF1,500 so Inventory Account is reduced by that amount. A credit sale means that payment will be received later. The business is owed money for the Inventory by a debtor (trade receivables) and the amount owing, RWF2,500, is shown as a Current Asset in Trade Receivables. 6. Statement of Financial Position as at 6 January Statement of Financial Position of G. Sarr. as at 6 January RWF Non-current Assets: Premises 5,000 Capital Furniture 400 Profit to date Van 500 5,900 Non-current Liabilities Mortgage Current Assets: Inventory 2,500 Current Liability: Trade Receivables 2,500 Trade Payables Cash at Bank 4,350 15,250 RWF 10,000 1,000 11,000 4,000 250 15,250 The liability is met by issuing a cheque. Both the cash at bank and the creditor balance are reduced by RWF250. 7. Statement of Financial Position as at 7 January Statement of Financial Position of G. Sarr. as at 7 January RWF Non-current Assets: Premises 5,000 Capital Furniture 400 Profit to date Van 500 5,900 Non-current Liabilities Mortgage Current Assets: Inventory 2,500 Current Liability: Trade Receivables 2,500 Trade Payables Cash at Bank 4,300 15,200 RWF 10,000 950 10,950 4,000 250 15,200 The expense paid out of the bank reduces the value of the business; in this case, the profit of the period to date is reduced by the expense disbursed. Page 59 8. Statement of Financial Position as at 8 January Statement of Financial Position of G. Sarr. as at 8 January RWF Non-current Assets: Premises 5,000 Capital Furniture 400 Profit to date Van 500 5,900 Non-current Liabilities Mortgage Current Assets: Inventory 5,500 Current Liability: Trade Receivables 2,500 Trade Payables Cash at Bank 4,300 18,200 RWF 10,000 950 10,950 4,000 3,250 18,200 The creation of the additional asset, Inventory, is matched by a corresponding increase in trade payables, as the whole of the additional Inventory was purchased on credit. 9. Statement of Financial Position as at 9 January Statement of Financial Position of G. Sarr.as at 9 January RWF Non-current Assets: Premises 5,000 Capital Furniture 400 Profit to date Van 500 5,900 Non-current Liabilities Mortgage Current Assets: Inventory 5,500 Current Liability: Trade Receivables 1,000 Trade Payables Cash at Bank 5,800 18,200 RWF 10,000 950 10,950 4,000 3,250 18,200 The effect of the collection of the debt is to reduce one asset, the Trade Receivables, and to increase another, cash. From the examples given, it can be seen that even the simplest transactions effected by daily business are reflected in the Statement of Financial Position The above mentioned transactions can also be recorded in the nominal ledger as follows: Note the details show where the other entry or entries can be found Page 60 BANK A/C DR 1 Jan 2 Jan 9 Jan CR Capital Mortgage Loan Trade Receivables RWF 10,000 4,000 1,500 2 Jan 3 Jan 4 Jan 6 Jan 7 Jan 9 Jan RWF 5,000 400 4,000 250 50 5,800 15,500 Premises Furniture Inventory Trade Pay Electricity Balance c/d 15,500 9 Jan Balance b/d 5,800 PREMISES A/C DR 2 Jan CR Bank RWF 5,000 RWF FURNITURE A/C DR 2 Jan CR Bank RWF 400 RWF VAN A/C DR 3 Jan CR Creditor RWF 500 RWF INVENTORY A/C DR CR 4 Jan Bank 8 Jan Creditor RWF 4,000 3,000 7,000 9 Jan Statement Comprehensive Income Balance c/d of RWF 1,500 5,500 7,000 TRADE RECEIVABLES A/C DR 5 Jan CR Sales RWF 2,500 Page 61 9 Jan 9 Jan Bank Balance c/d RWF 1,500 1,000 2,500 ELECTRICITY EXPENSE A/C DR 9 Jan RWF 50 Bank Statement of Comprehensive Income 50 2,500 CR RWF 50 50 CAPITAL A/C DR CR RWF 1 Jan Bank RWF 10,000 MORTGAGE LOAN A/C DR CR RWF 2 Jan Bank RWF 4,000 TRADE PAYABLE A/C DR 6 Jan 9 Jan Bank Balance c/d RWF 250 3,250 3,500 3 Jan 8 Jan Van Inventory 9 Jan Balance b/d CR RWF 500 3,000 3,500 3,250 SALES A/C DR CR Statement of Comprehensive Income RWF 2,500 5 Jan Trade Receivables 2,500 RWF 2,500 2,500 STATEMENT OF COMPREHENSIVE INCOME A/C DR CR Inventory Profit c/d RWF 1,500 1,000 2,500 Sales 2,500 Profit b/d Electricity 50 Page 62 RWF 2,500 1,000 Profit c/d 950 1,000 1,000 The trial balance is extracted before final adjustments are made to ensure that the double entry has so far been correctly dealt with. G.Sarr. Trial Balance as at 9th January Debit RWF 5,800 5,000 400 500 5,500 1,000 Bank Premises Furniture Van Inventory Trade Receivables Capital Loan Trade Payables Statement of Comprehensive Income 18,200 H. Credit RWF 10,000 4,000 3,250 950 18,200 CAPITAL EXPENDITURE AND REVENUE EXPENDITURE CAPITAL EXPENDITURE is expenditure, which results in the ACQUISITION OF NONCURRENT ASSETS or an IMPROVEMENT in their EARNINGS CAPACITY ⇒ NOT CHARGED AS AN EXPENSE in the PROFIT AND LOSS ACCOUNT ⇒ APPEARS UNDER "NON-CURRENT ASSETS" in the STATEMENT OF FINANCIAL POSITION REVENUE EXPENDITURE is expenditure for the purpose of either: ⇒ TRADE OR BUSINESS e.g. administration, distribution ⇒ MAINTAINING the EXISTING EARNINGS CAPACITY OF NON-CURRENT ASSETS e.g. repairs ⇒ CHARGED to the STATEMENT OF COMPREHENSIVE INCOME IN THE PERIOD TO WHICH IT RELATES Effects of incorrect treatment • • • Amount of Expense Amount of Asset Amount of Profit (Net/Gross) The following table shows the effect of incorrect treatment of revenue and capital expenditure: Page 63 Incorrect Classification Effect on Accounts Effect on Net Profit Purchase of fixed asset treated as revenue expenditure Revenue expenditure treated as a capital item Expense overstated Fixed asset account understated Expense understated Fixed asset account overstated Understated Overstated Effect on Statement of Financial Position Capital understated Fixed asset understated Capital overstated Fixed asset overstated EXAMPLE State whether each of the following items should be classified as "capital" or "revenue" expenditure for the purpose of a trading, profit and loss account and Statement of Financial Position: 1. Purchase of leasehold premises 2. Lawyers’ fees in connection with the purchase of leasehold premises 3. Annual depreciation charge for the use of leasehold premises 4. Annual ground rent of lease 5. Cost of new machinery 6. Customs duty charged on new machinery from supplier to factory 7. Carriage on new machinery from supplier to factory 8. Cost of installing new machinery 9. Removal expenses 10. Annual patent renewal fees SOLUTION: 1. Capital 2. Capital 3. Revenue 4. Revenue 5. Capital 6. Capital 7. Capital 8. Capital 9. Revenue 10. Revenue I. QUESTIONS/SOLUTIONS Question: MR. Balewa. Page 64 Mr. Balewa. commenced business on 1 January 20X2. All expenses were paid by cheque and any cash received was banked daily. The following is a summary of the transactions, which took place during the first year of trading: (a) On 1 January 20X2, Mr. Balewa. commenced business with RWF5,000 which he lodged to the business bank account (b) During the period, total purchases amounted to RWF4,000 and payments made to suppliers were RWF3,550. On 31 December, 20X2, RWF450 was still due to suppliers in respect of these purchases (c) Sales for the year totalled RWF9,000 all on credit. Amounts received from customers during the year were RWF8,100. On 31 December, 20X2, RWF900 was still owing from customers (d) Mr B. purchased a van in December costing RWF2,500 (e) Administration Expenses were RWF2,300 for the year Required: 1. Write up the ledger accounts for Mr Balewa, 2. Extract the Trial Balance 3. Prepare the Statement of Comprehensive Income for the year ended 31 December, 20X2 given that the value of Inventory at 31 December 20X2 was RWF500 4. Prepare the Statement of Financial Position as at 31 December, 20X2 Question: MR A. Igwe. Mr A. Igwe. commenced business as a retail butcher on 1 January 20X9. All expenses were paid by cheque and any cash received was banked daily. The following is a summary of the transactions, which took place during the first year of trading: (a) On 1 January, 20X9 Mr A. Igwe. paid RWF4,000 into the business bank account (b) Credit sales totalled RWF8,000 - RWF6,500 was received and RWF1,500 was outstanding at the end of the year (c) Cash sales amounted to RWF15,000 (d) A delivery van was purchased on 1 January 20X9 at a cost of RWF3,900 (e) During the period, purchases amounted to RWF7,800,. Suppliers had been paid RWF7,200 for meat and invoices totalling RWF600 remained unpaid at 31 December 20X9 (f) Sundry expense (all paid during the period and relating to it) amounted to RWF2,200. During the year, Mr A. Igwe. drew RWF2,000 from the business (g) The annual rent of the shop was RWF1,200 and Mr A. Igwe. paid this amount on 1 January 20X9 (h) Mr A. Igwe. paid his assistant RWF1,900 during the year Required: 1. Write up the ledger accounts and cash book of Mr A. Igwe. to 31 December, 20X9 2. Extract a Trial Balance Page 65 3. 4. Prepare the Statement of Comprehensive Income for the year ended 31 December 20X9 - closing Inventory at 31 December was RWF850 Prepare the Statement of Financial Position as at 31 December 20X9 Question: BSB Ltd The following balances have been extracted from the books of BSB Limited as at the 31st December, 20X3 RWF 2,340 2,678 2,431 5,720 10,410 348 1,279 6,000 11,292 Trade Receivables Trade Creditors Inventory Equipment Premises Cash in hand Bank Overdraft Capital Statement of Comprehensive Income Required: 1. Prepare a Statement of Financial Position as at 31 December 20X3 EXERCISE 1 Q.1 Which of the following is not an asset? (a) Buildings (b) Cash Balance (c) Trade Receivables (d) Loan from Mrs K. Diop. Q.2 Which one of the following is a liability? (a) Machinery (b) Trade Payables for goods (c) Motor Vehicles (d) Cash at Bank Q.3 Gross Profit is: (a) Excess of sales over cost of goods sold (b) Sales less purchases (c) Cost of goods sold plus Opening Inventory (d) Net profit less expenses of the period Q.4 The descending order in which current assets should be shown in the Statement of Financial Position are: (a) Inventory, Trade Receivables, Bank, Cash (b) Cash, Bank, Trade Receivables, Inventory Page 66 (c) Trade Receivables, Inventory, Bank, Cash (d) Inventory, Trade Receivables, Cash, Bank Q.6 Capital expenditure is: (a) The extra capital paid in by the proprietor (b) The cost of running the business on a day-to-day basis (c) Money spent on buying Non-current assets or adding value to them (d) Money spent on selling Non-current assets Q.7 Q.8 Working capital is: (a) The Trade Receivables of a business (b) The balance at bank of a business (c) The current assets less long-term liabilities of a business (d) The excess of current assets over current liabilities of a business Which of the following items are shown under the wrong headings: Assets Liabilities Cash at bank Loan from J. Gowon Fixtures Machinery Creditors Motor Vehicles Buildings Inventory of Goods Trade Receivables Capital PTT LIMITED The following are details of the assets, liabilities at 31st December 20X0 and revenue and expenses for the year ended 31st December 20X0 of PTT Limited which commenced business on 1st January 20X0. The figures are presented in the form of a list of balances:RWF Share Capital 3,500 Non-current Assets 8,800 Inventory 400 Sales 30,000 Trade Receivables 800 Cost of Sales 20,000 Trade Payables 500 Administration Expenses 3,000 Selling and Distribution Expenses 4,000 Loan Capital 3,000 PREPARE: 1. Statement of Comprehensive Income for year ended 31st December, 20X0 Page 67 2. The Statement of Financial Position as at 31st December, 20X0 EXERCISE 2 Q.1 Which of the following is incorrect? (a) Assets - Capital = Liabilities (b) Liabilities + Capital = Assets (c) Liabilities + Assets = Capital (d) Assets - Liabilities = Capital Q.2 Which of the following is incorrect? (a) Assets RWF 7,850 Liabilities RWF 1,250 Capital RWF 6,600 (b) 8,200 2,800 5,400 (c) 9,550 1,150 8,200 (d) 6,540 1,120 5,420 Q.3 You are to complete the gaps on the following table? (a) (b) Assets RWF 55,000 Liabilities RWF 16,900 Capital RWF ? 17,200 34,400 ? (c) 36,100 (d) 119,500 (e) 88,000 ? 15,400 ? (f) ? Mr Balewa.: Pro Forma Solution 49,000 28,500 ? 62,000 110,000 (a) Capital RWF RWF Purchases RWF RWF Sales RWF RWF Page 68 Non-current Asset – Vehicle RWF RWF Administration Expenses RWF RWF Bank RWF RWF Trade Payables RWF RWF Trade Receivables RWF RWF (b) Trial Balance Debit RWF Credit RWF Capital Van at Cost Trade Receivables Trade Payables Bank Sales Purchases Administration Expenses (c) Statement of Comprehensive Income for the Year ended 31st December 20X2 RWF Sales Page 69 RWF Purchases Less Closing Inventory Cost of Goods Sold Gross Profit Less Expenses Administration Expenses Net Profit (d) Statement of Financial Position as at 31st December 20X2 RWF RWF Non-current Assets Van Current Assets Inventory Trade Receivables Bank Financed By: Capital Add: Net Profit Current Liabilities Trade Payables Mr Balewa.: Solution (a) Capital RWF Bank Creditors Purchases RWF 4,000 RWF 5,000 RWF Sales RWF Trade Receivables RWF 9,000 Non-current Asset - Vehicle Bank RWF 2,500 Page 70 RWF Administration Expenses RWF 2,300 Bank RWF Bank Capital Trade Receivables RWF 5,000 8,100 Trade Payables Van Administration Balance c/d 13,100 RWF 3,550 2,500 2,300 4,750 13,100 Trade Payables Bank Balance c/d RWF 3,550 450 4,000 RWF 4,000 Purchases 4,000 Trade Receivables RWF 9,000 Sales RWF 8,100 900 9,000 Bank Balance c/d 9,000 (b) Trial Balance Debit RWF Capital Van at Cost Trade Receivables Trade Payables Bank Sales Purchases Administration Expenses Credit RWF 5,000 2,500 900 450 4,750 9,000 4,000 2,300 14,450 14,450 (c) Statement of Comprehensive Income for the Year ended 31st December 20X2 RWF RWF Page 71 Sales Purchases Less Closing Inventory Cost of Goods Sold Gross Profit Less Expenses Administration Expenses Net Profit 9,000 4,000 (500) 3,500 5,500 (2,300) 3,200 (d) Statement of Financial Position as at 31st December 20X2 RWF Non-current Assets Van Current Assets Inventory Trade Receivables Bank 500 900 4,750 Financed By: Capital Add: Net Profit RWF 2,500 6,150 8,650 5,000 3,200 8,200 Current Liabilities Trade Payables (450) 8,650 Mr A. Igwe. : Pro Forma Solution Trade Receivables RWF RWF Sales Bank 31 December 20X9 Balance c/d 31 December 20X9 Balance b/d Capital Account RWF RWF 1 Jan 20X9 Bank Delivery Van RWF RWF 1 Jan 20X9 Bank Trade Payables Page 72 RWF RWF Bank 31 December 20X9 Balance c/d Purchases 31 December 20X9 Balance b/d Purchases RWF RWF Suppliers Sundry Expenses RWF RWF Bank Drawings RWF RWF Bank Rent RWF RWF Bank (b) Trial Balance as at December 20X9 RWF RWF Bank Trade Receivables Capital Delivery Van Trade Payables Drawings Sales Purchases Sundry Expenses Rent Assistant’s Wages The trial balance is extracted before final adjustments are made to ensure that the double entry has so far been correctly dealt with. Drawings are amounts taken out of the business by the owner; therefore these are deducted from capital. Page 73 (c) Statement of Comprehensive Income for the Year ended 31st December 20X9 RWF RWF Sales Less: Cost of goods sold Purchases Closing Inventory on 31 December 20X9 Gross Profit Less: Expenses Sundry Rent Assistant’s Wages Net Profit (d) Statement of Financial Position as at 31st December 20X9 RWF Non-current Assets Delivery Van Current Assets Inventory Trade Receivables Cash at Bank Financed By: Proprietor’s interest Capital at 1 January Profit for year Less: Drawings Current Liabilities Trade Payables Page 74 RWF Mr A. Igwe : Solution Bank Capital Sales – Cash Trade Receivables RWF 4,000 15,000 6,500 Delivery Van Trade Payables Sundry Expenses Drawings Rent Assistant’s Wages 31 December 20X9 Balance c/d 25,500 Balance b/d RWF 3,900 7,200 2,200 2,000 1,200 1,900 7,100 25,500 7,100 Sales Account RWF Cash Sales Trade Receivables RWF 15,000 8,000 23,000 Assistant’s Wages Bank RWF 1,900 RWF Trade Receivables Sales RWF 8,000 Bank 31 December 20X9 Balance c/d 8,000 31 December 20X9 Balance b/d RWF 6,500 1,500 8,000 1,500 Capital Account RWF 1 Jan 20X9 Bank Page 75 RWF 4,000 Delivery Van 1 Jan 20X9 Bank RWF 3,900 RWF Trade Payables Bank 31 December 20X9 Balance c/d RWF 7,200 RWF 7,800 Purchases 600 7,800 7,800 31 December 20X9 Balance b/d Suppliers Purchases RWF 7,800 600 RWF Sundry Expenses Bank RWF 2,200 RWF Drawings Bank RWF 2,000 RWF Rent Bank RWF 1,200 RWF (b) Trial Balance as at December 20X9 RWF 7,100 1,500 Bank Trade Receivables Capital Delivery Van Trade Payables Drawings Sales Purchases Sundry Expenses RWF 4,000 3,900 600 2,000 23,000 7,800 2,200 Page 76 Rent Assistant’s Wages 1,200 1,900 27,600 27,600 The trial balance is extracted before final adjustments are made to ensure that the double entry has so far been correctly dealt with. Drawings are amounts taken out of the business by the owner; therefore these are deducted from the capital. (c) Statement of Comprehensive Income for the Year ended 31st December 20X9 RWF RWF Sales 23,300 Less: Cost of goods sold Purchases 7,800 Closing Inventory on 31 December 20X9 850 6,950 16,050 Gross Profit Less: Expenses Sundry 2,200 Rent 1,200 Assistant’s Wages 1,900 5,300 Net Profit 10,750 (d) Statement of Financial Position as at 31st December 20X9 RWF Non-current Assets Delivery Van Current Assets Inventory 850 Trade Receivables 1,500 Cash at Bank 7,100 Financed By: Proprietor’s interest Capital at 1 January Profit for year 3,900 9,450 13,350 4,000 10,750 14,750 2,000 Less: Drawings Current Liabilities Trade Payables BSB Ltd: RWF 600 13,350 Pro Forma Solution Statement of Financial Position of BSB Ltd. as at 31st December 20X3 RWF Non-current Assets Page 77 RWF Premises Equipment Current Assets Inventory Trade Receivables Cash in Hand Financed By: Capital Statement of Comprehensive Income Current Liabilities: Creditors Bank Overdraft BSB Ltd: Solution Statement of Financial Position As at 31st December 20X3 RWF Non-current Assets Premises 10,410 Equipment 5,720 Current Assets Inventory 2,431 Trade Receivables 2,340 Cash in Hand 348 Financed By: Capital Statement of Comprehensive Income 2. (b) 3. (a) 4. (b) 5. (a) 6. (c) 7. (d) 8. Assets: 16,130 5,119 21,249 6,000 11,292 17,292 Current Liabilities: Creditors Bank Overdraft Exercise 1: 1. (d) RWF 2,678 1,279 Solution Creditors and Capital Page 78 3,957 21,249 Liabilities: Machinery, motor vehicles and Inventory PTT LIMITED: Pro Forma Solution Statement of Comprehensive Income for the year ended 31st December 20X0 RWF RWF Sales Less: Cost of Sales Gross Profit Less: Administration Expenses Selling and Distribution Expenses Net Profit PTT Limited Statement of Financial Position as at 31st December 20X0 (Horizontal Layout) RWF Assets Liabilities Non-current Assets Share Capital Reserves (Profit for Year) Shareholders Funds Current Assets Inventory Non-current Liabilities Trade Receivables Current Liabilities RWF PTT LIMITED Statement of Financial Position as at 31st December 20X0 (Vertical Layout) RWF Employment of Capital Non-current Assets Current Assets Inventory Trade Receivables Capital Employment Share Capital Reserves (Revenue) Shareholders Funds Non-current Liabilities Current Liabilities PTT LIMITED: Solution Page 79 RWF Statement of Comprehensive Income for the year ended 31st December 20X0 RWF RWF Sales 30,000 Less: Cost of Sales 20,000 Gross Profit 10,000 Less: Administration Expenses (3,000) Selling and Distribution Expenses (4,000) (7,000) Net Profit 3,000 PTT Limited Statement of Financial Position as at 31st December 20X0 (Horizontal Layout) RWF Assets Liabilities Non-current Assets 8,800 Share Capital Reserves (Profit for Year) Shareholders Funds Current Assets Inventory 400 Non-current Liabilities Trade Receivables 800 Current Liabilities 10,000 PTT LIMITED Statement of Financial Position as at 31st December 20X0 (Vertical Layout) RWF Employment of Capital Non-current Assets Current Assets Inventory 400 Trade Receivables 800 Capital Employment Share Capital Reserves (Revenue) Shareholders’ Funds Non-current Liabilities Current Liabilities Exercise 2: 1. (c) 2. (c) RWF 3,500 3,000 6,500 3,000 500 10,000 RWF 8,800 1,200 10,000 3,500 3,000 6,500 3,000 500 10,000 Solution Page 80 3. (a) RWF 38,100 (b) 51,600 (c) 7,600 (d) 104,100 (e) 26,00 (f) 159,000 Page 81 Study Unit 4 Accruals and Prepayments Contents __________________________________________________________________________ A. Accruals and Prepayments ______________________________________________________________________ B. Questions/Solutions ______________________________________________________________________ Page 82 A. ACCRUALS AND PREPAYMENTS The overriding criteria when preparing accounts, is that the Statement of Comprehensive Income must give a true and fair view of the profit or loss earned for the period and that the Statement of Financial Position must give a true and fair view of the position of the entity at a specified date. In order to achieve this true and fair view, a number of concepts were introduced and are followed. These are: Going Concern Continuity of the entity in its present form for the foreseeable future - there is no intention to put the company into liquidation or drastically to cut back the scale of operations Prudence Cautious presentation of the entity's financial position. Profits are recognised only when realised while losses are provided for as soon as they are foreseen Accruals Revenue earned in the period matched with costs incurred in earning it, not as money is received or paid Consistency There is similar accounting treatment of like items within each accounting period and from one period to the next Entity The accounts recognise the business as a distinct separate entity from its owners Money Measurement Accounts only deal with those items to which a monetary can be attributed Materiality If omission, misstatement or non-disclosure affects the view given, item is material and disclosure is required value Substance over Legal Form Recognises economic substance from legal form e.g. assets acquired on hire purchase Stable Monetary Unit The value of the monetary unit used is consistent over time Accounting Periods Accounts are prepared for discrete time periods On examination of the definition of the "Accruals" concept - revenue earned in the period matched with costs incurred in earning it, and not as money is received or paid - the entire concept of accruals and prepayments is born. In other words, the profit as reported for a period will include some invoices/expenses not yet received but the costs of which relate to the period - accrued expenses - while some invoices cover a period of time beyond the time frame of the present accounts – pre-payments or payments in advance. Page 83 EXAMPLE 1 ACC LTD commenced business on 1 Jan 20X4. During the first year of trading, the following telephone invoices were received. TELEPHONE ACCOUNT DR CR RWF RWF Feb Invoice – Jan 600 31 Dec Statement of Comprehensive Income Mar Invoice – Feb 600 Apr Invoice – Mar 600 May Invoice – Apr 600 Jun Invoice – May 600 Jul Invoice – Jun 600 Aug Invoice – Jul 600 Sep Invoice – Aug 600 Oct Invoice – Sep 600 Nov Invoice – Oct 600 Dec Invoice – Nov 600 If the account was closed now, the figure transferred to the Statement of Comprehensive Income would be RWF6,600. However, the invoice for December has not been received. In order to give the correct charge for telephone in the period, a journal must be posted: DR Telephone CR Accruals 600 600 Now, the telephone account can be closed off and the figure of RWF7,200 transferred to the Statement of Comprehensive Income. The figure of RWF600 will appear in the Statement of Financial Position under current liabilities. In Jan, the accrual of RWF600 is reversed DR Accruals CR Telephone 600 600 On receipt of the invoice in January, the invoice is processed as normal. TELEPHONE ACCOUNT DR CR RWF RWF Feb Invoice – Jan 600 31 Dec Statement of 7,200 Comprehensive Income Mar Invoice – Feb 600 Apr Invoice – Mar 600 May Invoice – Apr 600 Jun Invoice – May 600 Jul Invoice – Jun 600 Aug Invoice – Jul 600 Sep Invoice – Aug 600 Oct Invoice – Sep 600 Nov Invoice – Oct 600 Dec Invoice – Nov 600 Dec Accrual – Dec 600 7,200 7,200 Page 84 Jan Invoice – Dec 600 Jan Accrual – Dec 600 EXAMPLE 2 ACC LTD paid an insurance bill in January 20X4, for RWF3,000, which covered assets on a temporary basis. During the next six months, a number of other assets were included and on 30th June 20X4, the finance director negotiated the insurance premium for the following 12 months. The premium agreed was RWF7,000 for the year, which was paid immediately. INSURANCE ACCOUNT DR Jan Invoice RWF 3,000 June Invoice 7,000 CR RWF 31 Dec Statement of Comprehensive Income If this account is closed now, with the costs transferred to the Statement of Comprehensive Income, the profit or loss would be distorted by RWF3,500. To prevent this, a journal entry is posted: DR Prepayments CR Insurance 3,500 3,500 The account can now be closed and the costs of RWF6,500 transferred to the Statement of Comprehensive Income. The figure of RWF3,500 will appear in the Statement of Financial Position under current assets. In January 20X5, the journal is reversed to ensure the cost transferred from 20X4 is correctly accounted for in 2005. DR Insurance CR Prepayments 3,500 3,500 INSURANCE ACCOUNT DR Jan Invoice June Invoice Jan Prepayment RWF 3,000 31 Dec 7,000 10,000 3,500 Page 85 Statement of Comprehensive Income Prepayments CR RWF 6,500 3,500 10,000 Accruals and Prepayments – Alternative Approach The alternative approach to accruals and prepayments is to enter these as balancing figures in the respective ledger accounts. These balances are then brought down in the next accounting period. EXAMPLE 1 TELEPHONE ACCOUNT DR Feb Etc… Invoices Dec Balance c/d RWF 6,600 Dec CR RWF Statement of 7,200 Comprehensive Income 600 7,200 7,200 Jan Balance b/d 600 EXAMPLE 2 INSURANCE ACCOUNT DR Jan June RWF 3,000 7,000 Invoice/Bank Invoice/Bank Dec Dec Balance c/d Statement of Comprehensive Income 10,000 Jan B. Balance b/d CR RWF 3,500 6,500 10,000 3,500 QUESTIONS/SOLUTIONS Questions 1. Mr T. Jalloh. On 1 January 20X4 the following balances, among others, stood in the books of Mr T. Jalloh.: (a) Lighting, (Dr) RWF277. (b) Insurance, (Dr) RWF307. During the year ended 31 December 20X4 the information related to these two accounts is as follows: (i) Fire insurance, RWF960, covering the year ended 30 April was paid. (ii) General insurance, RWF630, covering the year ended 31 August 20X5 was paid. Page 86 (iii) An insurance rebate of RWF55 was received on 30 June 20X4. (iv) Electricity bills of RWF874 were paid. (v) An electricity bill of RWF83 for December 20X4 was unpaid as on 31 December 20X4. (vi) Fuel bills of RWF1,260 were paid. (vii) Stock of oil as on 31 December was RWF92. 2. Mr J. Osie. Mr J. Osie.’s year ended on 30 June 20X4. Write up the ledger accounts, showing the transfers to the final accounts and the balances carried down to the next year for the following: (a) Stationery: Paid for the year to 30 June 20X4 RWF855; Stocks of stationery at 30 June 20X3 RWF290; at 30 June 20X4 RWF345. (b) General expenses: Paid for the year to 30 June 20X4 RWF590; Owing at 30 June 20X3 RWF64; Owing at 30 June 20X4 RWF90. (c) Rent and Rates (combined account): Paid in the year to 30 June 20X4 RWF3,890; Rent owing at 30 June 20X3 RWF160; Rent paid in advance at 30 June 20X4 RWF250; Rates owing at 30 June 20X3 RWF205; Rates owing 30 June 20X4 RWF360. (d) Motor Expenses: Paid in the year to 30 June 20X4 RWF4,750; Owing as at 30 June 20X3 RWF180; Owing as at 30 June 20X4 RWF375. (e) Commission Receivable: Received during the year to 30 June 20X4 RWF850; owing at 30 June 20X3 RWF80; owing as at 30 June 20X4 RWF145. Solutions 1. Mr T. Jalloh. LIGHTING & FUEL Jan 1 Balance b/d Dec 31 Dec 31 Dec 31 Bank (Electric) Bank (Fuel) Owing c/d RWF 277 874 Dec 31 Dec 31 Statement of Comprehensive Income Stock c/d RWF 2,402 92 1,260 83 2,494 2,494 INSURANCE Jan 1 Dec 31 Balance b/d Bank (Fire) RWF 307 960 Page 87 Jun 30 Dec 31 Bank Statement of Comprehensive Income RWF 55 1,102 Dec 31 Bank (General) 630 Dec 31 Prepaid c/d* 1,897 *Prepaid calculated: 2. 740 1,897 Fire 4 months 960 x 4/12 General 8 months x 8/12 = = 320 420 740 Mr J. Osie. (a) STATIONERY 20X3 Jul 1 Stock b/f 20X4 Jun 30 Cash & Bank 290 855 1,145 20X4 Jun 30 Jun 30 Statement of Comprehensive Income Stock c/d 800 345 1,145 (b) GENERAL EXPENSES 20X4 Jun 30 Jun 30 Cash & Bank Owing c/d 590 20X3 Jul 1 90 20X4 Jun 30 Owing b/f Statement of Comprehensive Income 680 64 616 680 (c) RENT & RATES 20X4 Jun 30 Jun 30 Cash & Bank Rates Owing c/d 3,890 360 20X3 Jul 1 20X4 Jun 30 Jun 20 4,250 Page 88 Owing b/f Rent Rates Statement of Comprehensive Income Rent prepaid c/d 160 205 3,635 250 4,250 (d) MOTOR EXPENSES 20X4 Jun 30 Jun 30 Cash & Bank Owing c/d 4,750 375 20X3 Jul 1 20X4 Jun 30 Owing b/f Statement of Comprehensive Income 5,125 180 4,945 5,125 (e) COMMISSION RECEIVABLE 20X3 Jul 1 20X4 Jun 30 Owing b/f Statement of Comprehensive Income 80 20X4 Jun 30 Jun 30 Cash & Bank Owing c/d 850 145 915 995 Page 89 995 Study Unit 5 Trade Receivables, Bad Debts and Provisions Contents ___________________________________________________________________________ A. Provisions ___________________________________________________________________________ B. Trade Receivables, Bad Debts, Bad Debts Recovered and Provision for Bad Debts ___________________________________________________________________________ C. Other Provisions ___________________________________________________________________________ D. Provisions for Discounts Allowed ___________________________________________________________________________ E. Provisions for Discounts Received ___________________________________________________________________________ F. Question/Solutions __________________________________________________________________________________ Page 90 A. PROVISIONS Leading on from accruals and prepayments, in order to insure the accounts give a true and fair view, certain provisions may have to be created. Examples could include: • Bad debts, • Provision for bad debts, • Bad debts recovered and • Provisions for discounts - both discount allowed and received. B. TRADE RECEIVABLES, BAD PROVISION FOR BAD DEBTS DEBTS RECOVERED AND The overriding criterion is the prudence concept - provide for all bad debts. Such bad debts are written off as an expense in the Statement of Comprehensive Income. A provision for bad debts is an estimate of the expense for bad debts. The amount of the initial provision is charged to the Statement of Comprehensive Income. When a provision exists but is subsequently increased, the amount of the increase is a charge in the Statement of Comprehensive Income. When a provision exists and is reduced, the decrease is recorded in Statement of Comprehensive Income as income or as a reduction in the bad debt expense. The Statement of Financial Position must also be adjusted. The value of Trade Receivables should be shown in the Statement of Financial Position after deducting the bad debt provision (in full not just the change in the provision). BAD DEBTS When a company sells goods/services, the effect of which is to DR Trade Receivables CR Sales When the cash/cheque has been received, the effect is DR Bank CR Trade Receivables The company who has purchased the goods/services records these transactions as follows: DR Purchases CR Trade Payables When the company makes payment to the creditor DR Trade Payables CR Bank Page 91 With each sale, there is a risk associated with it - that is the risk that the money may not be received i.e. that the debtor may not pay. From time to time, entities within an industry go bankrupt or are put into liquidation. The result of which is that the payables may get not paid at all or get x Rwandan Francs for every RWF1,000 due. From the suppliers' view, some entries must be posted in the accounts to adjust for this. EXAMPLE BAD LTD sold goods on credit for RWF1,000 to DE Ltd. DE Ltd. subsequently went into liquidation and BAD Ltd does not expect to receive any money. Record the transactions in the books of BAD Ltd. Journal Entries On selling the goods DR Trade Receivables – DE Ltd CR Sales RWF RWF 1,000 1,000 On receipt of notice of Liquidation RWF RWF DR Bad Debts A/C 1,000 CR Trade Receivables – DE Ltd 1,000 At the end of the period, close the Bad Debts account and transfer the expense to the Statement of Comprehensive Income. The net effect of this is that the asset is not being recognised and the benefit of the sale is not recognised in the profit and loss for the period. BAD DEBTS RECOVERED Where the liquidator states that x Rwandan Francs in the RWF1 will be paid, prudence prevails - profits are recognised only when realised while losses are provided for as soon as they are foreseen - and the above journal should still be posted. On receipt of the x Rwandan Francs, the amount can be dealt as a bad debt recovered. The journal entry is: DR Trade Receivables - with the amount received CR Bad Debts recovered DR Bank - with the amount received CR Trade Receivables The amount received is posted to the trade receivables individual account twice. Once when notification is received from the liquidator stating the amount and date when it will be paid to acknowledge monies due and on the second time, then the actual amount is received. This is Page 92 to ensure maximum information in relation to the trade receivables is available on the Trade Receivables' individual account. It also complies with the prudence concept. At the end of the period, the balance on the bad debt recovered is transferred to the Statement of Comprehensive Income as revenue. DOUBTFUL DEBTS From time to time, the management of the company will review outstanding Trade Receivables to assess their collectability. Any known bad debts are written off as described above. Management may concede that while all known bad debts are written off, there may be other Trade Receivables who will not pay the full debt. In these instances, a provision for bad debts is created. There are two types of provisions: (a) Specific provision (b) General provision A specific provision is created where individual accounts throughout the Trade Receivables' ledger are identified where invoices are under dispute and either the full amount of the invoice or part of the invoice will remain unpaid. A list of Trade Receivables' names, together with the amount, is compiled and totalled. The total amount is the amount to be provided by way of specific provision. A general provision is created where no one individual account can be identified where invoices are subject to dispute. The provision is created on a generalisation that x% of Trade Receivable will not pay. Irrespective of whether the provision is a specific or a general provision, the journal entries are still the same. To create an opening provision, the journal entries are: DR Statement of Comprehensive Income Provision for Bad Debts CR Provision for Bad Debts Account – BAD DEBT PROVISION A/C DR Yr 1 Balance c/d RWF 7,000 7,000 Yr 1 Bad Debts Yr 2 Balance b/d CR RWF 7,000 7,000 7,000 The balance in the Bad Debt Provision A/c is shown in the Statement of Financial Position, under Current Assets, deducted from the Trade Receivables figure. The provision has the Page 93 effect of reducing the asset, while the amount written off to the Statement of Comprehensive Income ensures that the benefit of the sale is not recognised in the Statement of Comprehensive Income for the period. This again agrees with the requirements of the prudence concept. In the second and subsequent years, the closing balance from the previous year becomes the opening balance for the next year. Management must review Trade Receivables' accounts on a yearly basis using the same criteria as described. After the review is carried out and a figure for the final provision for bad debts is agreed, the Provision for Bad Debts Account may comply with one of these three situations: 1. The amount for the provision for this year agrees exactly with the provision for last year. 2. The amount for the provision for this year is higher than the provision for last year. 3. The amount for the provision for this year is lower than the provision for last year. If the amount for this year's provision for this year agrees exactly with the provision for last year, there is no change in the provision for bad debts account. BAD DEBT PROVISION A/C DR Yr 1 Balance c/d Yr 2 Balance c/d RWF 7,000 7,000 7,000 7,000 CR RWF 7,000 7,000 Yr 1 Bad Debts Yr 2 Balance b/d 7,000 7,000 Yr 3 Balance b/d 7,000 Where the amount for the provision for this year is higher than the provision for last year. Journal entry is: DR Provision for Bad Debts – Statement of Comprehensive Income CR Provision for Bad Debts Account BAD DEBT PROVISION A/C DR Yr 1 Yr 2 Balance c/d Balance c/d RWF 7,000 7,000 8,000 8,000 CR RWF 7,000 7,000 Yr 1 Bad Debts Yr 2 Statement of 1,000 Comprehensive Income Balance b/d 7,000 8,000 Yr 2 Yr 3 Page 94 Balance b/d 8,000 Where the amount for the provision for this year is lower than the provision for last year. The journal entry is: DR Provision for Bad Debts Account CR Provision for Bad Debts – Statement of Comprehensive Income BAD DEBT PROVISION A/C DR RWF 7,000 7,000 Yr 1 Balance c/d Yr 2 Statement of 1,000 Comprehensive Income Balance c/d 6,000 7,000 Yr 2 CR RWF 7,000 7,000 Yr 1 Bad Debts Yr 2 Balance b/d 7,000 7,000 Yr 3 Balance b/d 6,000 The full amount of the bad debt provision is deducted from the trade receivables in the Statement of Financial Position. Statement of Financial Position Extract: RWF Current Assets Trade Receivables Less Bad Debt Provision 100,000 6,000 94,000 C. OTHER PROVISIONS A company' management may provide for other costs and revenues, by way of provisions. The most common are discount allowed and discount received but there may be others. However, the accounting treatment will be similar throughout. There are two types of discounts - trade discounts and cash discounts. A trade discount is a discount which is given when the sale transaction is being completed between two parties of the same or linked trades. A cash discount is given on settlement of the debt if settlement is within a specified period of time. For example, two people go into a timber merchant’s yard. One person works in the trade, the other not. The trade discount would normally be given to the person who works in the trade while the one not working in the trade must pay the full price. Both agree to pay immediately. Both may now get the cash discount. So, in hindsight, the person who works in the industry gets both the trade discount and the cash discount while the person who works outside the trade only gets the cash discount. Irrespective of whether the discount is a trade discount or a cash discount, a company may give a discount to their trade receivables - discount allowed - or receive a discount from their trade payables - discount received. At period end the management must review both the Page 95 Trade Receivables accounts and the Trade Payables accounts to estimate the amount of discounts involved. Once agreed upon, the necessary journal entries must be made. D. PROVISIONS FOR DISCOUNTS ALLOWED Where a discount is being established for the first year, the journal entry is: DR Provision for Discount Allowed – Statement of Comprehensive Income CR Provision for Discount Allowed Account PROVISION FOR DISCOUNT ALLOWED A/C DR Yr 1 Balance c/d RWF 1,000 1,000 Yr 1 Discount Allowed Yr 2 Balance b/d CR RWF 1,000 1,000 1,000 In the second and subsequent years, the closing balance from the previous year becomes the opening balance for the next year. Management must review Trade Receivables accounts on a yearly basis using the same criteria as described. After the review is carried out and a figure of a final provision for discounts allowed is agreed, the Provision for Discounts Allowed Account may comply with one of these three situations: 1. The amount for the provision for this year agrees exactly with the provision for last year. 2. The amount for the provision for this year is higher than the provision for last year. 3. The amount for the provision for this year is lower than the provision for last year. The necessary adjustments apply here as with the provision for bad debts. The full amount of the provision for discount allowed account is deducted from Trade Receivables in the Statement of Financial Position. The provision has the effect of reducing the Trade Receivables shown in the Statement of Financial Position. The discount allowed provision is usually calculated as a percentage of Trade Receivables after deducting the year end bad debt provision. Example The year end Trade Receivables figure for ALL Ltd was RWF20,400. You are supplied with the following information: (a) A customer has been declared bankrupt owing RWF400. This is to be written off. (b) It has been decided that a 1% provision for discounts allowed should be made. (c) The provision for doubtful debts should be 3% of Trade Receivables. (d) The bad debts provision was RWF360. Page 96 Solution 1. Bad Debt Expense ... RWF400 2. Bad Debt Provision (RWF20,400 – 400) x 3% = RWF600. 3. The increase in the bad debt provision is RWF600 – 360 i.e. RWF240. 4. The discount allowed provision is calculated as follows: (RWF20,400 – 400 – 600) x 1% ... RWF194. Statement of Comprehensive Income Entries RWF 400 240 194 Bad Debt Expense (W1) Increase in Bad Debt Provision (W3) Increase in Discount Allowed Provision (W4) Statement of Financial Position RWF 20,000 (600) (194) Trade Receivables Less: Bad Debt Provision Provision for Discounts Allowed RWF 19,206 E. PROVISIONS FOR DISCOUNTS RECEIVED Where a discount provision is being set up and received for the first year, the journal entry is: DR Provision for Discount Received Account CR Provision for Discount Received – Statement of Comprehensive Income PROVISION FOR DISCOUNT RECEIVED A/C DR Yr 1 Yr 2 RWF Statement of 1,500 Comprehensive Income 1,500 Balance b/d Yr 1 Balance c/d CR RWF 1,500 1,500 1,500 In the second and subsequent years, the closing balance from the previous year becomes the opening balance for the next year. Management must review Trade Payables accounts on a yearly basis using the same criteria as described. After the review is carried out and a figure of a final provision for discounts received is agreed, the Provision for Discounts Received Account may comply with, again, one of these three situations: 1. The amount for the provision for this year agrees exactly with the provision for last year. 2. The amount for the provision for this year is higher than the provision for last year. 3. The amount for the provision for this year is lower than the provision for last year. Page 97 If the amount for this year's provision for this year agrees exactly with the provision for last year, there is no change in the provision for discount received account. PROVISION FOR DISCOUNT RECEIVED A/C DR RWF 1,500 1,500 Yr 1 Income Received Yr 2 Balance b/d 1,500 1,500 Yr 3 Balance c/d 1,500 Yr 1 Balance c/d Yr 2 Balance c/d CR RWF 1,500 1,500 1,500 1,500 Where the amount for the provision for this year is higher than the provision for last year. Journal entry is: DR Provision for Discount Received Account – with the increase CR Provision for Discount Received – Statement of Comprehensive Income PROVISION FOR DISCOUNT RECEIVED A/C DR Yr 1 Statement Comprehensive Income RWF of 1,500 Yr 1 Balance c/d 1,500 Yr 2 Yr 2 Yr 3 Balance b/d 1,500 Statement of 500 Comprehensive Income 2,000 Balance c/d CR RWF 1,500 1,500 Yr 2 Balance c/d 2,000 2,000 2,000 Where the amount for the provision for this year is lower than the provision for last year. The journal entry is: DR Provision for Discount Received Account – Statement of Comprehensive Income CR Provision for Discount Received Account Page 98 PROVISION FOR DISCOUNT RECEIVED A/C DR Yr 1 Discount Received RWF 1,500 1,500 Yr 2 Balance b/d 1,500 CR RWF 1,500 1,500 Yr 1 Balance c/d Yr 2 Yr 2 Discount Received Balance c/d 1,500 Yr 3 Balance c/d 500 1,000 1,500 1,000 The provision for discount received account is shown in the Statement of Financial Position, under Current Liabilities, relating to Trade Payables. The provision has the effect of reducing the total liability due to Trade Payables. Example of an Aged Trade Receivables Listing: P. Red B. Brown G. Green N. Blue L. Yellow Total Outstandi ng RWF 2,000 10,000 5,000 4,000 1,500 22,500 Dec Nov Oct RWF 1,000 10,000 1,000 500 500 13,000 RWF 1,000 1,500 500 3,000 RWF 1,500 1,500 Over 3 Mths RWF 1,500 750 2,250 Over 6 Mths RWF 750 1,000 1,750 Management may use an aged Trade Receivables Listing to assess likelihood of the debt not being paid. A higher provision is set against long outstanding sums. Page 99 F. QUESTION/SOLUTION Question 1. Mr N. Keita. The books of Mr N. Keita. showed a Provision for Bad Debts amounting to RWF1,400 on 1st February 20X4. The total debts, at that date, amounted to RWF36,000 of which it was known that RWF1,000 would not be received. It was decided to make the Provision for Bad Debts to an amount equal to 5% of the Trade Receivables. You are required to show: (a) The Provision for Bad Debts Account after implementing the foregoing transactions. (b) How the Trade Receivables will appear on the Statement of Financial Position. Solution - Mr N. Keita. PROVISION FOR BAD DEBTS DR Balance c/d (W1) RWF 1,750 1 Feb X4 Balance b/d Statement of Comprehensive Income 1,750 CR RWF 1,400 350 1,750 BAD DEBTS A/C DR Trade Receivables RWF 1,000 Statement of Comprehensive Income W1 Provision for Bad Debts Trade Receivables Less Bad Debts written off CR RWF 1,000 36,000 (1,000) 35,000 Provision required @ 5% Provision at 1st Feb 20X4 Increase required in provision 1,750 (1,400) 350 Statement of Comprehensive Income Entries Bad Debt Expense Increase in Bad Debt Provision (W1) Statement of Financial Position Extract Page 100 RWF 1,000 350 RWF Trade Receivables 35,000 Less: Provision for Bad Debts 5% 1,750 33,250 Statement of Comprehensive Income – Take the increase/decrease in provision to Statement of Comprehensive Income and deduct the full amount of the provision from Trade Receivables in Statement of Financial Position. 2. A Business A Business started trading on 1st January 20X6. During the two years ended at 31st December 20X6 and 20X7 the following debts were written off to bad debts account on the dates stated. 31 30 28 31 30 August September February August November 20X6 20X6 20X7 20X7 20X7 MR W Balewa MR S Ayim MR LJ Fofana MR N Muller MR A Orji RWF85 RWF140 RWF180 RWF60 RWF250 On 31st December 20X6 there had been a total of trade receivables remaining of RWF40,500. It was decided to make a provision for doubtful debts of RWF550. On 31st December 20X7 there had been a total of trade receivables remaining of RWF47,300. It was decided to make a provision for doubtful debts of RWF600. You are required to show: (a) The Bad Debts Account for each of the two years, with the provisions included in this account. (b) The charges to the Statement of Comprehensive Income for each of the two years. (c) The relevant extracts from the Statement of Financial Position as at 31st December 20X6 and 31st December 20X7. Solution – A Business (a) 20X6 Aug 31 MR WBalewa Sep 30 Dec 31 MR SAyim Provision c/d 20X7 Feb 28 Aug 31 MR LJ Fofana MR NMuller BAD DEBTS A/C RWF 20X6 85 Dec Statement 31 Comprehensive Income 140 550 775 180 60 Page 101 20X7 Jan 1 Dec 31 Provision b/d Statement Comprehensive RWF of 775 775 of 550 540 Income Nov 30 Dec 31 MR AOrji Provision c/d 250 600 1,090 1,090 (b) Statement of Comprehensive Income (Extracts) 20X6 20X7 RWF 775 540 Bad Debts Bad Debts (c) Statement of Financial Position (Extracts) 20X6 Trade Receivables Less Provision for Bad Debts 20X7 Trade Receivables Less Provision for Bad Debts RWF 40,500 (550) 39,950 47,300 (600) 46,700 Page 102 BLANK Page 103 Study Unit 6 Control Accounts Contents A. Control Accounts B. Trade Receivables Control Account C. Trade Payables Control Account D. Questions/Solutions E. Accounting for VAT ___________________________________________________________________________ Page 104 A. CONTROL ACCOUNTS The two most common examples of control accounts are the sales ledger control account and purchases ledger control account. These are sometimes known respectively as the trade receivables ledger and the trade payables ledger control accounts. A control account (or total account) is debited and credited with the total amounts of all transactions which have been debited and credited in detail to individual ledger accounts. For example, a company has 100 credit sales transactions with its Trade Receivables in a particular period, the total of these transactions is debited to the Trade Receivables Control account and each individual transaction is debited to the individual debtor account. The Trade Receivables control in this instance acts as a control on the Sales ledger, since the balance on the Trade Receivables control account at any time should equal the sum of the balances of all individual Trade Receivables’ accounts within that ledger, and provides a check on the accuracy of such balance. The Trade Payables Control account and the Purchases Ledger operate in the same way. The principle on which the control account is based is known, together with information of the additions and deductions entered in the account, the closing balance can be calculated. Applying this to a complete personal ledger the total of opening balance together with the additions and deductions during the period should give the total of closing balances. Format of Control Accounts Sometimes considerable confusion arises over which side of the Control Accounts (i.e. Debit or Credit) should the different aspects of the transaction be included. So it is important to emphasise at this point that control accounts are not necessarily a part of the double entry system. They are merely arithmetical proofs performing the same function as a trial balance to a particular ledger. (a) Memorandum Accounts It is usual to find the control accounts in the same form as an account, with the totals of the debit entries in the ledger on the left hand side of the control account, and the totals of the various credit entries in the ledger on the right hand side of the control account. Therefore, the control accounts are treated as an integral part of the double entry system, the balances of the control accounts being taken for the purpose of extracting a trial balance. In this case the personal accounts are being used as memorandum records only, i.e. they do not form part of the double entry system. (b) Self-Balancing Ledger A self-balancing ledger is one whose balances, when extracted, form a complete trial balance. It is obvious that the Trade Receivables and Trade Payables ledgers will not balance, because the balances they contain will be one sided. Thus the creditor’s ledger will comprise all credit balances, the debtors’ ledger all debit balances. The ledgers could be made self-balancing by means of a control or total account, which would be an extra account inserted at the back of the ledger to make it self-balancing. Items are posted to the individual ledger accounts in the usual way, but when the postings are complete, the total is posted to the opposite side of the control account. Therefore, at the end of a period the balances on the control account will be equal and opposite to the sum of balances on the ledger accounts thus proving the ledger and Page 105 allowing a trial balance to be extracted for each ledger. The principle of check underlying the total account is that “the whole must be equal to the sum of all its parts”. The remainder of this note is based on the assumption that the control accounts form an integral part of the double entry system while the individual balances on personal ledger accounts are being used for memorandum purposes only. B. THE TRADE RECEIVABLES CONTROL ACCOUNT This account is debited with the total of Trade Receivables brought forward from the previous period. For the period in question the account is then debited with the total of all the items which have been debited in detail to individual personal accounts in the sales ledger, and credited with the total of all the items which have been credited to such accounts. The balance of the Trade Receivables control account should therefore be equal to the total of all individual balances appearing in the sales ledgers at the end of the period. It must be remembered that the sales ledger may contain a few accounts showing credit balances, and the balance of the Trade Receivables control account will only represent the differences between the total of the debit balances and the total of the credit balances (if any) in the sales ledger. Therefore, an adjustment should be made to bring down balances on both sides of the Trade Receivables control account. The following is an illustration showing some of the items which will appear in the Trade Receivables control account: Trade Receivables Control Account Opening Balance Sales made during the period RWF i ii Dishonoured bills and cheques Cash refunded to Trade Receivables Transfers and other items Bad Debts Recovered Closing Credit Balances iii ix RWF x xi Opening Credit Balance Cash received from Receivables Discounted allowed Returns inwards Bills receivable Bad debts written off Bad debts recovered Transfers and other items Closing debit balance RWF RWF i Trade iv vii viii v vi x RWF xii RWF Notes to Illustration (i) The opening balances will be brought down from the previous period, and will agree with the total of the last list of individual Trade Receivables balances. (ii) The total amount of credit sales for the period will be obtained from the sales day book, the totals of which should be posted monthly or at other regular intervals to the Trade Receivables control account. (iii) Dishonoured bills and cheques will be detailed in the bills receivable book, and bank statements respectively. Page 106 (iv) The total amount of cash received from Trade Receivables which has been posted to the sales ledgers during the period will be obtained from the sales ledger column in the cash book and posted to the control account at monthly or other regular intervals. (v) Bills receivable will be total of the bills receivable book. (vi) Bad debts written off will be obtained from an analysis from the journal. (vii) Discounts are totals of the discount column of the debit side of the cash book. (viii) Returns inwards will be obtained from the totals of the returns inwards day book. (ix) Cash refunded to Trade Receivables will be obtained from the credit side of the cash book. (x) When a Bad debt is written off the balance on the receivable account is cleared to zero, the accounting entry are: Dr Bad Debts Cr Trade Receivables To record the write off of the Bad debt. If a trade receivable subsequently repays the bad debt we need to re-instate the debt and then record the subsequent repayment: Dr Trade Receivable Cr Bad Debts Recovered To record amount to be received from debtor previously written of Then Dr Bank / Cash Cr Trade Receivable To record the receipt of payment. (xi) Closing credit balance appears on left hand side of ledger account (debit side) and is brought down as an opening credit balance on the right hand side of the account. (xii) Closing debit balance appears on right hand side of ledger account (credit side) and is brought down as an opening debit balance on the left hand side of the account. Page 107 C. THE TRADE PAYABLES CONTROL ACCOUNT This account operates as a control account of the purchase ledgers and should disclose a balance equal to the total of all the individual balances in the creditor’s ledgers. Trade Payables Ledger Control Account Opening debit balances Cash paid to Trade Payables Discounts received Bill payable accepted Returns Outwards Transfers and other items Closing credit balances RWF i iii iv v vi viii xii RWF Opening Credit Balances Purchases during the period Transfers and other items Closing debit balances RWF i ii vii xii RWF Notes to Illustration (i) The opening balances will be brought down from the previous period, and will agree with the total of the last schedule of individual Trade Payables balances. (ii) The total amount of goods purchased during the period will be obtained from the payables ledger column in the cash book. (iii) The total amount of cash paid to Trade Payables during the period will be obtained from the payables ledger column in the cash book. (iv) Discounts received will be obtained from the totals of the Discount column on the credit side of the cash book, and from the cash discount column (if any) in the bills payable book. If no such column is provided in the bills payable book, and the items have not been passed through the discount column in the cash book, the total will be obtained from analysis of the journal. (v) Bills payable will be obtainable from the totals of the bills payable book. (vi) Returns outwards will be obtained from the totals of the purchases returns book. Advantages of Control Accounts The advantages of control accounts are as follows: (a) For management purposes the balances on the control account can always be taken to equal Trade Receivables and Trade Payables without waiting for an extraction of individual balances. Management control is thereby aided, for the speed at which information is obtained is one of the pre-requisites of efficient control. (b) If kept under the control of a responsible official, and not made accessible to the ledger clerks whose duty it is to post to the Trade Receivables and Trade Payables ledgers, the control accounts operate as a control over those ledgers, and constitute a valuable feature of the system of internal check. (c) Key control accounts such as Trade Receivables, Trade Payables, bank and stock can be agreed as an intermediate step before the extraction of a trial balance. As a result of this the time spent in agreeing the trial balance itself should be considerably reduced. Page 108 D. QUESTIONS/SOLUTIONS DB Limited The following information relates to transactions with the Trade Receivables of DB Limited for the year-ended 31st December 20X1. Customer Cash/ Credit LK & Co. Mr. Bekker SM Ltd. BS Ltd. Total Credit Credit Credit Cash Balance at 1st Jan RWF 20,000 16,000 14,000 Sales RWF 116,000 24,000 160,000 20,000 320,000 50,000 Sales Return RWF 8,000 2,000 10,000 Cash Received RWF 109,000 32,000 125,000 20,000 286,000 Discount Allowed RWF 3,000 1,000 4,000 The balance on Mr. Bekker account proved irrecoverable during the year and was written off. You are asked to: (a) Write up the Trade Receivables ledger as at 31st December 20X1. (b) Prepare the Trade Receivables control account as at 31st December 20X1. Solution DB Limited LK & Co. Trade Receivables Account 1 Jan X1 During X1 Balance b/d Sales RWF 20,000 116,000 During X1 During X1 During X1 31 Dec X1 Sales Returns Cash Received Discount Allowed Balance c/d 136,000 1 Jan X2 Balance b/d RWF 8,000 109,000 3,000 16,000 136,000 16,000 Mr. Bekker Trade Receivables Account 1 Jan X1 During X1 Balance b/d Sales RWF 16,000 24,000 During X1 During X1 During X1 Sales Returns Cash Received Bad Debts During X1 During X1 31 Dec X1 Cash Received Discount Allowed Balance c/d 40,000 RWF 2,000 32,000 6,000 40,000 SM Ltd. Trade Receivables 1 Jan X1 During X1 Balance b/d Sales RWF 14,000 160,000 174,000 1 Jan X2 Balance b/d 48,000 Page 109 RWF 125,000 1,000 48,000 174,000 Trade Receivables Control Account RWF 50,000 300,000 Balance b/d Sales on Credit (Note 1) RWF 10,000 4,000 266,000 6,000 64,000 350,000 Sales Returns Discount Allowed Bank/Cash Bad Debt Balance c/d 350,000 Balance b/d 64,000 List of Trade Receivables: RWF 6,000 48,000 64,000 LK & Company SM Limited Note 1: BS Ltd is a cash customer, therefore no Trade Receivables ledger account opened and not included in the Trade Receivables control. CC Limited The following information relates to transactions with the Trade Payables by CC Limited for the year-ended 31st December 20X1. Supplier Cash/ Credit Mr Marx CLO Ltd. NAV Ltd. JZR Ltd. Credit Credit Credit Cash Balance at 1st Jan RWF 8,000 28,000 36,000 Purchases Purchases Return RWF RWF 40,000 2,000 20,000 140,000 4,000 40,000 240,000 6,000 Cash Paid RWF 34,000 12,000 130,000 40,000 216,000 You are asked to: (a) Write up the Trade Payables ledger as at 31st December 20X1. (b) Prepare the Trade Payables control account as at 31st December 20X1. Page 110 Discount Received RWF 2,000 2,000 4,000 CC Limited Mr. Marx – Trade Payables Account During X1 During X1 During X1 31 Dec X1 Bank Discount Received Purchases Returns Balance c/d RWF 34,000 2,000 2,000 10,000 48,000 1 Jan X1 During X1 Balance b/d Purchases RWF 8,000 40,000 48,000 1 Jan X2 Balance b/d 10,000 Purchases RWF 20,000 CLO Limited – Trade Payables Account During X1 During X1 Bank Balance c/d RWF 12,000 8,000 20,000 During X1 20,000 1 Jan X2 Balance b/d 8,000 NAV Limited – Trade Payables Account During X1 During X1 During X1 31 Dec X1 Bank Discount Received Purchases Returns Balance c/d RWF 130,000 2,000 4,000 32,000 168,000 1 Jan X1 Balance b/d During X1 Purchases RWF 28,000 140,000 168,000 1 Jan X2 Balance b/d 32,000 Trade Payables Control Account Purchases Returns Bank/Cash Discount Received Balance c/d RWF 6,000 176,000 4,000 50,000 236,000 Balance b/d Non-cash Purchases RWF 36,000 200,000 236,000 Balance b/d 50,000 List of Trade Payables: RWF 10,000 8,000 32,000 50,000 Mr Marx CLO Limited NAV Limited Page 111 Control Accounts Example 1 From the following details you are required to write up the debtors’ (trade receivables) ledger and creditors' (trade payables) ledger control accounts for the month of January. RWF Trade Receivables at January 1 9,753 Trade Payables at January 1 3,456 Credit Sales for month 19,506 Credit Purchases for month 6,912 Returns Outward for month 115 Returns Inward for month 97 Cash Received from Customers 18,912 Customers Cheques Dishonoured 100 Cash Paid to Suppliers 5,814 Discount Allowed 178 Discount Received 117 Interest Charged to Customers on Overdue Accounts 5 Bad Debts Written Off 76 Accounts Settled by “Contra” 345 DR Balances in Trade Payables Ledger at January 31 28 CR Balances in Trade Receivables Ledger at January 31 49 Page 112 Solution 1 Trade Receivables Control Account 1 Jan Balance b/d Sales Cheques Dishonoured Interest Charged Balance c/d RWF 9,753 19,506 100 1 Jan 5 49 Sales Returns Cash Discount Allowed Bad Debts Contra Balance 29,413 31 Jan Balance b/d 9,805 31 Jan RWF 97 18,912 178 76 345 9,805 29,413 Balance b/d 49 Balance b/d Purchases Balance c/d RWF 3,456 6,912 28 Trade Payables Control Account 1 Jan Returns Outwards Cash Discount Received Contra Balance 31 Jan Balance b/d RWF 115 5,814 117 345 4,005 10,396 28 1 Jan 10,396 31 Jan Balance b/d 4,005 Example 2 You are given the following information extracted from the books of the company. On 1 July, 2001, trade receivables ledger balances were RWF7,560 debit and RWF32 credit, and the trade payables ledger balances RWF4,250 credit and RWF59 debit. During the year-ended 30th June, 20X2, sales amounted to RWF52,130; purchases to RWF42,173; discount allowable RWF1,825; discount receivable RWF1,524; returns inwards RWF725; returns outwards RWF520; bad debts written off RWF220; a debit balance RWF25 in Trade Payables ledger was transferred to the Trade Receivables ledger; a contra entry of RWF1,000 was made between the ledgers in respect of T. Webb, who was a debtor of the firm for this amount but who was also a creditor of the firm for a much larger sum, cash received from Trade Receivables RWF48,270; cash paid to Trade Payables RWF40,250. On 30th June, 20X2, Trade Receivables ledger balances were RWF7,643 debit, RWF nil credit and the Trade Payables ledger balances were RWF3,126 credit, RWF34 debit. You are required to prepare: (a) A Trade Payables control account for the year-ended 30th June, 20X2, and (b) A Trade Receivables control account for the year-ended 30th June, 20X2. Page 113 Solution 2 Trade Receivables Control Account 30 June 20X2 Balance b/d Sales Contra RWF 7,560 52,130 25 Balance b/d Discount Allowed Returns Inwards Bad Debts Contra (T Webb) Bank Balance 59,715 Balance b/d RWF 32 1,825 725 220 1,000 48,270 7,643 59,715 7,643 Trade Payables Control Account 30 June 20X2 Balance b/d Discount Returns Outwards Contra (T Webb) Bank Balance c/d Balance b/d RWF 59 1,524 520 1,000 40,250 3,126 46,479 34 Balance b/d Purchases Contra Balance c/d RWF 4,250 42,170 25 34 46,479 Balance b/d 3,126 Example 3 TRADE RECEIVABLES CONTROL ACCOUNT B. Chahine maintains the control account in the nominal ledger in respect of the Trade Receivables ledger. The net total of the balances extracted from the Trade Receivables ledger as on 31 December 20X9 amounted to RWF12,876, which did not agree with the balance on the Trade Receivables ledger control account. On checking the following errors were discovered, after the adjustment of which the books balanced and the corrected net total of the sales ledger balances agreed with the amended balance of the control account: 1. The sales return day book had been overcast by RWF200. 2. A balance owing by A.Debt of RWF478 had been written off as irrecoverable on 31 December 20X9 and debited to bad debts but no entry had been made on the control account. 3. No entries had been made in the control accounts in respect of a transfer of RWF360 standing to the credit of C. Sekibo’s account in the Trade Payables ledger to his account in the Trade Receivables ledger. 4. A debit balance of RWF1,470 and credit balances amounting to RWF46 had been omitted from the list of balances. Page 114 5. A cheque for RWF254 received from D.I.S. had been dishonoured but the entry recording this fact in the cash book had not been posted to D.I.S. account. You are required (where applicable): (a) To amend the list of balances extracted from the personal ledger. (b) To set out the Trade Receivables ledger control account showing the balance before and after the correction of the errors. Trade Receivables Control Accounts (a) Calculation of Personal Ledger Balance RWF 12,876 1,470 14,346 46 14,300 254 14,554 Original List Total Plus debit balances omitted (4) Less credit balances omitted (4) Plus dishonoured cheque not posted (5) Amended Total (b) Trade Receivables Ledger Control Account 31 Dec 31 Dec Balance (balancing fig) Sales Returns DB RWF 15,192 31 Dec Bad debt (D Debt) RWF 478 200 31 Dec C Sekibo (Contra) 360 Net Balances c/d (as per (a) calculation) 15,392 1 Jan Balance b/d 14,554 15,392 14,554 E. Accounting for VAT Scope of VAT Other than exempt goods and services, Value Added Tax (VAT) is charged on the following: • every taxable supply in Rwanda; and • every taxable import of goods or services. A person is required to register by law if he or she carries on a business in Rwanda whose turnover exceeds or is likely to exceed RWF 20 million (approximately US $34,000) in any relevant year or RWF 5 million (approximately US $8,500) in a calendar quarter. The tax is paid: • in the case of taxable supply by the taxable person making the supply Page 115 • in the case of imported goods, by the importer • in the case of imported services, by the receiver of the service. Goods will be deemed to be supplied outside Rwanda if their supply involves delivery to a place outside Rwanda for the purpose of installation, processing assembly or any other purposes whatsoever. Services are regarded as supplied in Rwanda if the supplier of the services: • has a place of business in Rwanda and no place of business elsewhere • has no place of business in Rwanda or elsewhere but his usual place of residence is in Rwanda • has places of business in Rwanda and elsewhere but the place of business most directly concerned with the supply of the services in question is the one in Rwanda • has no place of business in Rwanda, has place of business elsewhere but the recipient of the service uses or obtains the benefit of the services in Rwanda. Where a taxable supplier does not have a business establishment or a usual place of residence in Rwanda, the Commissioner General may require the taxable supplier to appoint a “tax agent’’ to act on his or her behalf in matters relating to tax. Where a supplier is deemed to have a place of supply in Rwanda and makes supplies in the course of his business in Rwanda, then he will be liable to register and account for VAT in Rwanda. VAT rates Once it is established that a supplier falls within the scope of VAT in Rwanda, it is necessary to determine whether he or she makes taxable or non-taxable (exempt) supplies. Taxable supplies are supplies which are subject to VAT at a rate of 0% (zero-rated) or 18% (standard rated). The VAT Act specifies those supplies that are classified as exempt or zero- rated supplies. Exempt supplies are not subject to output VAT. In the case of zero rated supplies, VAT is chargeable but at 0%. Suppliers who provide services or goods which are zero rated are entitled to recover the input VAT they have incurred. This is unlike exempt supplies where input VAT recovery is restricted. Any supplies which are not specifically included in the exempt and zero rated schedules under the VAT Act will be subject to VAT at the standard rate of 18%. In addition to charging VAT on the sale and supply of taxable goods and services, VAT is also payable on the importation of goods and services into Rwanda. VAT paid on the importation of goods is treated in the same way as input VAT on local supplies i.e. can be recovered unless restricted as set out above. On the other hand, VAT reverse charge payable on importation of services cannot be automatically reclaimed. VAT reverse charge Page 116 A local recipient of services from a foreign supplier will be required to account for VAT reverse charge at 18% of the value of the services procured. The Act further provides that the recipient may not reclaim the corresponding input VAT unless the services so procured are not available in the local market. This means that the cost of any services procured from outside Rwanda will increase by 18% where the reverse charge VAT is not recoverable. The RRA may deem services to be available in Rwanda even when the actual services procured are of a different specification/quality standard to those available locally. However, in respect of imported transport services, consumers of such services are allowed a deduction of VAT reverse charge even if the services are available in Rwanda. Time of supply VAT on the supply of goods and services must be accounted for by reference to the tax point rules. The tax point for any supply will be the earliest of: • date of supply • date of invoice • date of payment. Compliance obligations When a supplier makes a taxable supply or where he procures services from abroad for the purposes of his business, he must charge VAT (output VAT for supplies or VAT reverse charge for imported services) at the appropriate rate (0% to 18%) and account for it to RRA. A supplier who is registered for VAT and incurs input VAT on business purchases is entitled (subject to specific statutory exclusions) to reclaim the input VAT by offsetting it against the output VAT liability. The net liability to VAT, including VAT reverse charge must be accounted for to RRA in the prescribed VAT declaration and relevant supporting schedules. The VAT return together with any payment due has to be filed/ made to the RRA within 15 days following the end of the month for which the VAT is accounted for. From July 2010, VAT taxpayers with annual turnover of RWF 200 million (US $340,000) or below may elect to make declarations or payments on a quarterly or monthly basis. Failure to register as a taxable supplier, to submit the VAT return on a timely basis or submission of an incorrect return, or failure to pay VAT due on time will render the taxpayer liable to interest and penalties. Input tax not deductible (Blocked VAT supplies) Input tax is not deductible on the following supplies: Page 117 Supply Supply of motor cars Business entertainment Telephone, fuel and power services. Exports and reverse charge Description VAT charged on the supply or importation of a motor car unless the supply of the motor car is: • by way of hire or rental • for purposes of resale, by a car dealer, or for use in the course of a car hire or driving instruction business. VAT charged on services used or to be used for the purpose of business entertainment of a third party. VAT paid on business overheads (e.g. electricity and fuel) whose use cannot be practically separable from private or nonbusiness is restricted to a claim of 40% of the input tax. VAT paid on exported goods or services whose proceeds are not repatriated into Rwanda. The VAT on reverse charge applying on imported services is not automatically deductible as input tax unless similar services are not available in Rwanda. Time limit for claiming input tax Input tax may not be deducted or credited after a period of three years from the date of the relevant tax invoice. Tax paid prior to registration On registration as a taxable supplier, one may claim input tax paid in respect of goods received up to six months prior to the date of registration. Requirements of a valid tax invoice All VAT registered suppliers must raise a tax invoice which includes the following: • the word “tax invoice’’ in a prominent place • the address and VAT registration number of the supplier • the name, address and VAT registration number of the supplier • the serial number of the invoice and date of issue • the quantity or volume of the goods or services supplied • a description of the goods or services supplied • the selling price excluding VAT • the total amount of VAT charged • the selling price including VAT Page 118 Invoices that do not include the last three items may be admissible if they contain: • the selling price including VAT; and • a statement that the price includes VAT, with the rate of VAT. Simplified tax invoice The law provides for the issue of a simplified tax invoices by a taxable supplier who makes taxable supplies of less than RWF1,000 (US $1.7) per supply. Exempt supplies Supplies that are specifically exempt are as listed below: Item Water supply service Description • The main supply of clean water. • Sewerage treatment services to protect the environment for a non-profit motive. Goods and services for health purposes • The supply of health and medical services. • Articles designed for a person with disability. • The supply of equipment and drugs to hospitals and health centres. • Supply or importation of drugs and medical equipment made by authorised persons for medical use, to patients and persons with disability. Education materials and services • Education services provided to preprimary, primary and secondary students. • Educational services provided by social organisations to students and other youth, meant for promoting the social intellectual and spiritual development of the members other than for profit. • Education services provided to vocational and other high learning institutions. • Education material supplied directly to learning institutions. Books, newspapers, journals and other Certain books and newspapers are exempted electronic equipment used as educational from VAT. However commercial services, materials such as advertisement provided through newspapers and electronic media are not exempted. Transport services • Transportation of persons by road in licensed buses and coaches with a seating capacity of 14 persons or more. • Transportation of persons by air. • Transportation of persons by railway. • Transportation of persons or goods by boat. • Transportation of goods by road. Page 119 Lending leasing and sale • The sale or lease of an interest in land. • Sale of a building or part of a building, flat or tenement meant for residential purposes. • The renting of, or other grant of the right to use accommodation in a building used predominantly as a place of residence of any person and his family, if the period of accommodation for a continuous term exceeds 90 days. • The premium charged on the provision of life and medical insurance services. • Fees charged on the operation of current account. • Transfer of shares. • Capital market transactions for listed securities. • Exchange operations carried out by recognised financial institutions. • Interest chargeable on credit and deposits. • Operations of the National Bank of Rwanda. • Fees charged on vouchers and bank instruments. • The supply of gold bullion to a Bank .The supply must conform to the specification of No 71.08.2000 of the Customs Harmonised Systems Code. • The supply of any goods or services in the course of a person’s burial or cremation. • Energy saving lamps. • Solar water-heaters. • Wind energy systems. • Liquefied petroleum gas, cylinders and invertors. • Equipment used in the supply of biogas energy. • Kerosene intended for domestic use premium and gasoil. Financial and insurance services Precious metals Funeral services Energy supplies Trade union subscriptions Leasing of exempt goods All unprocessed agricultural and livestock products Agricultural inputs and equipment Certain goods and services imported by persons with investment certificates Equipment for information communication and technology Mobile handsets and subscriber identification module (SIM) cards Page 120 Zero rated supplies Item Exports Supplies to Privileged Persons Description • Export of goods from Rwanda by or on behalf of a taxable supplier. • The supply of services, including transport and ancillary services which are directly linked to the export of goods under the point above. • The supply of freight transport services from or to Rwanda, including transhipment and ancillary services that are directly linked to the transit of goods through Rwanda to destinations outside Rwanda. • The supply of goods by a duty free shop. • The supply of goods for use in aircraft stores on flights to destinations outside Rwanda. • The supply of aviation fuel. • The supply of services which are physically rendered outside Rwanda. • The supply, by a tour operator or travel agent, licensed as such, to a tourist of an inclusive tour, subject to such conditions as the Commissioner General may require. • Goods imported for the official purposes of a diplomatic mission accredited by the Republic of Rwanda. • Supplies made under special agreements between the Government of Rwanda and donor(s). • Supplies made to a Donor in Rwanda, in the course of implementing donor funded projects. • Supplies or importation made under special technical aid agreements, which are exempted under other laws of the country. Persons entitled to zero rating of goods imported by them or supplies otherwise received by them are required to pay VAT at the time of importation or receiving the supply and then apply for a refund of the VAT paid. Page 121 Study Unit 7 Bank Reconciliation Statements Contents _________________ A. The Cash Book and Bank Reconciliation Statements _________________ B. Bank Reconciliation Questions/Solutions _________________ C. Questions/Solutions _________________ Page 122 A. THE CASH BOOK AND BANK RECONCILIATION STATEMENTS The Cash Book - Introduction Cash transactions are the simplest and most universal form of business transaction. For example: A sells B some goods for RWF150. From A’s point of view, he has gained RWF150 in cash but sold the goods. This, in book-keeping terms, is the double aspect of every transaction. A debits “cash a/c” with RWF150 and credits “sales a/c” with RWF150. From B’s point of view, he has decreased cash by RWF150 but has gained the goods. In book-keeping terms, B debits “purchase account” with RWF150 and credits his “cash account” with RWF150. To record cash transactions, a cash book is used. By convention receipts (debits) are on the left hand side and payments (credits) are on the right hand side. Cash may be kept in hand or at the bank. Separate books can be kept, but usually one Cash Book is kept for both cash and bank. It is important to differentiate between cash and bank. Separate columns are used so that the balance of cash in hand and cash at bank can be found as required. Use of Cash Book Payments: Payments by cash are entered in the cash column on the credit side Payments by cheque are entered in the bank column on the credit side in date and cheque number order. Receipts: Receipts are normally all entered in the cash column on the debit side, then when paid into the bank the amount banked is credited to the cash (i.e. a payment out of cash) and debited to bank (i.e. a receipt by bank). The entries are referenced to one another in the folio column with a “C” meaning Contra. In some cases where bankings are made daily, the receipts can be debited straight into the bank column. Discount: When payment is made within a period of credit, a cash discount is sometimes allowed. This means, for example, that a credit of RWF100 may be settled for RWF95 if payment is made within seven days (a 5% cash discount). Page 123 The Book-Keeping Entry is: Enter the amount of the cheque in the bank column (RWF95),the discount in the discount column (RWF5), both on the credit side. General Balances Cash is a material object. It is therefore a debit balance (i.e. one has some of the asset cash) or it is a nil balance (i.e. one has none). The bank is different because one can (with the bank’s approval) overdraw an account and thus owe the bank. The bank overdraft is shown as a credit balance (i.e. a liability to the bank). Autonomous Items In the bank transactions arise which are at the instigation of persons other than the operator of the account. (i) Bank Charges and Commission (ii) Bank Interest (iii) Standing Orders (iv) Credit Transfers (Bank Giro) (v) Returned Cheques (vi) Direct Debits Entries of these items must be made when notified by the bank. Bank Reconciliation Statements – Introduction The bank statement shows all the transactions of which the bank has knowledge, and should normally show the same entries as the customer’s cash book. Therefore, it would be reasonable to assume that the balance shown on the bank statement should be the same as the bank balance in the cash book at any given date. In practice, you will find that they seldom agree. The main reason (apart from errors) for the difference is that either the bank statement or the cash book is not up to date. The purpose of a bank reconciliation statement is to reconcile differences due to this cause. It can then be seen whether or not there are any errors. Differences There are two types of differences: Items in Cash Book Not on Bank Statement Items on Bank Statement Not in Cash Book Items that are in the cash book but have not yet reached the bank’s records: These items are either cheques drawn but not yet presented for payment by the payee (un-presented cheques), or cash and cheques paid into the bank but not yet recorded on the bank statement Page 124 (lodgements not credited). To find these items, all entries in the cash book (bank) are ticked to the items of the bank statement, any entries left in the cash book are either errors or the items mentioned above. Errors in the cash book must first be corrected by entries in the cash book. The un-presented cheques and the lodgements not credited will appear in the reconciliation. Autonomous Items These items were mentioned in the cash book note. They will appear on the bank statements, but not all of them will appear in the cash book. After the cash book and statement have been ticked, these items will appear as unchecked on the bank statement. After their authenticity has been checked, they must be put into the cash book by suitable entries. Examples of these items would be: (i) (ii) (iii) (iv) (v) Bank Interest Bank Charges Standing Orders Direct debits Giro Credits Procedure Check that all bank statements are there. On the bank statement, underline the last entry of the date on which the reconciliation is to be made. Taking the debit side of the cash book, tick all the items to the credit side of the bank statements. By observation of dates and adding items together as necessary, it can be ensured that the items ticked are the same items. Taking the credit side of the cash book, tick all the items to the debit side of the bank statement. By observation of dates and cheque numbers it is usually possible to ensure that the items ticked are the same items. Any errors and/or omissions must be written in to the cash book. The reconciliation can now be written out. It starts with the balance per the bank statement and ends with the balance in the cash book (bank). Lodgements not credited are added to the balance at bank as if they have been credited by the bank. Conversely, lodgements not credited are deducted from a bank overdraft as, if they had been credited by the bank and as if the bank overdraft had fallen. Un-presented cheques are deducted from a balance at bank, but added to a bank overdraft. Page 125 B. BANK RECONCILIATIONS STATEMENTS QUESTIONS/SOLUTIONS B Bank The bank columns in B Bank’s cash book for the month of September were as follows: Sept 1 Sept 9 Sept 15 Sept 29 Sept 30 Balance b/d G Cawood B Clase G Grayling H Hall RWF 420 50 220 80 45 Sept 5 Sept 10 Sept 17 Sept 28 Sept 28 Sept 30 Sept 30 L Laas Wages G Malan G Wilson A White Petty Cash Balance c/d 815 Oct 1 Balance b/d 325 The bank statements showed B Bank’s account was as follows: Dr Sept 1 Sept 8 Sept 10 Sept 10 Sept 17 Sept 19 Sept 30 RWF 80 130 40 120 80 40 325 815 843 SNDS 844 SNDS 845 848 Cr 80.00 50.00 130.00 220.00 40.00 40.00 You are required to prepare a statement reconciling the balance as 30th September. Page 126 Balance 420.00 340.00 390.00 260.00 480.00 440.00 400.00 Bank Reconciliations B BANK Bank Reconciliation Statement as at 30th September RWF Balance per Bank Statement Add: Lodgements not credited: Sept 29 G Grayling Sept 30 H Hall RWF 400 80 45 125 Less: Cheques drawn but not presented Sept 28 G Wilson Sept 28 A White 120 80 200 Balance per Cash Book at 30th September RWF325 C Count The Bank columns in C Count’s cash book for the month of June were as follows: June 1 3 5 7 11 13 20 22 29 29 Balance b/d D Brink T Geyer W Dafel Z Mann S Shaw V Jones NCA Ltd S X Ltd B Buys RWF 240 320 64 27 169 82 79 300 210 450 July 1 Balance b/d 899 June 3 4 8 9 14 17 29 30 30 30 Wages S Nell W Wiese B Jacob Petty Cash Wages J T Ltd C Cleef N Mouy Balance c/d RWF 137 62 55 325 20 145 167 47 84 899 The statement received from the bank for the month of June showed the following entries: Dr RWF June 1 June 3 June 6 June 10 June 10 June 10 June 11 June 12 June 14 June 15 June 17 June 24 June 28 Brought Forward 094 SNDS 097 095 SNDS 096 SNDS 098 SNDS 099 SNDS CHGS Cr RWF 137.00 384.00 325.00 62.00 27.00 55.00 169.00 20.00 82.00 145.00 379.00 22.00 Page 127 Balance RWF 240.00 103.00 487.00 100.00 127.00 72.00 241.00 221.00 303.00 158.00 537.00 515.00 STEP 1 C Count Cash Book RWF 899.00 June 30 Balance b/f June 28 June 30 Charges RWF 22.00 Balance c/d 877.00 899.00 July 1 Balance b/d 899.00 877.00 Step 2 Bank Reconciliation at 30th June 20X1 RWF Balance per Bank Statement Add: Lodgements not credited: June 29 S X Ltd June 29 B Buys RWF 515 210 450 660 1,175 Less: Cheques drawn but not presented June 29 J T Ltd June 30 C Cleef June 30 N Mouy 167 47 84 298 877 Balance as per Cash Book C. QUESTIONS/SOLUTIONS Questions 1. A Mostert You are given the following information extracted from the records of A Mostert. Cash Book Details: Bank Dr 1 Dec 2 Dec 2 Dec 10 Dec 14 Dec 21 Dec 23 Dec Cheque No Cr RWF 16,491 962 1,103 2,312 1 Dec 6 Dec 14 Dec 17 Dec Alice David Pascal Chantal 782 783 784 785 RWF 857 221 511 97 Delta & Co 419 24 Dec Joseph 786 343 EHO Ltd 327 29 Dec Rent 787 260 Cash Sales to Bank 529 31 Dec Balance c/d Total b/f ABE Ltd BKR Ltd CHR Ltd Page 128 19,973 30 Dec George 119 22,262 22,262 P B Ltd. Bank Statement A Mostert Detail Balance Forward 836780 Remittance 836782 Charges 836781 Counter Credit Standing Order 836783 Remittance 836784 Counter Credit Remittance Counter Credit 836786 310923 Payments Lodgements 426 176 857 47 737 2,065 137 212 2,312 511 419 327 528 343 297 Date 1 Dec Balance 17,478 2 Dec 2 Dec 5 Dec 5 Dec 6 Dec 6 Dec 10 Dec 11 Dec 13 Dec 17 Dec 17 Dec 23 Dec 24 Dec 28 Dec 30 Dec 17,052 17,228 16,371 16,334 15,587 17,652 17,515 17,303 19,615 19,104 19,523 19,850 20,378 20,035 19,738 You are required to: (a) From the above data, correct the cash book and prepare a bank reconciliation as at 31st December. (b) List the reasons for preparing such a statement. (c) Comment briefly upon any aspects of your reconciliation which might require further investigation. Page 129 2. Mr Rabe On 15th May 20X8, Mr Rabe received his monthly bank statement for the month ended 30 April 20X8. The bank Statement contained the following details. Statement of Account with Money Limited All values are in thousands Date Particulars 1 April 2 April 3 April 6 April 6 April 9 April 10 April 12 April 17 April 20 April 23 April 23 April 25 April 27 April 30 April Payments RWF Balance 236127 Bank Giro Credit 236126 Charges 236129 427519 DD ESB 236128 Standing Order Sundry Credit 236130 236132 Bank Giro Credit Sundry Credit 236133 Receipts RWF 210.70 192.35 15.21 12.80 43.82 19.47 111.70 32.52 249.50 77.87 59.09 21.47 304.20 71.18 Balance RWF 1,053.29 842.59 1,034.94 1,019.73 1,006.93 963.11 943.64 831.94 799.42 1,048.92 971.05 911.96 933.43 1,237.63 1,166.45 For the corresponding period, Mr Rabe’s own records contained the following bank account details: Date 1 April 2 April 18 April 24 April 30 April Detail Balance Sales Sales Sales Sales RWF Date 827.38 192,35 249.50 304.20 192.80 _______ 1,766.23 5 April 10 April 16 April 18 April 20 April 25 April 30 April 30 April Detail Purchases Electricity Purchases Rent Purchases Purchases Wages Balance Chequ e No. 128 129 130 131 132 133 134 c/d RWF 111.70 43.82 87.77 30.00 59.09 71.18 52.27 1,310.40 1,766.23 Required: (a) From the above data correct the cash book and prepare a bank reconciliation statement. (b) Explain briefly which items in your bank reconciliation statement would require further investigation. Page 130 Solutions 1. A Mostert The opening balance in the bank statement and Cash book records do not agree: RWF 17,478 16,491 987 Bank Statement Cash Book Difference In practice you would have in addition to the Bank Statements and the Cash Book records, a copy of the last Bank Reconciliation Statement. How do we explain the above difference? Looking at the Cash Book Records for the period we can see that the first cheque issued in the period was number 782 but in the Bank Statement there are a number of cheques that were issued before this number (in a previous period): Cheque Number 836780 836781 Amount 426 737 1,163 This doesn’t fully explain the difference but if we look again at the Bank Statement and the Cash Book Records we can see that in the Bank Statement on 2nd December there is a lodgement of RWF176 that does not appear in the cash book records. Given that this lodgement is at the start of the period we can assume that it was part of the difference between the opening balances. (If you look at the other lodgements credited to the Bank over the period you will note that the date on the Bank Statement is generally 2 to 6 days after the date in the cash book records.) Cheque Number 836780 836781 Amount 426 737 1,163 (176) 987 Lodgement None of these items will appear in the reconciliation for the period because they relate to items outstanding at the end of the previous period. CASH BOOK ACCOUNT Balance b/d Cheque Overstated (No. 783) RWF 19,973 9 19,982 Page 131 RWF Bank Charges 47 Standing Order 137 Payment no in cash book (923) 297 Error in Lodgement 1 Balance c/d 19,500 19,982 Bank Reconciliation as at 31st December (a) RWF Balance as per Bank Statement Less: Payments not presented RWF 19,738 97 260 357 119 19,500 Add: Lodgement not yet on Statement Balance per Cash Book (b) A bank reconciliation is prepared: (i) To provide an independent check on the legitimacy of the entries in the cash book. (ii) (c) To provide an independent check on the accuracy of cash book entries. Aspects requiring further investigation are: (i) Correct amount of payment to David (ii) Validity of standing order – is it A Mostert? (iii) Payment of RWF297 – Cheques are not in ‘sequence’ number. (iv) The nature of the bank charges – why are there any at all with a current account balance of almost RWF20,000? 2. Mr Rabe The opening balance in the bank statement and Cash book records do not agree: RWF 1,053.29 827.38 225.91 Bank Statement Cash Book Difference Cheque No 236127 Cheque No 236126 210.70 15.21 These cheques will not form part of the reconciliation. Page 132 225.91 CASH BOOK ACCOUNT Balance b/d Bank Giro Credit Cheque (No 130) Overstated RWF 1,310.40 21.47 9.90 Bank Charges Cheque (No 519) Standing Order Balance c/d 1,341.77 RWF 12.80 19.47 32.52 1,276.98 1,341.77 (a) RWF Balance as per Bank Statement Add: Outstanding Lodgements Less: Outstanding Cheques 236131 Rent 236134 Wages Balance per Bank Account (b) 30.00 52.27 RWF 1,166.45 192.80 82.27 1,276.98 Items which require further investigation are: (i) Authority for and nature of standing order for RWF32.52. (ii) Authenticity of the cheque for RWF19.47 – the cheque number would indicate that it may have been wrongly charged by the bank. (iii) Correct amount for cheque 236130 – is it RWF87.77 or RWF77.87? (iv) Authenticity and nature of the bank giro credit for RWF21.47. Page 133 Study Unit 8 Suspense Account and Journal Entries Contents ______ A. Suspense Accounts ______ B. Example ______ C. Errors not affecting the Trial Balance ______ D. Question/Solution ______ E. The Journal ______ F. Questions/Solutions ______ Page 134 A. SUSPENSE ACCOUNTS A suspense account is a nominal ledger account which is created in two main situations: (a) If the trial balance does not balance the difference is placed in a suspense account; and (b) If the bookkeeper is unsure of the posting of one side of the double entry he may post the debit/credit to the suspense account. The suspense account is a temporary account. Once errors are located or the correct double entry has been ascertained the suspense account is cleared out. B. EXAMPLE After the preparation of a trial balance, an unexplained difference of DR RWF406 remains; a Suspense Account is opened for that amount. Subsequent investigations reveal: (i) RWF35 received from A. Jalloh and credited to his account has not been entered in the bank account. (ii) A payment of RWF47 to M. Strauss has been credited to that account. (iii) Discounts allowed (RWF198) and discounts received (RWF213) have been posted to the discount accounts as credits and debits respectively. (iv) Bank interest received of RWF111 has not been entered in the bank account. (v) The carriage outwards (RWF98) has been treated as a revenue item. Required: Prepare the Suspense Account making the entries necessary to eliminate the debit balance there is. SUSPENSE ACCOUNT Balance per Trial Balance (iii) Discounts received RWF 406 426 (i) (ii) (iv) (v) (vi) 832 Bank Account M Strauss Discount Allowed Bank Account Carriage Outward RWF 35 94 396 111 196 832 (i) The double entry is not complete. It is necessary to debit bank and credit suspense account. (ii) A payment to a supplier should be debited to that account but in this instance it has been credited, it is necessary to debit the account twice or with double the amount and credit suspense account to correct the error. (iii) Discount allowed should be debited to the discounts account; discount received should be credited to that account. Page 135 To correct the error it is necessary to debit the discount account with double the amount of the discount allowed and double the amount of the discount received, the corresponding entries will be in the suspense account. (iv) The double entry is not complete it is necessary to debit the bank account and credit the suspense account. (v) Carriage outwards is an expense and therefore should be debited to the carriage outwards account, to correct the error it is necessary to debit the carriage outwards account with double the amount and credit the suspense account. C. ERRORS NOT AFFECTING THE TRIAL BALANCE There are six types of errors which will not affect the trial balance. These are as follows: 1. The complete omission of a transaction. 2. Posting to the correct side of the ledger but to the wrong account. 3. Compensating errors e.g. if the sales account was added up to by RWF20 too much and the purchases account was also added up to by RWF20 too much, then these two errors would cancel out in the trial balance. 4. Error of principle – where an item is entered in the wrong class of account e.g. if a fixed asset such as a motor van is debited to an expenses account such as the motor expenses account. 5. Errors of original entry – where the original figure is incorrect yet double entry is observed using this incorrect figure. 6. Complete reversal of entries – where the correct accounts are used but each item is shown on the wrong side of the account. Suppose we received a cheque of RWF200 from D. Mare the double entry would be debit bank and credit D.Mare. In error it is entered as debit D. Mare and credit bank. D. QUESTION/SOLUTION Question - Sam Horak You act as accountant to Sam Horak. Mr Horak has requested you draw up the Statement of Comprehensive Income for previous year’s trading together with Statement of Financial Position. To this end he supplied you with a trial balance as at 31st December 20X3. He pointed out, however, that the debit side of said trial balance exceeded the credit side by RWF3,769.48. To balance the Trial Balance he opened a suspense account on the credit side. His bookkeeper further investigated and discovered the following discrepancies: (i) Sale of goods to J G Ltd. was posted to sales a/c as RWF990 and not RWF99 as originally recorded in sales day book. (ii) A machine was sold on 28th October to Michael Quint. The proceeds were RWF3,700. The book value of the machine at 28th October was RWF3,970. Unfortunately when posting the entry to machinery account the proceeds were entered as RWF4,470 and the profit/loss computed accordingly. (iii) Purchase of motor vehicle costing RWF3,750 was posted to purchases account. Page 136 (iv) Purchases returns in the sum of RWF350 were posted to the debit side of purchases returns account. (v) RWF760 discounts allowed posted to the credit side of the discounts received account. (vi) Bank overdraft in the sum of RWF3,000 was entered on the incorrect side of the trial balance. (vii) A trade payable account in the sum of RWF1,765 entered in the incorrect side of the trial balance. (viii) Sale of goods in the sum of RWF78,52 was posted in error to the account of John Hugo instead of Ernest Hugo. (ix) Goods taken from stock in the sum of RWF1,900 were credited to the sales account only. (x) Purchase of wrapping paper in the sum of RWF210.10 was included in the purchases day book but was not posted to the relevant account in the nominal ledger. (xi) Carriage inwards in the sum of RWF584.71 was entered on the incorrect side of the trial balance. You are required to draw up the suspense ledger account incorporating the relevant adjustments. Solution - Sam Horak SUSPENSE ACCOUNT Machinery Sales Purchase Returns Bank Account Trade Creditors RWF 3,700.00 700.00 6,000.00 3,530.00 Balance Sales Account Sale of Machinery Discounts Received Drawings Carriage Inwards Wrapping Paper 13,930.00 RWF 3,769.48 891.00 4,470.00 1,520.00 1,900.00 1,169.42 210.10 13,930.00 Notes 1. The posting of the motor vehicle to the purchases account is an error of principle, if it does not affect the trial balance. 2. The posting of the sale of goods to John Hugo’s account instead of Ernest Hugo’s account will not affect the trial balance. Page 137 E. THE JOURNAL Introduction A Journal, like other books of prime entry, is used to record a transaction prior to its entry in the ledger. Since the vast majority of transactions are capable of being assigned to one or the other of the day books, the use of the Journal is confined to items such as: (a) Opening and closing entries of the business. (b) Correcting and adjusting entries. (c) The purchase and sale of non-current assets. (d) Transfers from one account to another. Method of Writing up the Journal In the Journal, a memorandum is made, in the simplest possible terms, of entries to be made in the ledger. The essential information consists of: (a) The date (b) The name of the account to be debited. (c) The name of the account to be credited. (d) The amount of money. (e) A brief description of the transaction. (f) The ruling of the Journal and the method of entry are as follows: Journal Date (Date) Folio (A/C to be debited) (A/c to be credited) Brief description of transactions Dr Cr Fol Fol DR RWF Amount CR RWF Amount Notes (a) The amount to be debited appears first in the Journal by convention. Note the use of the word “Dr”. (b) Each entry must be accompanied by an explanation called the “narrative”. The narrative should contain full information as to the nature of the transaction and the dates of contracts, minutes, resolutions, etc. giving rise to it, so that the authority for the transaction as well as the origin of the entry will be shown. (c) The folio column should be entered when the transaction is posted to the ledger. (d) Always total up the debit and credit columns, making sure they balance. Advantages of a Journal The main advantages to be gained from the use of journals are: • The risk of omission of one or both of the entries required for each transaction is reduced. This is particularly important where more than one ledger is kept. Page 138 • More information on the nature of the transaction can be recorded than is possible in the ledger. • The journal affords a permanent record of the nature of important transactions which can be referred to in future. Important Remember to journalise all important and unusual items. It is essential that journal entries be written neatly and completely. Use of Journals Opening Entries: When either a new set of books is opened or a new business is started, the opening entries in the books are frequently journalised. Example A. Limited commenced trading on 1st April 20X4, with capital introduced of RWF5,000. He acquired the following: RWF 1,000 500 2,000 200 Lease of a Shop Motor Car Inventory Furniture and Fixtures Write up the opening journal entry. Solution JOURNAL Date 20X4 April 1 Leasehold Motor Vehicles Furniture & Fixtures Inventory Cash Capital Folio Dr L1 M1 F1 S1 CB 1,000 500 200 2,000 1,300 _____ RWF5,000 Cr 5,000 RWF5,000 Being capital introduced and assets acquired on commencement of trading. Note The balancing figure of RWF1,300 represents the cash remaining in the business. Correction of Errors If an error is made in the books, it is important to remember that the wrong entries should not be deleted from the books, but instead new entries, correcting or cancelling the old, are made. A journal is usefully employed to achieve this end. Page 139 Example On 10th March 20X4, it was discovered that a cheque for RWF30, paid to M. Jalloh on 1st March, was posted in error to the account of T. Everts. This cheque would have been wrongly debited in T. Everts’ account. To correct this, a credit entry in his account is required, and a debit entry is required to the account of M. Jalloh, thus: JOURNAL Date 20X4 March 10 Folio M. Jalloh Dr. T. Everts Cheque No. ... paid to M. Jalloh on March 1st posted in error to T. Everts, C.B. Folio ... J5 E3 Dr. RWF 30 Cr. RWF 30 Purchase/Sale of Property, Plant and Equipment A journal is commonly used to enter the purchases of capital items so that a permanent record of important purchases can be maintained. This record comes in useful when calculating depreciation and computing tax. The most common entries are: (i) Purchase of property, plant and equipment on credit/cash. (ii) Disposal of property, plant and equipment. (iii) Scrapping of property, plant and equipment. Transferring Items Incorrectly Posted. The principle here is similar to the correction of errors. F. QUESTIONS/SOLUTIONS Question - E. Truter Record the following transactions as journal entries. (a) Sale of a machine used by the business for RWF5,000 cash, this being the book value. (b) Purchase of RWF10,000 of goods on credit. (c) Withdrawal of RWF1,000 cash by the proprietor for his personal use. (d) Collection of RWF1,000 from E. Jalloh who has an account receivable with the firm. (e) Return of RWF2,000 of goods to a supplier because it is faulty. The supplier has granted the firm credit for the original goods. (f) Payment of RWF15,000 by the business to a supplier on account of an account payable. (g) Purchase for machinery for RWF3,000 on credit. (h) Additional cash of RWF10,000 invested in the business by the proprietor. (i) Sale of machine for RWF2,000 on credit (at book value). Page 140 Solution - E. Truter Journal Entries (a) Dr Cash Cr RWF5,000 Non Current Assets RWF5,000 To record the sale of a printing machine at book value (b) Dr Purchases Cr RWF10,000 Trade Payables RWF10,000 To record the purchase of goods on credit (c) Dr Drawings Cr RWF1,000 Cash RWF1,000 To record the withdrawal of cash by the proprietor (d) Dr Cash Cr RWF1,000 Trade Receivables (E Jones) RWF1,000 To record the collection of cash from E Jones (e) Dr Trade Payables Cr RWF2,000 Purchase Returns RWF2,000 To record the return of goods (f) Dr Trade Payables Cr RWF15,000 Cash RWF15,000 To record a payment made to a supplier (g) Dr Non-Current Assets Cr RWF3,000 Trade Payables RWF3,000 To record the purchase of machinery on credit (h) Dr Cash Cr RWF10,000 Capital RWF10,000 To record additional cash invested in the business by the proprietor (j) Dr Trade Receivables Cr RWF2,000 Non-Current Assets – Net Book Value To record the sale of a machine at book value on credit Page 141 RWF2,000 Question - Jean Claude Jean Claude’s trial balance failed to agree on 31/12/20X4 and he entered the difference in a suspense account. On examination of the books the following errors were revealed. (i) Interest paid by Jean Claude RWF100 had been entered on the incorrect side of the interest account. (ii) Bank charges RWF15 entered correctly in the cash book had not been posted to the ledger. (iii) A payment of RWF140 for repairs to motor vehicles had been debited to the motor vehicles account. (iv) A cheque for RWF96 received from a debtor M. Otto, had been entered correctly in the cash book but credited to the trade receivables account as RWF69. (v) Goods sold on credit for RWF180 had not been entered in the books. (vi) The purchases day book had been over-cast by RWF25. You are required to: (a) Journalise the necessary corrections. (b) Show the Suspense Account. (c) Calculate the correct net profit if the original figure was RWF9,800. Solution - Jean Claude Journal DR (a) (i) Interest Account CR 200 Suspense Account 200 To reverse posting to incorrect side of interest account (ii) Bank Charges Account 15 Suspense Account 15 To post amount omitted (iii) Motor Repairs Account 140 Motor Vehicles Account 140 To correct error of posting to incorrect Account (iv) Suspense Account 27 M Otto (debtor) 27 To correct error of crediting trade payables with RWF69 instead of RWF96 (v) Trade Receivable Account 180 Sales Account 180 Correction of omission of sale Page 142 (vi) Suspense Account 25 Purchases Account 25 Correction of error whereby purchases were overstated (b) JEAN CLAUDE – SUSPENSE ACCOUNT Difference in Trial Balance M Otto (debtor) Purchases RWF 163 (iv) (iv) 27 25 215 Interest (i) RWF 200 Bank Charges (ii) 15 215 (c) Statement of Corrected Net Profit RWF 9,800 Net Profit as originally calculated Add: Sales understated Purchases overstated Less: Interest understated Bank charges understated Motor repairs understated Corrected Net Profit for Year (v) (vi) 180 25 (i) (ii) (iii) 200 15 140 205 10,005 (355) 9,650 Question - J. Kemp Having prepared the Trial Balance of J. Kemp for year-ended 31st January 20X4 you discover that it does not balance and, pending later investigation, you place the difference in a suspense account. You prepare Final Accounts, which show a net profit of RWF8,735. Your investigations reveal the following: (i) A refund of rates RWF150 had been debited to the rates account. (ii) A payment of RWF750 for motor expenses had been debited to motor vehicles account. (iii) A payment of RWF538 for cash purchases had been credited to the purchase account as RWF358. (iv) The sales book had been under-cast by RWF1,000. (v) Discounts received RWF750 had been debited to discounts allowed account. (vi) A payment to trade payable P. Henning of RWF690 had been debited to the purchases account. (vii) An invoice for stationery RWF365 had been debited to purchases account. Page 143 Required: (a) The journal entries for the above. (b) Show entries in the suspense account. (c) Show your calculation of the corrected net profit. Solution - J. Kemp Journal Entries DR (a) (i) Suspense CR 300 Rates 2 x 150 300 Being correction of error; rates refund debited to rates account (ii) Motor Expenses 750 Motor Vehicles 750 Being correction of error; payment for motor expenses posted to motor vehicles (iii) Purchases 896 Suspense 896 Being correction of error; payment of RWF538 for purchases posted to credit side as RWF358 (iv) Suspense 1,000 Sales 1,000 Being correction of error; the sales book had been under cast by RWF1,000 DR (v) Suspense CR 1,500 Discounts Allowed 750 Discounts Received 750 Being correction of error; discounts received RWF750 debited to discounts allowed (vi) Trade Payables (P Henning) 690 Purchases 690 Being correction of error; a payment to a creditor debited to purchases (vii) Stationery 365 Purchases 365 Being correction of error; an invoice for stationery posted to purchases Page 144 (b) SUSPENSE ACCOUNT RWF 20X4 Jan 31 Rates (i) Sales Discounts Received Discounts Allowed (iv) (v) (v) 300 1,000 750 750 2,800 RWF 20X4 Jan 31 Trial Balance difference Purchases 1,904 (iii) 896 2,800 (c) Calculation of Corrected Net Profit Year-ended 31/1/20X4 RWF 8,735 Original Net Profit Add Back (i) Rates (iv) Sales (v) Discounts (vi) Purchases 300 1,000 1,500 690 12,225 Less: (ii) Motor Expenses (iii) Purchases Current Net Profit Note: (750) (896) 10,579 Item vii does not alter the profit. Page 145 Study Unit 9 IAS 1 – Presentation of Financial Statements Contents ______________________________________________________________________ A. Objective B. Purpose of Financial Statements C. Components of Financial Statements D. Financial Review by Management E. Structure, Content and Reporting F. Definitions G. Statement of Financial Position Format H. Example 1 – Statement of Financial Position I. The Statement of Comprehensive Income J. Function of Expenditure Method K. Nature of Expenditure Method L. Changes in Inventories of Finished Goods and Work-In-Progress M. Raw Materials and Consumables Used N. Information to be Presented either on the face of the Statement of Comprehensive Income or in the Notes O. Statement of Changes in Equity Page 146 Continued Page Contents (continued) P. Statement of Recognised Income and Expense 115 Q. Disclosure of Significant Accounting Policies 115 R. Question/Solution 115 Page 147 A. OBJECTIVE The objectives of IAS 1 are to: 1. Provide the formats for the presentation of Financial Statements, such as Statement of Comprehensive Income and Statement of Financial Position. 2. Ensure that the Financial Statements are comparable year on year for the entity and comparable to competitors. 3. Set out the disclosure required by management relating to the judgements they have made in selecting the entity’s accounting policies. 4. Set out the disclosure to be made in relation to estimating uncertainty at the Statement of Financial Position date, in particular where there is a significant risk of causing a material adjustment to the carrying amounts at which assets and liabilities will be presented in the next financial year. B. PURPOSE OF FINANCIAL STATEMENTS The objective of general purpose financial statements is to provide information about the financial position of an entity. Financial statements also show the results of management’s stewardship of the entity’s resources. C. COMPONENTS OF FINANCIAL STATEMENTS A complete set of financial statements comprises a: (a) Statement of Financial Position (b) Statement of Comprehensive Income (c) A statement showing either: (d) (i) All changes in equity or (ii) Changes in equity other than capital transactions/distributions to owners Cash (or Funds) Flow Statement (e) Notes to the accounts comprising a summary of significant accounting policies and explanatory notes. D. FINANCIAL REVIEW BY MANAGEMENT In addition to the Financial Statements identified in Section C above, management may present a Financial Review outside the Financial Statements. The Financial Review explains the main features of the entities financial performance and financial position as well as the main areas of uncertainty. This Financial Review typically includes: (a) An outline of the main factors affecting performance including changes in the business environment in which the entity operates. How the entity has reacted to those changes and the effect. (b) Entity’s policy for investment and its dividend policy. (c) How the entity is financed. Page 148 (d) Any resources that the entity uses that are not disclosed on the Statement of Financial Position in accordance with IFRSs. Other reports which may be included are: (a) Environmental Reports – Particularly in industries where environmental issues are of significance. (b) Value Added Statements. Any reports provided in addition to the Financial Statements are outside the scope of the IASs. E. STRUCTURE, CONTENT AND REPORTING • The financial statements shall be identified clearly and distinguished from other information. • The financial statements should show: − The name of the reporting entity − The Statement of Financial Position date or the period covered by the Statement of Comprehensive Income • The currency in which the financial statements are presented • The level of rounding used in presenting amounts e.g. RWF’000, RWFm or the like. • The financial statements shall be presented at least annually. F. DEFINITIONS Material – “Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the Financial Statements. Materiality depends in the size and nature of the omission or misstatement judged in the circumstances. The size or nature of the item, or a combination of both, could be the determining factor.” G. STATEMENT OF FINANCIAL POSITION FORMAT It is important before attempting a Statement of Financial Position clearly to understand the split between current and non-current assets and liabilities Current Assets An asset shall be classified as current when it satisfies any of the following criteria: (a) It is expected to be realised or is intended for sale or use in the entity’s normal operating cycle; (b) It is held primarily for the purpose of being traded; (c) It is expected to be realised within 12 months after the Statement of Financial Position date, or (d) It is cash or a cash equivalent (as defined by IAS 7 Cash Flow Statements) Page 149 All other assets shall be classified as non-current. Current Liabilities A liability shall be classified as current when it satisfies any of the following criteria: (a) It is expected to be settled in the entity’s normal operating cycle; (b) It is held primarily for the purpose of being traded; (c) It is due to be settled within 12 months after the Statement of Financial Position date. All other liabilities shall be classified as non-current liabilities. ABC LTD STATEMENT OF FINANCIAL POSITION AS AT 31ST DECEMBER 20X4 RWFm RWFm Assets Non-Current Assets Property Plant and Equipment Intangible Assets Investments 150 78 22 30 280 Current Assets Inventories (raw materials, work in progress, finished goods etc.) Trade Receivables Prepayments Cash and Cash Equivalents 81 76 4 22 183 463 Total Assets Equity and Liabilities Shareholders’ Equity Share Capital Share Premium Revaluation Reserve Retained Earnings Total Equity 100 20 35 97 252 Non-Current Liabilities Long-Term Borrowings Long-Term Provisions Total Non-Current Liabilities 150 10 160 Current Liabilities Trade Payables Accruals Income Tax Payable Total Current Liabilities 35 4 12 51 Page 150 Total Equity and Liabilities 463 H. EXAMPLE 1 – STATEMENT OF FINANCIAL POSITION The following information is available about the balances of ALP, a limited liability company. Balances at 31st May 20X4 Non-Current - Cost Assets - Accumulated Depreciation Cash at Bank Issued Share Capital – Ordinary Shares of RWF1 each Inventory (raw mats., wip, finished goods) Trade Payables Retained Earnings 10% Loan Notes Trade Receivables Loan Note Interest Owing RWF 500,000 100,000 95,000 200,000 125,000 82,000 292,500 150,000 112,000 7,500 REQUIREMENT: Prepare the Statement of Financial Position of ALP as at 31st May 20X4 using the format IAS 1 – Presentation of Financial Statements. ALP Limited Statement of Financial Position as at 31st May 20X4 RWF Assets Non-Current Assets: Cost Less Accumulated Depreciation RWF 500,000 (100,000) 400,000 Current Assets Inventory Trade Receivables Cash at Bank 125,000 112,000 95,000 332,000 732,000 Total Assets Equity and Liabilities Shareholders’ Equity Share Capital Retained Earnings 200,000 292,500 492,500 Non-Current Liabilities 10% Loan Notes 150,000 Current Liabilities Trade Payables Accruals Total Current Liabilities Total Liabilities Total Equity and Liabilities 82,000 7,500 89,500 239,500 732,000 Page 151 I. THE STATEMENT OF COMPREHENSIVE INCOME There are two different layouts for the Statement of Comprehensive Income. One format presents an analysis of expenses based on their function within the entity, the other format uses a classification based on the nature of expenses. J. FUNCTION OF EXPENDITURE METHOD This form of analysis classifies expenses according to their function as part of cost of sales or for example the costs of distribution or administrative activities. This method can provide more relevant information to users than the classification of expenses by nature but the allocation of costs to functions may require arbitrary allocations and involve considerable judgement. Example RWF 10,500 (4,100) 6,400 300 (2,200) (1,800) 2,700 (300) 2,400 (380) 2,020 Sales Revenue Cost of Sales Gross Profit Other Operating Income Distribution Costs Administrative Expenses Profit from Operations Finance Cost (Interest) Profit Before Tax Income Tax Expense Net Profit for the Period K. NATURE OF EXPENDITURE METHOD Expenses are combined in the Statement of Comprehensive Income according to their nature, for example depreciation, purchase of materials, employee benefits and advertising costs. The method is simple to apply because no allocations of expenses to functions are required. Example Sales Revenue Other Income Changes in Inventories of Finished Goods and Work-In-Progress Raw Materials and Consumables Used Employee Benefits Cost Depreciation Expense Other Expenses Total Expenses Profit from Operations Finance Cost (Interest) Profit Before Tax Income Tax Expense Net Profit for the Period Page 152 RWF 10,500 300 200 3,900 2,500 600 900 (8,100) 2,700 (300) 2,400 380 2,020 The choice between the two methods depends on historical and industry factors and the nature of the entity. Management is required to select the most relevant and reliable presentation. However, because information on the nature of expenses is useful in predicting future cash flows additional disclosure is required when the function of expense classification is used. L. CHANGES IN INVENTORIES OF FINISHED GOODS AND WORK-IN-PROGRESS This represents the difference between the opening and closing inventories of finished goods and work-in-progress. If Closing Stock (in total for both Finished Goods and Work in Progress) is lower in value than opening stock then you add this figure to the other expenses being deducted from Sales Revenue to give you Profit from operations. If Closing Stock (in total for both Finished Goods and Work in Progress) is higher in value than opening stock then you deduct this figure from the total expenses being deducted from Sales Revenue to give you Profit from operations. M. RAW MATERIALS AND CONSUMABLES USED This represents opening inventories of raw materials and consumables plus purchases of these minus closing inventories of raw materials and consumables. Example PLO Limited’s directors have supplied you with the following information in respect of their Statement of Comprehensive Income. Opening Inventories: Raw Materials Work-In-Progress Finished Goods Purchases of Raw Materials Closing Inventories: Raw Materials Work-In-Progress Finished Goods RWFm 120 300 180 500 160 280 170 REQUIREMENT: Calculate the required amounts for the headings: (a) “Changes in inventories of finished goods and work-in-progress” , (b) “Raw materials and consumables used” and (c) Cost of Sales Page 153 SOLUTION: (a) Changes in inventories of finished goods and work-in-progress (180 – 170) + (300 – 280) (b) (c) Raw materials and consumables used (120 + 500 – 160) Cost of Sales Opening Stock (120 + 300 + 180) Purchases Less Closing Stock (160 + 280 + 170) Cost of Goods Sold (30) (460) 600 500 1,100 (610) 490 Note: The cost of sales figure is the same as the total of the changes in inventories of finished goods and work in progress (30) and Raw materials and consumables used (460). In the event that there is an increase in the inventories of finished goods and work-in-progress this amount will be shown as a credit in the Statement of Comprehensive Income. N. INFORMATION TO BE PRESENTED EITHER ON THE FACE OF THE STATEMENT OF COMPREHENSIVE INCOME OR IN THE NOTES When items of income and expense are material, their nature and amount shall be disclosed separately. Examples of these would include: (a) The write down of inventories to net realisable value (b) The write down of property, plant and equipment to recoverable amount (c) Gains/losses on disposal of property, plant and equipment (d) Gains/losses on disposal of investments (e) Legal settlements An entity shall not present any items of income and expenses as extraordinary items. The description extraordinary item was used in the past to represent income and expenses arising from events outside the ordinary activities of the business. IAS 1 has abolished this classification of items. Example – Statement of Comprehensive Income: Function of Expenditure Method Set out below are details from the financial records of WAT Limited: RWFm Distribution Costs 5,470 Finance Costs 647 Cost of Sales 18,230 Sales Revenue 44,870 Income Tax Expense 1,617 Administration Expenses 9,740 Page 154 REQUIREMENT: Prepare the Statement of Comprehensive Income using the Function of Expenditure Method. SOLUTION: WAT Limited Statement of Comprehensive Income for the year-ended 31st March 20X4 RWFm 44,870 18,230 26,640 (9,740) (5,470) 11,430 (647) 10,783 (1,617) 9,166 Sales Revenue Cost of Sales Gross Profit Administration Expenses Distribution Costs Profit from Operations Finance Costs Profit Before Tax Income Tax Expense Net Profit for the Year Example – Statement of Comprehensive Income : Nature of Expenses Method Set out below are details from the financial records of FRD Limited for the year-ended 31st March 20X4: RWFm 9,430 520 8,750 10,650 44,870 4,090 1,617 647 Depreciation Decrease in inventories of finished goods and work-in-progress Raw Materials Used Staff Costs Sales Revenue Other Operating Expenses Income Tax Expense Finance Costs REQUIREMENT: Prepare the Statement of Comprehensive Income using the Nature of Expenditure Method. SOLUTION: FRD Limited Statement of Comprehensive Income for the year-ended 31st March 20X4 Sales Revenue Decrease in inventories of finished goods and work-in-progress Raw Materials Used Staff Costs Depreciation Other Operating Expenses Total Expenses Profit from Operations Finance Costs Profit Before Tax Income Tax Expense Net Profit for the Year Page 155 RWFm 44,870 520 8,750 10,650 9,430 4,090 33,440 11,430 (647) 10,783 (1,617) 9,166 Example Set out below are details from the financial records of FYN Limited for the year-ended 31st March 20X4: RWFm 8,760 450 6,350 8,650 46,340 5,180 1,800 Depreciation Increase in inventories of finished goods and work-in-progress Raw Materials Used Staff Costs Sales Revenue Other Operating Expenses Income Tax Expense Interest Costs 750 REQUIREMENT: Prepare the Statement of Comprehensive Income using the Nature of Expenditure Method. SOLUTION: FYN Limited Statement of Comprehensive Income for the year-ended 31st March 20X4 Sales Revenue Increase in inventories of finished goods and work-in-progress Raw Materials Used Staff Costs Depreciation Other Operating Expenses Total Expenses Profit from Operations Finance Costs Profit Before Tax Income Tax Expense Net Profit for the Year RWFm 46,340 (450) 6,350 8,650 8,760 5,180 28,490 17,850 (750) 17,100 (1,800) 15,300 O. STATEMENT OF CHANGES IN EQUITY An entity shall present a statement of changes in equity showing on the face of the statement: (a) Profit or loss for the period (b) Each item of income and expense for the period that is recognised directly in equity e.g. a revaluation surplus on the revaluation of property (c) The effects of changes in accounting policies and correction of errors recognised in accordance with IAS8 (d) The amounts of transactions with equity holders e.g. issue of shares, any premium thereon and dividends to equity holders. (e) The balance of retained earnings (accumulated profit) at the start of the year, changes during the year and the balance at the end of the year. (f) The balance on each reserve account at the start of the year, changes during the year and the balance at the end of the year. Page 156 Example – Statement of Changes in Equity Opening Balance Issue of Share Capital Revaluation of Property Net Profit Dividend Paid Closing Balance Share Capital RWFm 150 50 Share Premium RWFm 70 20 Revaluation Reserve RWFm 110 - Accumulated Profit RWFm 39 - Total RWFm 369 70 - - 40 - 40 200 90 150 51 (10) 80 51 (10) 520 Essentially the statement of changes in equity presents, in a columnar format, all the changes which have affected the various equity balances of share capital and reserves. P. STATEMENT OF RECOGNISED INCOME AND EXPENSE Example Gain / Loss on Revaluation of Properties Exchange differences on translation of foreign operations Net Income recognised directly in Equity Profit for the period Total Recognised Income and Expense for the Period RWF 100,000 50,000 150,000 460,000 610,000 The Statement of Recognised Income and Expense (formerly known as Statement of Recognised Gains and Losses) represents the total income and expenses of the entity for the period. It includes income and expenses that are taken directly to Reserves, for example Revaluation of Non-Current assets and Foreign Currency Translation as well as the profit / loss generated by the entity for the period. Q. DISCLOSURE OF SIGNIFICANT ACCOUNTING POLICIES An entity shall disclose the significant accounting policies used in preparing the financial statements. Page 157 R. QUESTION/SOLUTION Question – APA The following information is available about the balances and transactions of APA, a limited liability company. Balances at 30th April 20X3 Non-current assets - Cost - Accumulated Depreciation Inventory All Raw Materials Trade Receivables Cash at Bank Trade Payables Issued Share Capital – ordinary shares of RWF1 each Accumulated Profits 10% Loan Notes Loan Note Interest Owing RWF 1,000,000 230,000 410,000 380,000 87,000 219,000 400,000 818,000 200,000 10,000 Transactions during year-ended 30th April 20X4 Sales Revenue Purchases Staff Costs Other Operating Expenses Interest on loan notes paid during year Issue of 100,000 RWF1 ordinary shares at a premium of RWF0.50 per share RWF 4,006,000 2,120,000 1,340,000 300,000 20,000 There were no purchases or sales of non-current assets during the year. Adjustments at 30th April 20X4 (1) Depreciation of RWF100,000 is to be allowed for (2) Receivables totalling RWF20,000 are to be written off. RWF Balances at 30th April 20X4 (1) Inventory All Raw Materials 450,000 (2) Trade Receivables (before writing off debts shown above) 690,000 (3) Cash at Bank 114,000 (4) Trade Payables 180,000 REQUIREMENT: Prepare the Statement of Comprehensive Income for the year-ended 30th April 20X4 and the Statement of Financial Position of APA as at 30th April 20X4 in accordance with IAS 1 Presentation of Financial Statements. The Statement of Comprehensive Income should be prepared using the nature of expenditure method. Page 158 SOLUTION: APA Limited Statement of Comprehensive Income for the year-ended 30th April 20X4 RWF’000 Sales Revenue 4,006 Raw Materials Used (410 + 2,120 – 450) 2,080 Staff Costs 1,340 Depreciation 100 Other Operating Expenses (300 + 20) 320 Total Expenses (3,840) Profit from Operations 166 Interest Costs (20) Profit Before Tax 146 Income Tax Profit for the Year 146 APA Limited Statement of Financial Position for the year-ended 30th April 20X4 RWF Assets Non-Current Assets Cost Accumulated Depreciation 1,000,000 330,000 Current Assets: Inventory Trade Receivables Cash at Bank RWF 670,000 450,000 670,000 114,000 Total Assets 1,234,000 1,904,000 Equity and Liabilities Shareholders’ Equity Issued Capital Share Premium Retained Earnings (818 + 146) Total Equity 500,000 50,000 964,000 1,514,000 Non-Current Liabilities 10% Loan Notes Current Liabilities Payables Interest accrued Total Current Liabilities Total Equity and Liabilities 200,000 180,000 10,000 190,000 1,904,000 Page 159 Question – CNS The following items have been extracted from the trial balance of CNS, a limited liability company, as at 30th September 20X4. Ref. To RWF RWF Notes Opening Inventory 186,400 Purchases 1,748,200 Carriage Inwards 38,100 Carriage Outwards 2 47,250 Sales Revenue 3,210,000 Trade Receivables 318,000 Wages & Salaries 2 and 3 694,200 Sundry Administrative Expenses 2 381,000 Allowance for doubtful debts, 4 18,200 st as at 1 October 20X3 Bad Debts written off during the year 4 14,680 Office Equipment as at 1st October 20X3: Cost 5 214,000 Accumulated Depreciation 5 88,700 Office Equipment: Additions during the year 5 48,000 Proceeds of sale of items during the year 5 12,600 Interest paid 2 30,000 Notes: 1. Closing inventory amounted to RWF219,600 2. Prepayments and accruals: Prepayments RWF Carriage Outwards Wages & Salaries Sundry Administrative Expenses Interest Payable 3. 4,900 Wages and salaries cost is to be allocated: Cost of Sales Distribution Costs Administrative Expenses Accruals RWF 1,250 5,800 13,600 30,000 10% 20% 70% 4. Further bad debts totalling RWF8,000 are to be written off, and the closing allowance for doubtful debts is to be equal to 5% of the final trade receivables figure. The bad and doubtful debt expense is to be included in administrative expenses. 5. Office equipment: Depreciation is to be provided at 20% per annum on the straight-line basis, with a full year’s charge in the year of purchase and none in the year of sale. During the year office equipment, which had cost RWF40,000 with accumulated depreciation of RWF26,800 was sold for RWF12,600. All office equipment is used for administrative purposes. 6. Income Tax of RWF22,000 is to be provided for. Page 160 REQUIREMENT: Prepare the company’s Statement of Comprehensive Income for the year-ended 30th September 20X4 using the function of expenditure layout in accordance with IAS 1 Presentation of Financial Statements. SOLUTION: CNS Limited Statement of Comprehensive Income for the year-ended 30th September 20X4 RWF Sales Revenue Cost of Sales (W1) Gross Profit Distribution Costs (W1) Administrative Expenses (W1) Profit from operations Interest payable (30,000 + 30,000) Profit before Tax Income Tax Profit for the Year (188,500) (944,680) RWF 3,210,000 (1,823,100) 1,386,900 (1,133,180) 253,720 (60,000) 193,720 22,000 171,720 W1 Opening Inventory Purchases Carriage Inwards Carriage Outwards (47,250 + 1,250) Wages and Salaries 694,200 5,800 700,000 Cost of Sales RWF 186,400 1,748,200 38,100 Distribution Costs RWF Administrative Expenses RWF 48,500 70,000 Sundry administrative expenses (381,000 + 13,600 – 4,900) Bad and doubtful debts (14,680 + 8,000 – 2,700) (W2) Depreciation of office equipment 20% x (214,000 – 40,000 + 48,000) Loss on sale (W3) Closing inventory (219,600) 1,823,100 Page 161 140,000 490,000 389,700 19,980 44,400 600 188,500 944,680 W2 Provision for Bad Debts Trade Receivables per Question Bad Debts to write off Provision Required at 5% Current Provision Decrease in Provision Required 318,000 (8,000) 310,000 15,500 (18,200) 2,700 W3 Profit / Loss on Disposal Cost Accumulated Depreciation Net Book Value 40,000 (26,800) 13,200 Sales Proceeds Net Book Value Profit / (Loss) on disposal 12,600 (13,200) (600) Page 162 BLANK Page 163 Study Unit 10 IAS 2 - Inventories Contents _________ A. Introduction - Inventories _________ B. Definitions _________ C. Measurement _________ D. Disclosure _________ E. Methods of Costing _________ Page 164 A. INTRODUCTION Introduction - Inventories An Inventory is a list, but as raw materials, work-in-progress and finished good are detailed on lists or inventories, the term inventories is now commonly used to mean the items on those lists. The calculation of the amounts at which inventories are stated in the accounts in one of the most important and difficult areas in financial reporting. Relatively small variations in the values at which inventories are stated can have significant impact on reported profits, while the proper valuation of inventories involves the exercise of judgement. The determination of profit for an accounting year requires the matching of costs with related revenues. The cost of unsold or unconsumed inventories will have been incurred in the expectation of future revenue. It is appropriate to carry forward this cost to be matched with the revenue when it arises. If there is no reasonable expectation of sufficient future revenue to cover cost incurred e.g. as a result of deterioration, obsolescence or a change in demand, the irrecoverable cost should be charged to revenue in the year under review. Thus, inventories need to be stated at the lower of cost and net realisable value. B. DEFINITIONS Inventories are assets: (a) Held for resale in the ordinary course of business (b) In the process of production for resale e.g. raw materials, work-in-progress and finished goods (c) In the form of materials or supplies to be consumed in the production process or of services Cost shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Cost of purchase comprises purchase price including import duties, non-returnable taxes, transport and handling costs and any other directly attributable costs, less trade discounts, rebates and subsidies. Cost of conversion comprises: (a) Costs which are directly related to units of production e.g. direct labour, direct expenses and sub-contracted work (b) Production overheads (c) Other overheads, if any attributable in the particular circumstances of the business to bringing the product or service to its present location and condition Production overheads: overheads incurred in respect of materials, labour or services for production, based on the normal capacity as expected on average under normal circumstances, taking one year with another. Each overhead should be classified according to function e.g. production, selling or administration so as to ensure the inclusion, in cost of conversion, of those overheads including depreciation which relate to production, notwithstanding that these may accrue wholly or partly on a time basis. Page 165 Net realisable value is: the estimated selling price in the ordinary course of business less: (a) The estimated costs of completion and (b) Estimated costs necessary to make the sale. Fair Value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. C. MEASUREMENT INVENTORIES ARE MEASURED AT THE LOWER OF COST AND NET REALISABLE VALUE FOR EACH SEPARATE ITEM IN THE PERIODIC FINANCIAL STATEMENTS. SIMILAR ITEMS MAY BE GROUPED TOGETHER FOR VALUATION PURPOSES. D. DISCLOSURE The accounting policies which have been used in calculating the cost and net realisable value are disclosed in the statements and reports. A suitable description of the amount at which inventories are stated in accounts might be "at the lower of cost and net realisable value". In general, inventories should be sub-classified in the Statement of Financial Position or in the notes in the financial statements so as to indicate the amounts held in each of the main categories in the standard Statement of Financial Position formats. Statement of Financial Position (Excerpt) RWF 2,370,000 X X X X Inventories (Note 9) Trade Receivables Quoted Investments Cash Note 9 RWF 500,000 670,000 1,200,000 2,370,000 Raw materials Work in progress Finished goods EXAMPLE 1 Z Ltd. has an item in closing inventory which cost RWF250 with an expected selling price of RWF290. After the Statement of Financial Position date, due to severe competition, the selling price falls to RWF245. Under IAS 2 stock should be valued at the lower of cost and net realisable value. The cost is RWF250, however the net realisable value is RWF245. The stock should therefore be stated at RWF245. Page 166 EXAMPLE 2 H Ltd. has an item in closing inventory which cost RWF750 with a then expected selling price of RWF850. The item was damaged while being moved in the stores. It will cost RWF90 to repair this item and it can then be sold for RWF800. The cost of the item is RWF750, its net realisable value is RWF800 – 90 i.e. RWF710. The inventory item should be stated at a value of RWF710. E. METHODS OF COSTING It is frequently not practicable to relate expenditure to specific units of inventory. The ascertainment of the nearest approximation to cost gives rise to two problems: (i) (ii) The selection of an appropriate method for calculating the related costs where a number of identical items have been purchased or made at different times i.e.: (a) First In, First Out (FIFO) (b) Last In, First Out (LIFO) (c) Weighted Average The selection of an appropriate method for relating costs to inventories i.e.: (a) Job costing (b) Batch costing (c) Process costing (d) Standard costing In selecting the methods referred to above, management must exercise judgement to ensure that the methods chosen provide the fairest practical approximation to 'actual cost'. FIFO: The assumption underlying it is that the first inventory item to be bought is the first to be sold. The closing inventory is, therefore, the most recently acquired. In a period of rising prices, this method will result in a high stock valuation. This will represent the actual cost of the inventory as long as the issues to production/sales have followed a first-in, first-out pattern. LIFO: The underlying assumption is that the last inventory to be bought is the first to be sold. The value of the closing inventory is, therefore, that of the earliest inventory acquired. It should be noted that LIFO is no longer permitted as a valuation method by IAS 2. Weighted Average: The underlying assumption in charging out inventory sold is that the value of the closing inventory is the average price paid for it over the period. It is calculated by dividing the total value of purchases by the total number of units/tonnes purchased. In times of rising price levels, this method gives a lower valuation to unsold inventory than FIFO above and a higher valuation than LIFO and vice versa when price levels fall. Page 167 EXAMPLE 3 A grain merchant, who has no opening inventory, has four deliveries of a grain made to the same loading bay over a period of three months. The quantities delivered and the invoiced costs are as follows: Tonnes 1 January 4 February 26 February 15 March Cost per Tonne 1,000 tonnes 600 tonnes 800 tonnes 1,200 tonnes @ RWF80 per tonne @ RWF84 per tonne @ RWF101 per tonne @ RWF100 per tonne Total RWF 80,000 50,400 80,800 120,000 RWF331,200 During the same period, he sells 2,200 tonnes of the 3,600 tonnes, delivered, at RWF120 per tonne. Obviously, he has 1,400 tonnes left but what was the cost of these? How much profit was made? The answers lie in the valuation of closing inventory. Establish: Sales Purchases 2,200 x RWF120 RWF264,000 RWF331,200 - Fact - Fact The closing inventory valuation depends on the valuation method used. Using FIFO, the value of the closing inventory would be 1,200 tonnes 200 tonnes @ RWF100 @ RWF101 120,000 20,200 RWF140,200 Using Weighted Average, the value of the closing inventory would be: RWF331,200 3,600 tonnes 1,400 tonnes x RWF92 = (RWF92 per tonne = RWF128,800 FIFO RWF Profit for the Period Sales Less: Purchases Closing Inventory Cost of Sales Profit Weighted Average RWF RWF RWF 264,000 331,200 (140,200) Summary Closing Inventory Valuation Profit 264,000 331,200 (128,800) (191,000) 73,000 (202,400) 61,600 140,200 73,000 128,800 61,600 Page 168 COSTING METHODS Job costing is a costing method where costs are incurred for a specific order undertaken for a customer’s special requirements and each order is for a short duration e.g. Manufacturing a sailing boat. Batch costing is a costing method where costs are incurred for a specific order undertaken but the costs apply to similar articles e.g. bean processing and pea processing. Process costing is a costing method where goods are produced from continuous operations e.g. pentium chip making. Standard costing is a budgetary control technique which compares standard costs and standard revenues with actual results obtained. Absorption costing is a costing method which charges a proportion of fixed overheads for the period against the items produced. Direct costing or Marginal costing is a costing system which does not charge a proportion of fixed overheads for the period against the items produced i.e. the inventory is charged with variable costs and valued on that basis. Production Overheads IAS 2 requires that the cost of inventory should include production overheads. The production overheads should be absorbed into inventory based on the normal production capacity. Example 4 ZEN Ltd. manufactures a single product called the Alpha. The company manufactured 8,000 units of Alpha during the year and sold 6,000 units at RWF12 each. The variable cost of each unit of Alpha is RWF4 per unit and fixed production overheads were RWF50,000 for the year. The normal capacity is assumed to be 10,000 units. The 2,000 units in closing stock will be valued as follows: Variable Cost Fixed Production Overhead (RWF50,000 ÷ 10,000 units) RWF 4 5 RWF9 Closing Inventory Valuation RWF9 x 2,000 units = RWF18,000 Note: The fixed production overhead is calculated based on the normal capacity of 10,000 units and not the actual quantity manufactured. Page 169 Study Unit 11 IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors Contents A. Introduction B. Definitions C. Accounting Policies D. Changes in Accounting Policies E. Disclosure – Changes in Accounting Policies F. Changes in Accounting Estimates G. Disclosure – Changes in Accounting Estimates H. Errors I. Disclosure – Prior Period Errors Page 170 A. INTRODUCTION The objectives of IAS 8 Accounting Policies, Changes in Estimate and Errors are: • Set out the criteria for choosing and changing accounting policies and • Accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and correction of errors. B. DEFINITIONS Accounting Policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. A change in Accounting Estimate is an adjustment of the carrying amount of an asset, liability, or an amount of the periodic consumption of an asset, that results from the assessment of present status of, and expected future benefits and obligations associated with, assets and liabilities. Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors. Material Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the items, or a combination of both, could be the determining factor. Prior Period Errors are omissions from, and misstatements in, the entity’s financial statements for prior periods arising from a failure to use, or misuse, reliable information that: (a) Was available when financial statements for those periods were authorised for issue; and (b) Could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. C. ACCOUNTING POLICIES If there is an accounting standard that applies to a transaction or event, the accounting policy to be applied in reporting that transaction or event shall be chosen by referring to the Accounting Standard. The entity does not have to apply the standard if the effect of applying the standard is immaterial If there is no Accounting Standard relating to the transaction or event, management should use their judgement in developing and applying an accounting policy that results in information that is: (a) Relevant to the users of the Financial Statements, and (b) Reliable: Page 171 (i) Faithful presentation of Financial position, financial performance and cash flow, (ii) Reflect the substance of the transaction and not just the legal form, (iii) Free from bias, (iv) Prudent and (v) Complete. The entity shall apply accounting standards consistently for similar transactions and events and over time, unless the standard specifically allows or requires categorisation of items for which different policies may be appropriate. D. CHANGES IN ACCOUNTING POLICIES An entity can only change an accounting policy if: (a) It is required by a standard, or (b) It provides more reliable and relevant information about the effects of the transactions, other events or conditions on the entity’s financial position, performance or cash flows. Transactions that are different from those which have previously occurred and transactions that have not occurred before do not represent a change in an Accounting Policy. E. DISCLOSURE – CHANGES IN ACCOUNTING POLICY Where an entity makes a voluntary change in an accounting policy which has an effect on the current period or prior periods, that would have an effect on that period but it is not possible to determine the amount of the adjustment, or might have an effect on future periods, the entity should disclose: (a) Nature of the change in accounting policy, (b) Reasons why the change will provide more reliable and relevant information, (c) Amount of the adjustment for current period and each prior period for each financial statement line item affected, (d) Amount of the adjustment relating to prior periods before those presented, if practicable, (e) The circumstances that caused the existence of that condition and a description of how and from when the change in the accounting policy has been applied. When the effect of the initial application of a standard has an impact on the current period or any prior period, but it is not practicable to estimate the amount of the adjustment, or it might have an effect on future periods, an entity shall disclose: (a) Title of the Standard, (b) Where relevant the change in the accounting policy is made in accordance with its transitional provisions, (c) Nature of the change in accounting Policy, (d) A description of the transitional provisions, Page 172 (e) If applicable, the transitional provisions might have an effect on future periods, (f) For the current period and each prior period presented the amount of the adjustment for each line item in the financial statements, (g) Amount of the adjustment relating to periods before those presented to the extent that it is practicable. If retrospective application is not possible the circumstances that caused the existence of that condition and a description of how and from when the change in the accounting policy has been applied. When an entity has not applied a standard that has been issued but is not yet effective, the entity shall disclose: (a) This fact and (b) Known or reasonably estimated information relevant to assessing the possible impact that application of the new standard will have on the entity’s financial statement in the period of initial application. F. CHANGES IN ACCOUNTING ESTIMATES Some items cannot be measured with precision but can only be estimated. These estimates are based on the most recently available information. Examples of items that require estimation are Bad Debts and Useful lives of assets. Use of estimates is common practice in Financial Statements they do not mean that the information is unreliable. How estimates are calculated may change over time due to a change in business practices, more experience in the area or the availability of additional information. A revision of an estimate is neither a change in an accounting estimate nor the correction of an error. A change in a measurement basis being applied is a change in an accounting policy and not a change in an accounting estimate. When a change in an accounting estimate gives rise to a change in assets, liabilities or equity it should be recognised by adjusting the carrying amount of the asset, liability or equity as appropriate. G. DISCLOSURE – CHANGES IN ACCOUNTING ESTIMATES The entity shall disclose the nature and amount of the change in accounting estimate where it has an effect on the current period or future periods. The entity does not have to disclose the effect on future periods if it is impracticable to do so, but must disclose this fact. H. ERRORS Errors can occur in the recognition, measurement, presentation or disclosure of elements of financial statements. Financial statements that contain errors do not comply with IFRSs, these errors can be either material or immaterial but made intentionally to present a particular aspect of the entity’s financial position or performance. Errors in the current period should be corrected before the financial statements are authorised for issue. However, errors that are not discovered until a subsequent period are corrected in Page 173 the comparative information presented in the financial statements for that subsequent period, for example, an error is discovered in the financial statements relating to the year-ended 30th September 2008 while finalising the accounts for the year-ended 30th September 2009, the comparative information presented in the “prior year comparatives” in the financial statements for the year-ended 30th September 2009 will be corrected. A material prior period error shall be corrected in the first set of financial statements authorised for issue after the discovery of the error: (a) Restate the comparative amount for the prior period(s) presented in which the error occurred, or (b) If the error occurred before the earliest period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented. I. DISCLOSURE OF PRIOR PERIOD ERRORS The entity has to make the following disclosure: (a) Nature of the error, (b) As far as practicable, the amount of the correction for each financial statement line item affected, (c) Amount of the correction at the beginning of the earliest prior period presented, and (d) If a retrospective restatement is not possible then the circumstances that led to the existence of the error and a description of how and from when the error has been corrected. These disclosures do not need to be repeated in subsequent Financial Statements. Page 174 BLANK Page 175 Study Unit 12 IAS 10 – Events after the Reporting Period Contents ___________________________________________________________________________ A. Objective ___________________________________________________________________________ B. Definitions ___________________________________________________________________________ C. Recognition & Measurement ___________________________________________________________________________ D. Dividends ___________________________________________________________________________ E. Going Concern ___________________________________________________________________________ F. Disclosure ___________________________________________________________________________ Page 176 A. OBJECTIVE The objective of this standard is to set out the circumstances in which an entity should adjust its financial statements for events that occur after the Statement of Financial Position Date but before the Financial Statements are approved by the Board of Directors. The standard also sets out the disclosures to be made about these events. The standard indicates that an entity should not prepare its financial statements on a going concern basis if events after the Statement of Financial Position clearly indicate that this is no longer appropriate. B. DEFINITIONS Events after the Reporting Period are those events, favourable and unfavourable, that occur between the Statement of Financial Position date and the date when the financial statements are authorised for issue. Two types of Events can be identified: (a) Those that provide evidence of conditions that existed at the Statement of Financial Position date (adjusting Events after the Reporting Period); and (b) Those that are indicative of conditions that arose after the Statement of Financial Position date (Non-adjusting events after the balance date). C. RECOGNITION AND MEASUREMENT ADJUSTING EVENTS AFTER THE REPORTING PERIOD An entity shall adjust the amounts recognised in its financial statements to reflect adjusting Events after the Reporting Period. The following are examples of adjusting events that require the entity to adjust the amounts shown in the financial statement: (a) Settlement of a Court case after the Statement of Financial Position date which confirms that the entity has a present obligation (b) Discovery of fraud or errors that show the financial statements are incorrect (c) Non-Current Assets - The subsequent determination of the purchase price or of the proceeds of sale of assets purchased or sold before the year-end (d) Property - A valuation which provides evidence of a permanent diminution in value. (e) Investments - The receipt of a copy of the financial statements or other information in respect of any company which provides evidence of a permanent diminution in the value of a long-term investment. (f) Inventory - The receipt of proceeds of sales after the Statement of Financial Position date or other evidence concerning the net realisable value of inventory. (g) Receivables - The renegotiation of amounts owing by receivables, or the bankruptcy of a customer. (h) Taxation - The receipt of information regarding rates of taxation. (i) Claims - Amounts received or receivable in respect of insurance claims which were in the course of negotiation at the Statement of Financial Position date. Page 177 NON-ADJUSTING EVENTS AFTER THE REPORTING PERIOD An entity shall not adjust the amounts recognised in its financial statements to reflect nonadjusting Events after the Reporting Period. (a) A major business combination after the Statement of Financial Position or disposing of a major subsidiary. (b) Issues of shares and debentures (c) Purchases and sales of non-current assets and investments (d) Losses of non-current assets or inventory as a result of a catastrophe such as fire or flood (e) Announcing or commencing the implementation of a major restructuring. (See IAS 37) (f) Announcing a plan to discontinue an operation (g) Strikes and other labour disputes D. DIVIDENDS If an entity declares dividends to equity shareholders after the Statement of Financial Position date the entity shall not recognise those dividends as a liability at the Statement of Financial Position date. The dividends are not recognised as a liability at the Statement of Financial Position date because they are not a present obligation at the Statement of Financial Position date. E. GOING CONCERN An entity shall not prepare its financial statements on a going concern basis if management determines after the Statement of Financial Position date that it intends to liquidate the entity or to cease trading or that it has no realistic alternative but to do so. F. DISCLOSURE An entity shall disclose the date when the financial statements were authorised for issue and who gave the authorisation. If an entity receives information after the Statement of Financial Position date about conditions that existed at the Statement of Financial Position, it shall update disclosures that relate to those conditions, in the light of the new information. For non-adjusting events an entity shall disclose: (a) The nature of the event, and (b) An estimate of its financial effect or a statement that such an estimate cannot be made. Page 178 BLANK Page 179 Study Unit 13 IAS 16 Property, Plant and Equipment Contents ____________ A. Objective ____________ B. Definitions ____________ C. Depreciation ____________ D. Accounting for Depreciation ____________ E Disposal of Property, Plant and Equipment ____________ F. Ledger Accounts and Journal Entries ____________ G. Recognition and Measurement ____________ H. Disclosure ____________ I. Examples ____________ Page 180 A. OBJECTIVE The Objective of IAS 16 is to set out the accounting treatment for Property, Plant and Equipment. The main areas dealt with in the standard are: • Recognition of non-current assets(fixed assets), • Determination of the carrying amount, • Determination of the depreciation charges • Determination of the impairment losses to be recognised in the financial statements. B. DEFINITIONS Property, Plant and Equipment: Tangible assets held for use in production or supply of goods or services or for rental or administration purposes and are expected to be used during more than one accounting period. Depreciation: Systematic allocation of depreciable amount, the cost (or re-valued amount) less residual value over an asset’s useful life Carrying amount is the amount at which the asset is recognised after deducting any accumulated depreciation and accumulated impairment losses. An Impairment Loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. Fair Value: The amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. Recoverable Amount: The higher of the asset’s net selling price and its value in use. Value in Use (IAS 36): The present value of estimated future cash flows expected from the continuing use of an asset and from its disposal at the end of its useful life. C. DEPRECIATION The assessment of depreciation and its allocation to accounting periods involves the consideration of three factors: (a) The carrying amount of the asset - whether cost or valuation (b) The length of the asset's expected useful economic life to the business of the enterprise, having due regard to the incidence of obsolescence and The estimated residual value of the asset at the end of its useful economic life in the business of the enterprise (c) Page 181 The useful economic life of an asset is the period over which the present owner will derive economic benefits from its use. The following factors need to be considered in determining the useful life of an asset: (a) The expected usage of the asset by the enterprise. The usage is of an asset is determined by the expected capacity of the asset or its physical output. (b) The expected physical wear and tear is affected by operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme of the enterprise and the care and maintenance of the asset when idle. (c) Technical obsolescence arising from changes or improvements in production or from a change in the market demand for the product or service output of the asset (d) Legal or similar limits on the use of the asset, such as expiry dates of related leases. The useful economic lives and depreciation methods of assets should be reviewed regularly and, where necessary, revised and accounted for as a change in estimate. D. ACCOUNTING FOR DEPRECIATION Provision for depreciation of non-current asset having a finite useful economic life should be made by allocating the cost or re-valued amount less the estimated residual value of the assets as fairly as possible to the periods expected to benefit from their use. The depreciation methods used should be the one which is the most appropriate having regard to the type of asset and their use in the business. Methods of Calculation There are a number of different methods used in calculating the depreciation charge. The most common methods are: (a) The Straight line method (b) The Reducing balance method The Straight Line Method Under this method, the total depreciable amount is charged in equal instalments to each accounting period over the expected useful life of the asset. Formula: Cost of Asset - the Residual Value (e.g. scrap value) Expected useful life of the asset Example CDE Ltd. acquired a non-current asset which cost RWF10,000 on 1st January 20X0. The estimated useful life of the asset is 5 years with no residual value. The depreciation charge in the profit and loss account each year is calculated as follows: RWF10,000 – nil = RWF2,000 per annum 5 years Page 182 Example CDE Ltd. acquired a non-current asset which cost RWF60,000 on 1st January 20X0. The estimated useful life of the asset is 5 years with a residual value of RWF5,000. The depreciation charge in the profit and loss account each year is calculated as follows: RWF60,000 – RWF5,000 5 years = RWF11,000 per annum The net book value (NBV) of the non-current asset would be: Year-end 31.12.X0 31.12.X1 31.12.X2 31.12.X3 Cost RWF 60,000 RWF 60,000 RWF 60,000 RWF 60,000 Acc. Dep’n 11,000 22,000 33,000 44,000 NBV 49,000 38,000 27,000 16,000 31.12.X 4 RWF 60,00 0 55,00 0 5,000 Non-current asset is shown in the Statement of Financial Position at its cost less accumulated depreciation to date. The Reducing Balance Method Under this method, the annual depreciation charge is a fixed percentage of the net book value of the asset at the end of the previous accounting period. Example CDE Ltd. acquired a non-current asset which cost RWF10,000 on 1st January 20X0. The reducing balance rate is 40%. The depreciation charge in the Statement of Comprehensive Income each year is calculated as follows: Acc. Dep’n Asset Cost Depreciation 20X0 NBV end of 20X0 Depreciation 20X1 RWF 10,000 (4,000) 6,000 (2,400) NBV end of 20X1 Depreciation 20X2 3,600 (1,440) NBV end of 20X2 2,160 RWF 4,000 6,400 (4,000 + 2,400) 7,840 (6,400 + 1,440) Both methods compared Example CDE Ltd. acquired a non-current asset which cost RWF8,000 on 1st January 20X1. The estimated useful life of the asset is 4 years with a residual value of RWF500. The reducing balance rate is 50%. Page 183 The depreciation charge in the Statement of Comprehensive Income each year is calculated as follows: Straight Line Method: RWF8,000 – RWF500 4 years = RWF1,875 per annum Straight Line Cost Depreciation 20X1 RWF 8,000 (1,875) NBV ye/ 31.12.X1 Depreciation 20X2 6,125 (1,875) NBV y/e 31.12.X2 Depreciation 20X3 4,250 (1,875) NBV y/e 31.12.X3 Depreciation 20X4 2,375 (1,875) NBV y/e 31.12.X4 500 Reducing Balance RWF 8,000 (4,000) i.e. 50% x 8,000 4,000 (2,000) i.e. 50% x 4,000 2,000 (1,000) i.e. 50% x 2,000 1,000 (500) i.e. 50% x 1,000 500 Straight Line Method – Statement of Financial Position Extract Year-end Cost Acc. Dep’n NBV 31.12.X1 31.12.X2 31.12.X3 RWF 8,000 1,875 6,125 RWF 8,000 3,750 4,250 RWF 8,000 5,625 2,375 31.12.X 4 RWF 8,000 7,500 500 Reducing Balance Method – Statement of Financial Position Extract Year-end Cost Acc. Dep’n NBV 31.12.X1 31.12.X2 31.12.X3 RWF 8,000 4,000 4,000 RWF 8,000 6,000 2,000 RWF 8,000 7,000 1,000 31.12.X 4 RWF 8,000 7,500 500 Exercise (a) A Van is bought for RWF6,000 on 1st January 20X2. It will be used for 3 years and then sold back to the supplier for RWF3,072. Show the depreciation calculations for each year using: (a) The reducing balance method with a rate of 20% (b) The straight line method Page 184 (b) A company, which makes up its accounts annually to 31 December, provides for depreciation of its machinery at the rate of 10% per annum on the diminishing balance system On 31 December, 20X2, the machinery consisted of three items purchased as follows: On 1 January 20X0 On 1 April 20X1 On 1 July 20X2 Machine A Machine B Machine C RWF 3,000 2,000 1,000 Cost Cost Cost Required: Your calculations showing the depreciation provision for the year 20X2. Solution: (a) Reducing Line Method RWF Van cost 6,000 2002 Dep’n 20% 1,200 NBV end Yr 1 4,800 2003 Dep’n 20% 960 NBV end Yr 2 3,840 2004 Dep’n 20% 768 NBV end Yr 3 3,072 Straight Line Method RWF Van cost 6,000 2002 Dep’n 976 NBV end Yr 1 5,024 2003 Dep’n 976 NBV end Yr 2 4,048 2004 Dep’n 976 NBV end Yr 3 3,072 “Straight-line” Calculation: 6,000 – 3,072 3 yrs 2,928 = = 976 3 (b) A 3,000 300 2,700 Bought 1/1/20X0 20X0 Dep’n 10% for 12 mths 2001 Bought 1/4/20X1 Dep’n 10% x 2,700 Dep’n 10% for 9 mths Machines B C 2,000 270 2,430 Bought 1/7/20X2 20X2 Dep’n 10% of 2,430 Dep’n 10% x 1,850 Dep’n 10% for 6 mths 150 1,850 1,000 243 185 2,187 20X2 Total depreciation (243 + 185 + 50) Page 185 1,665 RWF478 50 950 E. DISPOSAL OF PROPERTY, PLANT AND EQUIPMENT A profit/loss on the disposal of property, plant and equipment is calculated as the difference between the net disposal proceeds and the net book value. The profit / loss on disposal is included in the Statement of Comprehensive Income in the year in which the disposal occurs. Example On 1st July 20X2 M Ltd sold a plant for RWF4,500. The plant was bought on 1st January 20X0 for RWF16,000. Depreciation is calculated on a straight line basis over 4 years. The company’s year-end is 31st December. Solution Profit/Loss on Disposal RWF 4,500 (6,000) (1,500) Sale proceeds Carrying Amount (W1) Profit/(loss) on disposal W1 Calculation of Carrying Amount/Net Book Value RWF 16,000 st Cost 1 January 20X0 Depreciation – Year-end 31st December 20X0 31st December 20X1 31st December 20X2 (4,000 x 6/12) Carrying Amount as at 1st July 20X2 F. (4,000) (4,000) (2,000) 6,000 LEDGER ACCOUNTS AND JOURNAL ENTRIES Property, Plant and Equipment – Additions When a tangible fixed asset is bought the cost is entered into a tangible fixed asset account in the nominal ledger…. Plant and Equipment Account RWF RWF 1st Jan Bank 10,000 X4 The journal entry for the purchase of a tangible fixed asset is: Debit Plant and Equipment Account Credit Bank Property, Plant and Equipment – Depreciation When property, plant and equipment is depreciated the charge for the year is entered in the depreciation expense account and the accumulated depreciation account. Page 186 Plant and Equipment – Accumulated Depreciation Account RWF 1st Jan X4 Opening Balance 31st Dec Depreciation expense X4 RWF X 2,500 Plant and Equipment –Depreciation Expense Account 31st Dec Statement X4 Comprehensive Income of RWF 2,500 31st Dec Plant & Equipment X4 RWF 2,500 Acc Dep’n The journal entries for the depreciation charge for the year is: Debit Plant and Machinery Depreciation Expense Account Credit Accumulated Depreciation Account The Depreciation Expense account is cleared out at the end of the year to the Statement of Comprehensive Income. Debit Statement of Comprehensive Income - Depreciation Credit Plant & Equipment – Depreciation Expense Account The balance in the Accumulated Depreciation account represents the total amount of depreciation charged against the asset since the purchase date. Property, Plant and Equipment – Disposal When property, plant and equipment is sold or scrapped the cost is transferred to a disposal account. Also the accumulated depreciation to date should be transferred from the accumulated depreciation account to the disposal account. Lastly the proceeds of sale should be credited to disposal account. The journal entries for the disposal of property, plant and equipment are: (1) Debit Disposal Account Credit Property, Plant and Equipment Cost Account To transfer the original cost of the asset to the disposal account (2) Debit Accumulated Depreciation Account Credit Disposal Account To transfer the accumulated depreciation charged to the Statement of Comprehensive Income from date of purchase to date of disposal. (3) Debit Bank Page 187 Credit Disposal Account To record the cash received on sale/disposal of the asset Disposal Account RWF 1st Jul X4 Plant & Equipment 10,000 A/C 1st Jul X4 Acc Depreciation Account 1st Jul X4 Bank Loss to Statement of Comprehensive Income 10,000 RWF 6,125 3,000 875 10,000 Trade in Allowance Often when a motor vehicle is being replaced it is traded in against a new vehicle. The double entry for this transaction is debit motor vehicles cost account and credit motor vehicles disposal account with the trade in value of the motor vehicle. Example X Limited traded in a motor vehicle which originally cost RWF20,000 against a new motor vehicle costing RWF35,000. The garage gave a trade-in allowance to X Limited of RWF10,000. At the date of the trade-in the accumulated depreciation on the old motor vehicle was RWF8,000. X Limited paid the garage a cheque for RWF25,000. Motor Vehicle - Cost Account (1) (3) (4) Balance b/d Disposal A/C Bank Balance b/d RWF 20,000 10,000 25,000 55,000 (2) Disposal Account Balance c/d RWF 20,000 35,000 55,000 35,000 Disposal Account (2) Motor Vehicle A/C RWF 20,000 (3) (5) (6) 20,000 RWF Motor Vehicle A/C 10,000 Acc. Depreciation A/C 8,000 Loss to Statement of 2,000 Comprehensive Income 20,000 Notes to Ledger Account 1. Opening balance represents the original cost of the asset on hand at the start of the financial period. Page 188 2. The motor vehicle is traded in against a new vehicle, therefore the asset is removed (that is, credited) from the Motor Vehicle Cost Account and debited to the disposal account. 3. On disposal of the vehicle the company is given a trade in allowance rather than cash, the accounting entries are: DR Motor Vehicle Cost Cr Disposal Account 4. The cash paid out in addition to the trade in allowance for the new vehicle. 5. The total depreciation charged on the asset is debited from the Motor Vehicle – Accumulated Depreciation Account and credited to the Disposal Account. 6. The loss on disposal balances the account, it is calculated as sales proceeds less the net book value: Sales Proceeds/Trade in Allowance Net Book Value (20,000 – 8,000) Profit/(loss) on disposal 10,000 (12,000) (2,000) G. RECOGNITION AND MEASUREMENT An item of property, plant and equipment should be recognised as an asset when: • It is probable that future economic benefits associated with it will flow to the entity and; • Cost of the asset can be measured reliably. Initial Measurement Property, plant and equipment should initially be measured at cost. Cost is the purchase price, import duties and non-deductible purchase taxes/VAT. Cost should also include directly attributable costs of bringing the asset to working condition for its intended use. Examples of directly attributable costs include initial delivery and handling costs, site preparation, installation costs, and cost of employee wages arising directly from construction or acquisition. Exchange of Assets Cost is measured at fair value of asset received which is equal to fair value of the asset given up e.g. trade-in allowance, plus cash transferred. Measurement Subsequent to Initial Recognition An entity may choose between the cost model and the revaluation model. The choice of measurement is applied consistently to the entire class of property, plant and equipment. Cost Model In this model the assets are carried at cost less accumulated depreciation and any accumulated impairment losses. Revaluation Model In this model the assets are carried at their re-valued amount, being fair value at date of revaluation, less any subsequent depreciation and any accumulated impairment losses. Page 189 Accounting Treatment of Revaluation Any revaluation increase is normally credited directly to the revaluation surplus in equity. However, if the asset had previously been the subject of a revaluation decrease then the entity reverses the amount of the decrease previously taken to the Statement of Comprehensive Income. Example Original Cost of Asset 650,000 Current Carrying Amount 500,000 The asset has been re-valued and the surveyor believes its true value is RWF700,000. Solution The asset originally cost RWF650,000 but was previously re-valued downwards to RWF500,000, a decrease of RWF150,000. This decrease would have been debited to the Statement of Comprehensive Income, so now that the asset is being re-valued upwards what entries do we pass in our account: Because of the previous diminution in value: Dr Asset Cr Statement of Comprehensive Income Cr 200,000 Revaluation Reserve – Statement of Financial Position 150,000 50,000 If the asset had not been the subject of a previous decrease in value through revaluation then the entries passed would have been: Dr Asset 200,000 Cr Revaluation Reserve – Statement of Financial 200,000 Position Any revaluation decrease is normally recognised in the Statement of Comprehensive Income, except where it reverses a previous revaluation increase of the asset then it is offset against the balance on the revaluation reserve. Example Original Cost of Asset 400,000 Current Carrying Amount 500,000 The asset has been re-valued and the surveyor believes its true value is RWF450,000. Solution The asset originally cost RWF400,000 but was previously re-valued upwards to RWF500,000, an increase of RWF100,000. This increase would have been credited to the Revaluation Reserve Account, so now that the asset is been re-valued downwards what entries do we pass in our account? Page 190 Because of the previous revaluation: Dr Revaluation Reserve Cr Asset 50,000 50,000 If the asset had not been the subject of a previous decrease in value through revaluation then the entries passed would have been: Dr Statement of Comprehensive Income Cr Asset 50,000 50,000 H. DISCLOSURE The financial statements should disclose, for each class of property, plant and equipment: (a) The measurement bases used for determining the gross carrying amount. (b) The depreciation methods used (c) The useful lives or depreciation rates used (d) The gross carrying amount and the accumulated depreciation at the beginning and end of the period (e) I. A reconciliation of the carrying amount at the beginning and end of the period showing: (i) Additions (ii) Disposals (iii) Increases or decreases during the period resulting from revaluations (iv) Depreciation EXAMPLES Question 1 A company makes up its accounts to the 31st December each year. It provides for depreciation on a reducing balance method at a rate of 10%. On 31st December 20X4 the assets consisted of the following items: • Machine A purchased April 20X1 for RWF3,000 • Machine B purchased July 20X2 for RWF2,000 • Machine C purchased October 20X3 for RWF1,000 Required: Calculate the depreciation charge for the year-end 31st December 20X4. Question 2 An asset was bought in 20X0 for RWF3,000. It had an expected useful life of 10 years with no expected residual value. In February 20X5 a decision was taken to sell the asset for Page 191 RWF1,200. The Year-end is 31st December 20X5. Assume a full year’s depreciation in the year of purchase and none in the year of sale. Required: Calculate the profit / loss on disposal under each of the methods: a) Reducing Balance at 10%, b) Straight Line Method Question 3 An asset was purchased on 1st July 20X0 for RWF10,000, if has an expected life of 5 years. The company uses the straight line method of depreciation. The asset was sold in 1st April 20X3 for RWF5,000. Company year-end is 31st December. Required: Prepare the ledger accounts for each of the years assuming: a) The company pro-rates the depreciation charge in the year of purchase and disposal. b) The company takes a full years charge in the year of purchase of none in the year of disposal. Solution – Question 1 20X1 20X2 Bought 1.4.20X1 Dep’n 10% x 3,000 x 3/4 A 3,000 225 2,775 Bought 1.7.20X2 Dep’n 10% x 2,775 Dep’n 10% 2,000 x 1/2 277 Bought 1.10.20X3 Dep’n 10% of 2,498 Dep’n 10% x 1,900 Dep’n 10% x 1,000 x 3/12 20X4 Depreciation @ 10% Net Book Value C 2,000 2,498 20X3 B 100 1,900 1,000 249 190 2,248 225 2,023 Depreciation Charge for 20X4 is (225 + 171 + 97) Page 192 1,710 171 1,539 RWF493 25 975 97 878 Solution – Question 2 Straight Line Method COST DEPRECIATION Y/E 31.12.X0 NET BOOK VALUE 31.12.X0 DEPRECIATION Y/E 31.12.X1 NET BOOK VALUE 31.12.X1 DEPRECIATION Y/E 31.12.X2 NET BOOK VALUE 31.12.X2 DEPRECIATION Y/E 31.12.X3 NET BOOK VALUE 31.12.X3 DEPRECIATION Y/E 31.12.X4 NET BOOK VALUE 31.12.X4 Reducing Balance 3,000 (300) 2,700 (300) 2,400 (300) 2,100 (300) 1,800 (300) 1,500 3,000 (300) 2,700 (270) 2,430 (243) 2,187 (219) 1,968 (196) 1,772 Straight Line Method 1,200 (1,500) (300) PROCEEDS NET BOOK VALUE PROFIT/(LOSS) ON DISPOSAL Reducing Balance 1,200 (1,772) (572) Solution – Question 3 (a) Asset – Cost Account 1.7.X0 Bank 1.1.X3 Balance b/d 31.12.X0 Balance c/d 31.12.X1 Balance c/d RWF 10,000 10,000 10,000 10,000 Balance c/d 4.X3 Disposal Account Asset – Accumulated Depreciation RWF 1,000 31.12.X0 Statement of Comprehensive Income 1,000 3,000 1.1.X1 Balance b/d 31.12.X1 Statement of Comprehensive Income 3,000 31.12.X2 Balance c/d 5,000 Page 193 RWF 10,000 10,000 10,000 10,000 RWF 1,000 1,000 1,000 2,000 3,000 1.1.X2 Balance b/d 31.12.X2 Statement of Comprehensive Income 3,000 2,000 5,000 1.4.X3 Disposal Account 5,500 5,000 1.1.X3 31.3.X3 Balance b/d Statement of Comprehensive Income 5,500 5,000 500 5,500 Disposal Account Motor Vehicle A/C Profit – Statement of Comprehensive Income RWF 10,000 500 Bank Acc. Depreciation A/C 10,500 RWF 5,000 5,500 10,500 Depreciation X0: 10,000 x 20% = 2,000 x 6/12 = 1,000 Depreciation X3: 2,000 x 3/12 = 500 (b) Full year Depreciation in the year of purchase and none in the year of sale. Asset – Cost Account 1.7.X0 Bank 1.1.X3 Balance b/d RWF 10,000 10,000 10,000 10,000 Balance c/d 4.X3 Disposal Account RWF 10,000 10,000 10,000 10,000 Asset – Accumulated Depreciation 31.12.X0 Balance c/d RWF 2,000 31.12.X0 Statement of Comprehensive Income 2,000 31.12.X1 Balance c/d 4,000 2,000 1.1.X1 Balance b/d 31.12.X1 Statement of Comprehensive Income 4,000 31.12.X2 Balance c/d 6,000 Page 194 RWF 2,000 2,000 2,000 4,000 1.1.X2 Balance b/d 31.12.X2 Statement of Comprehensive 4,000 2,000 Income 6,000 1.4.X3 Disposal Account 6,000 6,000 6,000 1.1.X3 Balance b/d 6,000 6,000 Disposal Account Motor Vehicle A/C Profit – Statement of Comprehensive Income RWF 10,000 1,000 11,000 Page 195 Bank Acc. Depreciation A/C RWF 5,000 6,000 11,000 Study Unit 14 IAS 18 – Revenue Contents ___________________________________________________________________________ A. Objective ___________________________________________________________________________ B. Definitions ___________________________________________________________________________ C. Recognition & Measurement ___________________________________________________________________________ D. Sale of Goods ___________________________________________________________________________ E. Rendering of Services ___________________________________________________________________________ F. Interest, Royalties and Dividends ___________________________________________________________________________ G. Disclosure ___________________________________________________________________________ Page 196 A. OBJECTIVE The objective of this standard is to provide assistance in determining when to recognise revenue. It should be recognised when it is probable that economic benefits that can be measured reliably have accrued to the entity. IAS 18 Revenue sets out the criteria as to when revenue should be recognised and gives practical guidance as to the application of these criteria. B. DEFINITIONS Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants. Revenue only represents amounts received by the entity in its own account, it excludes monies received on behalf of third parties, such as sales taxes and value added taxes. When the entity acts as an agent the commission earned is treated as revenue and not the amounts received on behalf of the principal. Fair Value is the amount for which an asset will be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. C. RECOGNITION AND MEASUREMENT IAS 18 Revenue states that revenue shall be measured as fair value either received or receivable taking into account any trade discounts or volume rebates allowed. The consideration in the vast majority of cases is in the form of cash and cash equivalents, however, companies may offer interest free credit and in this case the fair value is calculated by discounting the future cash flows using an imputed rate of interest. This imputed rate of interest is determined by either: 1) The prevailing rate of interest on similar credit facilities, or 2) The rate of interest that discounts the nominal amount of the facility to the current cash sales price of the goods or services. In some circumstances it is necessary to recognise separately identifiable components of a transaction. Forr example, the sale of goods that includes a service contract: the entity should recognise a portion of the proceeds now that relates to the sale of the goods and defer an amount over the period of the service contract. Goods and services may be exchanged for similar goods and services; this is not recognised as a transaction that generates revenue. If the goods and services swapped are dissimilar then the transaction is recognised as a transaction that generates revenue and the revenue recognised is fair value of the goods / services received adjusted by the amount of any cash or cash equivalents transferred. Fair value of goods received is only appropriate when it can be measured reliably, otherwise use the fair value of goods / services given up adjusted by the amount of cash / cash equivalents transferred. Page 197 D. SALE OF GOODS Revenue from the sale of goods will be recognised when the following conditions are all met: a) The entity (seller) has transferred all the significant risks and rewards of ownership to the purchaser, b) The entity has no managerial involvement or control of the asset, c) The amount of revenue attributed to the sale can be measured reliably, d) Economic benefits will flow to the entity (seller) as a result of the transaction and e) The costs associated with the transaction can be measured reliably. In most cases the transfer of significant risks and rewards usually occurs when legal title to the goods / asset is transferred. Revenue and expenses relating to a particular transaction should be recognised at the same time, this is known as matching. E. RENDERING OF SERVICES When an entity is involved with the provision of services, the revenue relating to a transaction is recognised in the Statement of Comprehensive Income by considering the stage of completion of the service at the Statement of Financial Position date. The result of a transaction can be estimated reliably when the following conditions are satisfied: a) Revenue can be measured reliably, b) Economic benefits will probably flow to the entity, c) The stage of completion of the transaction can be measured reliably at the Statement of Financial Position date and d) Both the costs incurred to date and the costs to complete can be measured reliably. If the outcome of a transaction cannot be measured reliably or there is uncertainty, revenue should only be recognised to the extent of the expenses that have been recognised that are recoverable. F. INTEREST, ROYALTIES AND DIVIDENDS Revenue is recognised on the following bases: a) Interest recognised as the effective interest method per IAS39 (not examinable at Formation 2). b) Royalties recognised on an accruals basis. c) Dividends recognised when the shareholder’s right to receive payment is established. G. DISCLOSURE An entity will make the following disclosures: 1) The entity’s accounting policies for recognising revenue and determining the stage of completion of transactions involved in the provision of services. Page 198 2) Revenue analysed between: (i) Sale of Goods (ii) Rendering of Services (iii) Interest (iv) Royalties and (v) Dividends 3) Amount of revenue from exchange of goods or services included in each of the categories identified in (2) above. Page 199 Study Unit 15 IAS 20 - Government Grants Contents A. Objective B. Basic Concepts C. Definitions D. Types of Grant Available E. Accounting Treatment F. Disclosure G. Repayment of Grants H. Grant Recognition Page 200 A. OBJECTIVE The objective of IAS 20 is to set out the accounting treatment for both government grants and other forms of government assistance. Government assistance takes many forms, including grants, equity finance, subsidised loans and advisory assistance. Government grants are made in order to persuade or assist enterprises to pursue courses of action, which are deemed to be socially or economically desirable. The range of grants available is wide and changes regularly, reflecting changes in government policy. More significantly, different grants tend to be given on different terms as to eligibility, manner of determination, manner of payment and conditions to be fulfilled. The term 'government' covers national government and all of the various tiers of local and district/regional government of any country, government agencies and 'non-departmental public bodies'. B. BASIC CONCEPTS The accruals concept requires that revenue and costs are accrued, matched with one another so far as their relationship can be established or justifiably assumed, and dealt with in the Statement of Comprehensive Income of the period to which they relate. Government grants should be recognised in the Statement of Comprehensive Income so as to match them with the expenditure towards which they are intended to contribute. The prudence concept requires that revenue and profits are not anticipated, but are recognised by inclusion in the Statement of Comprehensive Income only when realised in the form either of cash or of other assets the ultimate cash realisation of which can be established with reasonable certainty. Accordingly, government grants should not be recognised in the Statement of Comprehensive Income until the conditions for their receipt have been complied with and there is reasonable assurance that the grant will be received. In many cases, the grant-making body has the right to recover all or part of a grant paid if the enterprise has not complied with the conditions under which the grant was made. On the assumption that the enterprise is a going concern, the application of the prudence concept does not normally require postponement of the recognition of the grant in the Statement of Comprehensive Income solely because there is a possibility that it might have to be repaid in the future. The enterprise should consider regularly whether there is a likelihood of a breach of the conditions on which the grant was made. If such a breach has occurred, or appears likely to occur, and it is probable that some grant will have to be repaid, provision should be made for the liability. C. DEFINITIONS Government Grants are assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the entity. Page 201 D. TYPES OF GRANT AVAILABLE Government grants may be given for a number of projects. Examples would be: (a) Grants related to Assets: Primary condition is that the entity qualifying for them should purchase, construct or otherwise acquire long-term assets (b) Grants related to Income: Other than those related to assets e.g. towards staff training costs E. ACCOUNTING TREATMENT Grants Related to Assets Government grants shall be recognised as income over the periods necessary to match them with the related costs on a systematic basis. They shall not be credited directly to shareholders’ interests. Presentation of Grants Related to Assets Government grants related to assets shall be presented in the Statement of Financial Position either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset. Example B Limited has an asset to which the following details apply: Asset cost RWF20,000 Useful life 5 years Grant received RWF5,000 The accounting treatment of this grant is as follows: (a) Income Approach RWF20,000 divided by 5 years RWF5,000 divided by 5 years = RWF4,000 depreciation expense per annum = RWF1,000 income per annum Each year Statement of Comprehensive Income (Extract) Dr RWF Grant amortisation Depreciation expense Statement of Financial Position (Extract) Cr RWF 1,000 4,000 Yr 3 Yr 4 Yr 5 RWF 20,000 RWF 20,000 RWF 20,000 RWF 20,000 (4,000) (8,000) (12,000) (16,000) (20,000) 16,000 12,000 8,000 4,000 Nil Creditors: amounts due over/under 1 year Government Grant 4,000 3,000 2,000 1,000 Nil Non-Current Asset – Cost - Accumulated Depreciation - Net Book Value Yr 1 Yr 2 RWF 20,000 Deferred Income method - Journal Entries on receipt of a Capital Grant Page 202 1. DR Bank CR Liabilities With the amount of the grant received 2. (b) DR Liabilities CR Statement of Comprehensive Income With the annual amount of the grant amortisation Net Cost Method/Immediate Deduction Method RWF 20,000 5,000 15,000 Divided by 5 years = RWF3,000 depreciation per annum Cost Less grant Balance Each year Statement of Comprehensive Income (Extract) RWF 3,000 Depreciation cost Statement of Financial Position (Extract) Non-Current Asset – Cost - Depreciation - Net book value Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 RWF 15,000 (3,000) 12,000 RWF 15,000 (6,000) 9,000 RWF 15,000 (9,000) 6,000 RWF 15,000 (12,000) 3,000 RWF 15,000 (15,000) Nil Immediate Deduction Method - Journal Entries on receipt of a Capital Grant DR Bank CR Fixed Assets With the amount of the grant received Grants Related to Income The matching of grants received and expenditure is straightforward if the grant is made as a contribution toward specified items of expenditure and is described as such. Once the relationship between the grant and the related expenditure has been established, the recognition of the grant in the Statement of Comprehensive Income will follow. The grant should be recognised in the same period as the related expenditure - 'matching' concept. Page 203 Example XYZ Ltd. incurred expenditure on staff training costs of RWF4,500 during the year-ended 31 December 20X6. They received a grant towards this cost of RWF2,200. Show the Journal entry and the Statement of Comprehensive Income for the period. RWF RWF 1. DR Staff Training Costs 4,500 CR Bank/Cash 4,500 2. 3. DR Bank CR Staff Training Costs 2,200 2,200 20X6 Statement of Comprehensive Income (Extract) Staff Training Costs 2,300 (4,500 2,200) – Difficulties arise where the terms of the grant do not specify precisely the expenditure it is intended to meet, but use such phrases as 'to assist with a project' or 'to encourage job creation' or where the basis of calculation is related to two or more criteria - e.g. the capital expenditure incurred and the number of jobs created. In these instances, it is usually appropriate to consider the circumstances which give rise to the payment of the grant. If the grant is paid when evidence is produced that certain expenditure has been incurred, the grant should be matched with that expenditure. If the grant is paid on a different basis, it will usually be paid on the achievement of a non-financial objective, such as the creation of a specified number of new jobs. In these circumstances, the grant should be matched with the identifiable cost of achieving that objective e.g. the cost of creating and, maintaining for the required period the specified new jobs. F. DISCLOSURE (a) The financial statement should disclose the accounting policy adopted for government grants, including the methods of presentation adopted in the financial statements (b) The nature and extent of grants recognised (c) An indication of other forms of government assistance providing direct benefit (d) Unfulfilled conditions and other contingencies attaching to government assistance recognised G. REPAYMENT OF GOVERNMENT GRANTS A government grant that becomes repayable shall be accounted for as a revision to an accounting estimate. Repayment of a grant shall be applied first against any unamortised credit. To the extent that the repayment exceeds any such deferred credit or where no deferred credit exists, the repayment shall be recognised immediately as an expense. Repayment of a grant relating to an asset shall be recorded by increasing the carrying amount of the asset or reducing the deferred income balance by the amount repayable. Page 204 The cumulative additional depreciation that would have been recognised to date as an expense, if no grant had been received, shall be recognised immediately as an expense. Example Using the example of B Limited above and assuming the grant of RWF5,000 was repaid in full in year 3, show the accounting entries in year 3 under: (a) The income approach and (b) The net cost method For the repayment of the grant: (a) Income Approach RWF 2,000 3,000 Debit Expense Deferred Income – Grant Credit Bank (b) RWF 5,000 Net Cost Method RWF 2,000 5,000 Debit Expense Non-Current Asset – Cost Credit Bank Accumulated Depreciation RWF 5,000 2,000 In the Statement of Comprehensive Income depreciation will be RWF4,000 for year 3 and in the Statement of Financial Position the non-current assets will be shown at RWF20,000 less accumulated depreciation of RWF12,000. H. GRANT RECOGNITION A government grant is not recognised until there is reasonable assurance that the entity will comply with the conditions attaching to it and the grant will be received. Page 205 Study Unit 16 IAS 37 – Provisions, Contingent Liabilities and Contingent Assets Contents ___________________________________________________________________________ A. Objective ___________________________________________________________________________ B. Definitions ___________________________________________________________________________ C. Recognition ___________________________________________________________________________ D. Measurement ___________________________________________________________________________ E. Changes in Provisions ___________________________________________________________________________ F. Use of Provisions ___________________________________________________________________________ G. Application of the Recognition and Measurement Rules ___________________________________________________________________________ H. Disclosure ___________________________________________________________________________ I. Example - Recognition ___________________________________________________________________________ Page 206 A. OBJECTIVE The objective of this standard is to ensure that the appropriate recognition rules and measurement bases are applied to provisions, contingent liabilities and contingent assets. The standard also sets out the disclosure to be made to ensure that sufficient information is available to assist users in understanding the nature, timing and amount of any provisions, contingent liabilities and contingent assets. B. DEFINITIONS A Provision is a liability of uncertain timing or amount. A liability is a present obligation of an entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefit. An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation. A legal obligation is an obligation that derives from: a) A contract, b) Legislation or c) Operation of law. A constructive obligation is an obligation that derives from an entity’s actions where: a) By an established pattern or past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities, and b) As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. A contingent liability is: a) A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity, and b) A present obligation that arises from past events but is not recognised because: (i) It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligations, or (ii) The amount of the obligation cannot be measured with sufficient reliability. A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. Page 207 A restructuring is a programme that is planned and controlled by management, and materially changes either: a) The scope of the business undertaken by an entity, or b) The manner in which that business is conducted. A provision differs from other liabilities due to the uncertainty as to the timing and amount of the expenditure involved. C. RECOGNITION A provision is recognised when all of the following conditions are met: a) An entity has a present obligation as a result of a past event, b) It is probable that there will be an outflow of economic benefits to settle the obligation, c) A reliable estimate of the amount of the obligation can be made. Contingent Liability If the possibility of an outflow of economic benefit is remote then the entity does not need to disclose the contingent liability. If the possibility of an outflow of economic benefit is probable and a reliable estimate of the amount can be made then a provision should be made. Contingent Asset A contingent asset is the possibility of an inflow of economic benefits. Where the possibility is virtually certain the contingent asset should be recognised. If the possibility of the inflow of economic benefits is probable then details of the contingent asset should be disclosed. Both contingent assets and contingent liabilities should be reviewed continually to ensure that are accurately presented in the financial statements. D. MEASUREMENT The amount of the provision presented in the financial statements will be the best estimate of the amount of the expenditure required to settle the present obligation as at the Statement of Financial Position date. These estimates are based on the judgement of the management of the entity with reference to their past experience of similar transactions and, on some occasions, the advice of experts. Example COD Ltd sells domestic appliances with a warranty that covers the cost of repairs of any manufacturing defects that occur within the first year. If minor defects occurred in all goods sold, the cost would be RWF2m. If major defects occurred in all goods sold, the cost would be RWF8m. Based on COD’s past experience 80% of the goods sold will have no defects, 15% will have minor defects and 5% will have major defects. Page 208 The expected cost of the entity’s warranty is: No defects Minor Defects Major Defects Total Provision for Warranty Claims (80% x Nil) (15% x RWF2m) (5% x RWF8m) Nil 300k 400k 700k In calculating the best estimate of a provision consideration should be given to any risks and uncertainties that exist. This does not justify the creation of excessive provisions or a deliberate overstatement of liabilities. Future events that may affect the amount required to settle an obligation shall be reflected in the amount of the provision where there is sufficient objective evidence that they will occur. Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognised when, and only when, it is virtually certain that reimbursement will be received. The reimbursement shall be treated as a separate asset. The amount recognised for the reimbursement shall not exceed the amount of the provision. In the Statement of Comprehensive Income, the expense relating to a provision may be presented net of the amount recognised for a reimbursement. E. CHANGES IN PROVISIONS Provisions should be reviewed annually at the Statement of Financial Position date to ensure that it represents the best estimate. If there is no longer a requirement for the provision, that is, we do not expect that there will be an outflow of economic benefit, we should reverse the provision. F. USES OF PROVISIONS A provision should only be used for expenditure for which the provision was originally established. G. APPLICATIONOF THE RECOGNITION AND MEASUREMENT RULES Future Operating Losses No provision shall be made for future operating losses. Onerous Contracts If an entity has an onerous contract then the present obligation under the contract should be recognised and measured as a provision. Restructuring The following are examples of events that are considered to be restructuring: a) Sale or termination of a part of the business, b) Closure of business in a country or region or the relocation of business activities from one country or region to another, c) Change in management structure, Page 209 d) Fundamental reorganisation that have a material effect on the nature and focus of the entity’s operations. A constructive obligation to restructure arises only when an entity: a) Has a detailed plan for restructuring, identifying at least: (i) Business or part of business concerned, (ii) Principal locations affected, (iii) Location, function, and approximate number of employees who will be compensated for termination of their services, (iv) Expenditure to be undertaken and (v) b) when the plan will be implemented and Has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it. A decision by the Board of Management prior to the Statement of Financial Position date to implement a restructuring plan does not of itself constitute a constructive obligation unless they have started to implement the restructuring plan or they have announced the main features of the plan to those affected. No obligation arises for the sale of an operation until the entity is committed to the sale, that is, there is a binding sale agreement. A restructuring provision shall include only the direct expenditure arising from the restructuring, which is both necessarily entailed by the restructuring and not associated with the on-going activities of the entity. H. DISCLOSURE For each class of provision an entity must disclose: a) The carrying amounts at the beginning and end of the period, b) Additional provisions made in the period, including an increase to existing provisions, c) Amounts used during the period, d) Unused amounts reversed during the period and e) Any increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate. Comparative information is not required. An entity shall disclose for each class of provision: a) A brief description of the nature and timing of any expected outflow of economic benefit, b) Details of any uncertainties about the amount and timing of these outflows, it may be necessary to disclose any major assumptions made concerning future events, c) Amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement. Page 210 For each Contingent liability where the possibility of the settlement is not remote the entity should provide a brief description of the nature of the contingent liability, and where practicable: a) An estimate of the financial effect, b) An indication of the uncertainties relating to the amount or timing of any outflow, c) The possibility of any reimbursement. For each contingent asset disclose: a) A brief description of the nature of the contingent asset, b) An estimate of the financial effect. I. EXAMPLES - RECOGNITION Warranties The obligating event is the sale of the product with a warranty. It is probable that there will be an outflow of resources. A provision is recognised for the best estimate of the cost of correcting the defects on goods sold prior to the Statement of Financial Position date. Contaminated Land – Legislation virtually certain to be enacted It is probable that there will be an outflow of resources as the enactment of the legislation is virtually certain and therefore an obligating event. It is necessary to recognise a provision for the best estimate of the cost to clean up the contaminated land. Contaminated Land – No environmental legislation but company has a widely publicised environmental policy to clean up any contamination The company has an obligation to clean up the contaminated land as a result of its past practice. The likelihood that there will be an outflow of resources to correct the contamination is probable. The entity will recognise a provision for the best estimate of the costs of the clean-up. Offshore Oilfield A licensing agreement requires it to remove the oil rig at the end of the production and restore the seabed. Ninety per cent of the eventual costs relate to the removal of the rig and the restoration of the damage to the seabed, the remaining ten per cent arises through the extraction of the oil. The obligating event is the construction of the oil rig and its removal and restorationof the seabed. The likelihood attaching to the event is highly probable. A provision should be raised for the best estimate of the cost of removing the oil rig and restoring the sea bed, that is, the ninety per cent of the eventual costs. The balance is recognised as a liability when the oil is extracted. Refunds Policy A retail company refunds dissatisfied customers even though this is not required by legislation. The obligating event is the sale of goods to customers who have an expectation based on past experience that they will receive a refund if they are unhappy with their Page 211 purchases. The likelihood that the company will have to refund customers is probable. A provision is recognised for the best estimate of the cost of the refunds. Closure of a Division – No implementation before the Statement of Financial Position Date There is no obligating event as no action has been taken at the Statement of Financial Position date so therefore no provision can be raised. Closure of a Division – Communication / Implementation before Statement of Financial Position Date The fact that the company has communicated its plans to close a division. As a result of the communication it is highly probable that the division will be closed. A provision should be recognised, this should represent the best estimate of the cost involved in closing the division. Staff retraining as a result of changes in the Statement of Comprehensive Income For example, changes in Income Tax Legislation: certain companies will need to retrain their administrative staff to ensure compliance with the legislation. At the Statement of Financial Position date no retraining has taken place. There is no obligating event because no retraining has taken place, so no provision is recognised. Onerous Contract A company has moved during the year to new premises but their old premises still has 4 years remaining on its lease. The company cannot cancel the lease and they cannot sublet the premises. The obligating event is the signing of the original lease agreement and this gives rise to a legal obligation. A provision is recognised for the best estimate of the unavoidable lease payments. Refurbishment Costs – No legislative Requirement A furnace has a lining that needs to be replaced every five years for technical reasons. At the Statement of Financial Position date, the lining has been in use for three years. There is no obligating event as at the Statement of Financial Position date as the lining exists independently of the company’s future actions – even the intention to incur the expenditure depends on the company deciding to continue operating the furnace or to replace the lining. Instead of a provision being recognised, the depreciation of the lining takes account of its consumption, that is, it is depreciated over five years. The re-lining costs then incurred are capitalised with the consumption of each new lining shown by depreciation over the subsequent five years. There is noevent so no provision is recognised. Refurbishment Costs – Legislative Requirement An airline is required by law to overhaul its aircraft once every three years. There is no event so therefore no provision is recognised. The rationale is the same as in the previous example of Refurbishment costs where there is no legislative requirement. Page 212 BLANK Page 213 Study Unit 17 IAS 12 – Income Taxes Contents A. Objective B. Definitions C. Recognition and Presentation D. Disclosure Page 214 A. OBJECTIVE The objective of IAS 12 is to prescribe the accounting treatment for income taxes. B. DEFINITION Temporary difference: a difference between the carrying amount of an asset or liability and its tax base. Taxable temporary difference: a temporary difference that will result in taxable amounts in the future when the carrying amount of the asset is recovered or the liability is settled. Deductible temporary difference: a temporary difference that will result in amounts that are tax deductible in the future when the carrying amount of the asset if recovered or the liability is settled. C. RECOGNITION AND PRESENTATION Recognition of current tax Current tax for the current and prior periods should be recognised as a liability to the extent that it has not yet been settled, and as an asset to the extent that the amounts already paid exceed the amount due. The benefit of a tax loss which can be carried back to recover current tax of a prior period should be recognised as an asset. Current tax assets and liabilities should be measured at the amount expected to be paid to (recovered from) taxation authorities, using rates/laws that have been enacted or substantively enacted by the Statement of Financial Position date. Presentation Current tax assets and current tax liabilities should be offset on the Statement of Financial Position only if the entity has the legal right and the intention to settle on a net basis. D. DISCLOSURE IAS 12 requires the following disclosures: • Major components of tax expense (tax income), including: - Current tax expense (income) - Any adjustments of taxes of prior periods - Amount of deferred tax expense (income) relating to the origination and reversal of temporary differences - Amount of deferred tax expense (income) relating to changes in tax rates or the imposition of new taxes - Amount of the benefit arising from a previously unrecognised tax loss, tax credit or temporary difference of a prior period - Write-down, or reversal of a previous write down, of a deferred tax asset - Amount of tax expense (income) relating to changes in accounting policies and corrections of errors Page 215 • Aggregate current and deferred tax relating to items reported directly in equity • Tax relating to each component of other comprehensive income • Explanation of the relationship between tax expense (income) and the tax that would be expected by applying the current tax rate to accounting profit or loss • Changes in tax rates • Amounts and other details of deductible temporary differences, unused tax losses, and unused tax credits • Temporary differences associated with investments in subsidiaries, associates, branches, and joint ventures • For each type of temporary difference and unused tax loss and credit, the amount of deferred tax assets or liabilities recognised in the statement of financial position and the amount of deferred tax income or expense recognised in the Statement of Comprehensive Income • Tax relating to discontinued operations • Tax consequences of dividends declared after the end of the reporting period • Details of deferred tax assets • Tax consequences of future dividend payments Page 216 BLANK Page 217 Study Unit 18 IAS 17 – Leases Contents A. Objective B. Classification of Leases C. Accounting by Lessees D. Disclosure: Lessees – Finance Lease E. Disclosure: Lessees – Operating Lease Page 218 A. OBJECTIVE The objective of IAS 17 is to prescribe, for lesses and lessors, the appropriate accounting policies and disclosures to apply in relation to finance and operating leases. B. CLASSIFICATION OF LEASES A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. All other leases are classified as operating leases. Classification is made at the inception of the lease. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: • • • • • the lease transfers ownership of the asset to the lessee by the end of the lease term the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised the lease term is for the major part of the economic life of the asset, even if title is not transferred at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset the lease assets are of a specialised nature such that only the lessee can use them without major modifications being made Other situations that might also lead to classification as a finance lease are: • • • if the lessee is entitled to cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by means of a rebate of lease payments) the lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent In classifying a lease of land and buildings, land and buildings elements would normally be classified separately. The minimum lease payments are allocated between the land and buildings elements in proportion to their relative fair values. The land element is normally classified as an operating lease unless title passes to the lessee at the end of the lease term. The buildings element is classified as an operating or finance lease by applying the classification criteria in IAS 17. However, separate measurement of the land and buildings elements is not required if the lessee’s interest in both land and buildings is classified as an investment property in accordance with IAS 40 and the fair value model is adopted. Page 219 C. ACCOUNTING BY LESSEES The following principles should be applied in the financial statements of lessees: • • • • At commencement if the lease term, finance leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s incremental borrowing rate) Finance lease payments should be apportioned between the finance charge and the reduction of the outstanding liability (the finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability) The depreciation policy for assets held under finance leases should be consistent with that for owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the end of the lease – the asset should be depreciated over the shorted of the lease term or the life of the asset. For operating leases, the lease payments should be recognised as an expense in the Statement of Comprehensive Income over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit Incentives for the agreement of a new or renewed operating lease should be recognised by the lessee as a reduction of the rental expense over the lease term, irrespective of the incentive’s nature or form, or the timing of payments. D. DISCLOSURE: LESSEES – FINANCE LEASE • • • Carrying amount of asset Reconciliation between total minimum lease payments and their present value Amounts of minimum lease payments at Statement of Financial Position date and the present value thereof, for: o the next year o years 2 through 5 combined o beyond 5 years • • • Contingent rent recognised as an expense Total future minimum sublease income under non-cancellable subleases General description of significant leasing arrangements, including contingent rent provisions, renewal or purchase options, and restrictions imposed on dividends, borrowings, or further leasing Page 220 E. DISCLOSURES: LESSEES – OPERATING LEASE • Amounts of minimum lease payments at the Statement of Financial Position date under non-cancellable operating leases for: • • • • The next year Years 2 through 5 combined Beyond five years Total future minimum sublease income under non-cancellable subleases Lease and sublease payments recognised in income for the period Contingent rent recognised as an expense General description of significant leasing arrangements, including contingent rent provisions, renewal or purchase options, and restrictions imposed on dividends, borrowings, or further leasing Page 221 Study Unit 19 Sole Traders Contents A. Preparing Financial Statements for Different Forms of Business Entity B. Sole Trader Accounts - Introduction C. Two Approaches in Preparing Accounts D. Double Entry Approach E. Question/Solution F. Single Entry Approach G. Question/Solution H. Use of Ratios I. Question/Solution Page 222 A. PREPARING FINANCIAL STATEMENTS FOR DIFFERENT FORMS OF BUSINESS ENTITY There are a number of different forms of business entity. These are: (i) Sole-trader e.g. shop-keeper (ii) Companies, limited by shares or by guarantee (iii) Companies, unlimited A number of substantial differences exist between all of these. These are: 1. The business of the sole trader is not governed by one identifiable Act but is subject to provisions of customary / common law and other acts related to commercial activities.. 2. A sole trader operates as a single individual. A private company must have a minimum of two members and a maximum of one hundred, while a public company must have a minimum of seven members with no maximum number of members. (Companies Act 7/2009 , Article 6) 3. A sole trader operates his business on a personal basis; a company is a separate legal entity, distinct from its members. 4. The sole trader has the capacity to enter into binding contracts. The management of a company must act within the terms outlined in the Memorandum and Articles of Association of the company and is deemed to be an agent of the company. 5. A sole trader may commence trading without much formality. A company must complete a number of formalities before business can commence. Such legal documents include memorandum and articles of association. 6. A sole trader is liable for the debts of his business without limit. Company Limited by Guarantee Company formed on the principle of having the liability of its members limited by its constitution to such amount as the members may respectively undertake to contribute to the assets of the company in the event of its being wound up. Company Limited by Shares Company in which the liability of shareholders is limited to the number of subscribed shares, whether paid or not. Company Limited by Shares & Guarantee Is a Company formed on the principle of having the following liability of its members limited to:(a) the amount paid by shareholders or the amount agreed to pay on the shares respectively held by them, if any; (b) the security issued by shareholders equivalent to the amount agreed as surety in case of liquidations. Page 223 Reference: Companies Act Law No 07/2009 of 27/04/09 7. Payables of a sole trader's business have a right of action against the sole trader personally. The payables of a company have a right of action against the company itself and not against its members. 8. The property of a sole trader belongs to the individual himself and may be used for his own purposes, irrespective of whether for business or private use. The assets of the company do not belong to the members but rather to the company in its own separate legal right. 9. A sole trader often experiences difficulty in negotiating loans as lending institutions seek security on such a loan by way of charges on assets. A company has that capacity as the shareholders do not have the capacity to remove the assets for their own personal use. 10. On death, the business of the sole trader ceases. unaffected by death of a member. 11. A sole trader may sell his business to another (the original owner is liable for all debts up to the date of sale). 12. The accounts of sole traders need not be filed with any public office except possibly the Rwandan Revenue Authority for Income tax purposes. Subsequently, those accounts are not available for inspection by other interested parties. A company, on the other hand, must make annual returns to the Office of Registrar General and these are available for inspection. The business of a company is When preparing financial statements for any of the above, the principles of double-entry still apply. However, each will have their own individual requirements. B. SOLE TRADER ACCOUNTS - INTRODUCTION The business activities of a sole trader should be separate from his personal transactions. To assist in preparing the accounts, the sole trader should operate two bank accounts - one for the business and one for personal expenses. Any money put into the business from the sole trader's private resources are treated as capital. Any assets withdrawn from the business during the course of the year is known as drawings e.g. stock taken for own use, cash, motor vehicle. Drawings are not included as expenses in the Statement of Comprehensive Income. Rather, the drawings are debited to the capital account in the Statement of Financial Position. The profit at the end of the period belongs solely to the trader. At the end of the accounting period, the profit is credited to the capital account in the Statement of Financial Position while a loss is debited. One major disadvantage of being a sole trader is that the sole trader has not got limited liability; i.e. should the business incur debts and there are insufficient resources in the business to pay all the payables, the sole trader must pay the payables from private funds. In some instances, the sole trader's private assets i.e. house, may have to be sold to pay the debts involved. Page 224 When preparing the accounts of sole traders or other small businesses, the books or records may fall short of a complete system of double entry. Such situations may vary from cases where virtually no records or bank accounts are maintained to cases where bank accounts and some record of transactions are maintained. Such accounting records, which fall short of a system of complete double entry, are known as incomplete records. The approach of the accountant in preparing accounts from incomplete records will depend on the extent of the incompleteness of the records. However, in all cases he will be attempting to: (a) Compute a Statement of Comprehensive Income for the accounting period (b) Prepare a Statement of Financial Position at the end of the accounting period C. TWO APPROACHES IN PREPARING ACCOUNTS Incomplete records can be divided into two types and there are, therefore, two methods of preparing accounts from such records. These are: (a) Double Entry Approach In cases where the double entry approach is used, bank statements will exist and probably some other record of transactions for the year - possibly cash records and cheque books. The approach here is prepare an opening statement of affairs, to establish the balance on the capital account and then to open ledger accounts and complete the double entry for the year. A final trial balance at the year-end will then be prepared and from this, a trading, a Statement of Comprehensive Income, together with a Statement of Financial Position can be completed. (b) Single Entry Approach In cases where the single entry approach is used, no bank account will have been maintained which means that it will not be possible to prepare a cash account for the year. In such cases, the accountant will prepare a statement of affairs as at the beginning and end of the accounting period, showing the total assets, total liabilities and net worth of the business at each of those dates. The increase in net worth i.e. net assets will be adjusted for cash introduced and drawings during the year and the resulting balance will represent the profit or loss for the year. In such cases, it will not be possible to prepare a Statement of Comprehensive Income for the year. D. DOUBLE ENTRY APPROACH The followings are the steps that should be taken in preparing final accounts under the double entry approach. 1. Opening Statement of Affairs A statement of affairs should be prepared as at the commencement of the accounting period. This will include a list of all the balances on the asset and liability accounts at that date and the resulting balance of net assets will represent the opening balance of the capital account for the period. Page 225 Each of the different classes of assets and liabilities will then be posted to the relevant ledger account as an opening balance. 2. Preparation of Cash Account Using the bank statements, lodgement dockets and cheque stubs, all of the receipts and payments should be analysed for the year. In practice, ruled analysis sheets will be used in the preparation of such an analysis of expenditure. A cash account will then be prepared for the year showing the different classes of income received and expenditure incurred during the year. It is important to include in the cash account, cash receipts during the year which were not lodged and which may have been taken as drawings or used to purchase further goods or pay for expenses in cash. Example Cash Account – Year Ended 31 December 20X4 1.01.X4 Balance b/d RWF 1,500 Receipts from Trade Receivables Cash Sales Capital Introduced 12,500 2,000 3,500 Payments to trade payables (goods) Expense - ESB payments - Rent Drawings 31.12.X5 Balance c/d 19,500 1.01.X5 Balance b/d RWF 11,000 1,500 2,500 600 3,900 19,500 3,900 In order to complete the double entry, the individual items of income and expenditure will be posted to the appropriate ledger accounts. 3. Trade Receivables Control Account The next step is the preparation of the trade receivables control account. This account should already contain an opening debit balance, which will be the figure posted from the statement of affairs. It will also contain a credit entry being the cash received from trade receivables during the year. A listing of the outstanding trade receivables at the end of the accounting period should now be prepared and posted to the credit of the account as the closing balance. No adjustment should be made in the trade receivables control account for bad debts. The balancing debit figure in the account will represent the value of sales during the period. Example You are given the following information at 31 Dec 20X4 and are requested to prepare a debtors control account. RWF Balance of trade receivables at 1 Jan 20X4 6,000 Cash received from trade receivables 27,500 Page 226 Balance on trade receivables control 31 Dec 20X4 7,500 Trade Receivables Control Account RWF 6,000 for 29,000 RWF Cash received – trade 27,500 receivables 31.12.X4 Balance c/d 7,500 35,000 35,000 1.01.X4 Balance b/d *** Total year sales 1.01.X5 Balance b/d 7,500 *** Balancing figure 4. Trade Payables Control Account Similarly, a trade payables control account will be prepared for the year. This account will show an opening credit balance being the trade payables transferred from the statement of affairs and a debit entry being the payments made to trade payables during the year. A list of credit balances will be prepared and posted to the debit of the account as a closing balance. The value of cash purchases will also be posted to the debit of the account. The balance on the account will now represent the value of purchases during the year. Example Prepare a creditors control account from the following information extracted for the year ended 31 Dec 20X4. RWF Balance on trade payables control at 1 Jan 20X4 15,000 Payments to trade payables 13,000 Balance on trade payables at 31 Dec 20X4 9,000 Trade Payables Control Account Payments to trade payables 31.12.X4 Balance c/d RWF 13,000 9,000 22,000 RWF 1.01.X4 Balance b/d 15,000 *** Total purchases for 7,000 year 22,000 1.01.X5 Balance b/d 9,000 *** Balancing figure 5. Accruals and Prepayments At the end of the accounting period, a list of accruals and prepayments should be prepared, journalised and posted to the appropriate ledger account. Example of accounts on which accruals and prepayments might arise are: • Rent Account • Rates Account • Electricity Account Page 227 • 6. 7. Subscription Account Other asset and liability accounts Postings should now be made on any other asset or liability accounts which affect the financial results of the business and which are not included above i.e. provision accounts. Examples: (a) Provision for depreciation DR Depreciation account CR Accumulated depreciation account/provision for depreciation account (b) Provision for bad debts DR Bad debts account CR Provision for bad debts account Preparation of final accounts (i) An inventory figure at the end of the accounting period will be calculated. (ii) Transfer from the various accounts will be made to the Statement of Comprehensive Income. Accounts should be balanced and balances carried down to the next period. (iii) A Statement of Financial Position will be prepared from the list of closing balances. The balance on the Statement of Comprehensive Income will be added to the capital account. Having adjusted this account for drawings during the year, the closing balance will represent the capital of the business at the end of the accounting period. 8. Reasonableness check on results for year A reasonableness check on the results for the year could be carried out, by comparing the gross profit ratios extracted from the accounts with: (a) The gross profit ratio in previous accounting periods And/or (b) Gross profit ratios produced by similar business concerns. A divergence in this ratio from the expected figure might raise doubts about accuracy of the stock figure or whether stock has been drawn from business for private use. 9. Inventory for Private use The owner of the business may take goods for private use. This is accounted for by the following journal entry: Debit Credit Drawings Account Purchases Account Page 228 E. QUESTION/SOLUTION Question Joseph Otto has been in business five years. He does not maintain a ledger. His summary receipts and payments account for the year ended 31st March 20X4 is as follows: Balance 1/4/20X3 Sales receipts Loan from Pascal Otto Sale of private car Balance 31/3/20X4 RWF 8,400 211,550 25,000 4,350 7,550 Drawings Purchases Van Expenses Workshop: Rent Rates Wages: Yves Moller 256,850 RWF 31,500 188,500 14,500 3,500 2,850 16,000 256,850 Additional information: (a) Depreciation is provided on the van annually at the rate of 20% of the book value. (b) The loan from Pascal Otto was received on 1st January 20X4; interest is payable on the loan at the rate of 10% per annum. (c) In addition to the items mentioned above, the assets and liabilities of Joseph Otto were as follows: At 31st March Van purchased 1/10/20X2, at cost Accumulated depreciation on van Inventory Trade receivables Van expenses prepaid Workshop rent accrued due Trade payables 20X3 20,000 2,000 25,000 23,000 14,500 20X4 20,000 2,000 40,000 61,450 500 1,000 11,000 Requirement: Prepare the trading and Statement of Comprehensive Income for the year ended 31st March 20X4, and a Statement of Financial Position as at that date. Solution 1. Opening Statement of Affairs 1st April 20x3 Assets Van Less Accumulated Depreciation RWF 20,000 (2,000) 18,000 25,000 23,000 8,400 74,400 Inventory Trade Receivables Bank Liabilities Trade Payables 14,500 ∴ Opening Capital 2. RWF59,900 Bank Account as Per Question Page 229 3. Trade Receivables Control Account RWF 23,000 250,000 273,000 Opening ∴ Sales RWF 61,450 211,550 273,000 Closing Bank 4. Trade Payables Control Account RWF 11,000 Opening 188,500 Purchases 199,500 Closing Bank 5. RWF 14,500 185,000 199,500 (a) Accruals and Prepayments: Van Expenses Account Bank RWF 14,500 RWF 500 14,000 Prepaid c/d Statement of Comprehensive Income 14,500 14,500 (b) Workshop Rent Account Bank Accrued c/d 6. RWF 3,500 Statement of Comprehensive Income 1,000 4,500 RWF 4,500 4,500 Other Asset/Liability Accounts (a) Depreciation on Van: Net book value at 1/4/X3 (b) RWF18,000 x 20% = RWF3,600 Loan Interest: Loan from Pascal Otto RWF25,000 x 10% x 3/12 Page 230 = RWF625 7. Preparation of Final Accounts: Statement of Comprehensive Income RWF Sales Inventory 1/4/X3 Purchases RWF 250,000 25,000 185,00 0 40,000 Inventory 31/3/X4 Cost of Sales Gross Profit Rent Rates Wages Van Expenses Loan Interest Depreciation Net Profit 170,000 80,000 4,500 2,850 16,000 14,000 625 3,600 Statement of Financial Position Cost Non-currentNon-Current Assets Van RWF 20,00 0 Current Assets Inventories Trade Receivables Prepayment Accumulated Depreciation RWF 5,600 41,575 38,425 Net Book Amount RWF 14,400 40,000 61,450 500 101,950 116,350 Capital: Balance 1/4/X4 Sales of Private Car – capital introduced Add net Profit RWF 59,900 4,350 38,425 102,67 5 31,500 Less Drawings 71,175 (25,000) Non-current Liabilities Current Liabilities Creditors 11,00 0 7,550 Bank Overdraft Page 231 Interest Due Rent Due F. 625 1,000 20,175 116,350 SINGLE ENTRY APPROACH Introduction In certain cases, owing to the deficiency of the records, it will be impossible to complete double entry accounts as described above. This might occur because no bank accounts were maintained and the records of the cash received and payments made were insufficient to give details of the transactions entered into. In order to establish the profit for the year and the financial position at the year end, the following steps should be taken: 1. 2. 3. An opening statement of affairs should be prepared as described above. A statement of affairs at the end of the accounting period should be prepared. The net increase in capital for the year can then be found by subtracting the balances on the capital accounts in 1 and 2 above from one another. This net increase in capital will then be reduced by the capital introduced during the year, increased by the drawings during the year and the resulting balance will represent the profit or loss for the year. G. QUESTION/SOLUTION J.Klopper J.Klopper is a dealer who has not kept proper books of account. At 31st August 20X4 his state of affairs was as follows: RWF Cash 115 Bank Balance 2,209 Fixtures 4,000 Inventory 16,740 Trade Receivables 11,890 Trade Payables 9,052 Motor Van 3,000 During the year to 31st August 20X5 his drawings amounted to RWF7,560. Winnings from a Casino RWF2,800 were put into the business. Extra fixtures were bought for RWF2,000. At 31st August 20X5 his assets and liabilities were: Cash RWF84, Bank Overdraft RWF165, Inventory RWF21,491, Trade Payables for goods RWF6,002, Payables for Expenses RWF236, Fixtures to be depreciated RWF600, Motor Van to be valued at RWF2,500, Trade Receivables RWF15,821, Pre-paid Expenses RWF72. Draw up a statement showing the profit or loss made by Klopper for the year ended 31st August 20X5. Page 232 Solution J. Klopper Opening Capital: 1st September 20X4 Cash Bank Fixtures Inventory Trade Receivables Motor Van Less Trade Payables RWF 115 2,209 4,000 16,740 11,890 3,000 RWF 37,954 9,052 28,902 st J. Klopper Statement of Financial Position as at 31 August 20X5 RWF RWF Non-current Assets Motor Van Less Depreciation Fixtures Less Depreciation 3,000 500 6,000 600 Current Assets Inventories Trade Receivables Prepaid Expenses Cash 21,491 15,821 72 84 Financed By: Capital Add Net Profit (W1) Add Cash Introduced 2,500 5,400 7,900 37,468 45,368 28,902 14,823 2,800 46,525 7,560 38,965 Less Drawings Current Liabilities Trade Creditors Expenses Owing Bank Overdraft 6,002 236 165 6,403 45,368 (W1) Net Profit Calculation RWF 38,965 28,902 10,063 7,560 17,623 (2,800) 14,823 Closing Net Assets Minus Opening Net Assets Increase Add Drawings Less Capital Introduced Net Profit Page 233 H. USE OF RATIOS Occasionally, ratios may be required to complete the question. Two key ratios are used – Mark-up and margin. Margin Mark Up = Gross Profit x 100 Sales = Gross Profit x 100 Cost of Sales Often referred to as the Gross Profit Percentage These two ratios are examined in a number of ways. Therefore, it is important to be fully familiar with them. Example 1: Goods cost RWF10,000. Mark-up by 20%. What is the selling price? Solution: Selling Price = 10,000 x 120 100 = RWF12,000 Example 2: GOODS COST RWF10,000. GROSS PROFIT PERCENTAGE IS 20%. WHAT IS THE SELLING PRICE? Solution: Selling Price = 10,000 x 100 80 = RWF12,500 Example 3: Goods sold for RWF10,000. Gross Profit Percentage is 20%. What is the cost price? What is the mark-up expressed as a % of cost? Solution: Cost = Price Mark Up = 10,000 x 80 100 = RWF8,000 10,000 – 8,000 x 100 8,000 = 25% Example 4: GOODS SOLD FOR RWF10,000. MARK-UP IS 10%. WHAT IS THE COST PRICE Page 234 Solution: Cost = Price I. 10,000 x 100 110 = RWF9,091 QUESTION/SOLUTION Eric Grewar - Incomplete Records Eric Grewar commenced business as a retailer on 1st April 20X2. On the same date he opened a Bank Account but has not kept any proper accounting records. In May 20X4 you are called in to assist in the preparation of accounts for tax purposes. You ascertain that on 1st April 20X3 Grewar had the following assets and liabilities. RWF Furniture and Equipment (Cost RWF5,400) 3,800 Motor Vehicles (Cost RWF2,800) 2,100 Goodwill (at cost) 2,000 Inventory 6,300 Loan from Jean Jones 1,500 Bank Overdraft 1,000 Trade Receivables 1,000 Trade Payables 3,200 Prepaid Expenses 500 Accrued Expenses 650 An analysis of the Bank Account for the year ended 31st March 20X4 revealed the following information: Receipts Trade Receivables Cash Sales New Loan from Jean Jones Payments RWF 5,200 34,300 5,500 Cash Purchases Trade Payables Expenses Motor Vehicles Drawings 45,000 RWF 23,200 8,900 5,300 1,750 5,200 44,350 The following additional information also came to light. (1) Mr Grewar has taken goods costing RWF100 for his own personal use. (2) The amounts outstanding for trade receivables and trade payables at the end of the current financial year were RWF1,300 and RWF3,800 respectively. Bad Debts of RWF100 had been taken into account in arriving at the trade receivables figure. (3) RWF450 was accrued and RWF520 prepaid at 31st March 20X4. (4) The inventory valuation at the end of the current year was RWF5,850. (5) Interest of 10% is to be provided for on both loans. (6) The agreed maximum on the bank overdraft is RWF5,000 and RWF50 interest is outstanding. (7) Depreciation of 20% on the original cost of all furniture, equipment and Motor Vehicles is to be provided. Page 235 You are required to: Prepare the Statement of Comprehensive Income for the year ended 31st March 20X4 and a Statement of Financial Position at the same date, showing all relevant workings. Solution - Eric Grewar Step 1 Prepare an opening statement of affairs in order to ascertain the capital at the beginning of the year. Assets Furniture and Equipment Motor Vehicles Goodwill Inventory Trade Receivables Prepaid Expenses RWF 3,800 2,100 2,000 6,300 1,000 500 15,700 Liabilities Loan from Jean Jones Bank Overdraft Trade Payables Accrued Expenses 1,500 1,000 3,200 650 6,350 ∴ Opening Capital Step 2 Prepare Cash and Bank Account RWF9,350 Bank Account Trade Receivables Cash Sales New loan from Jean Jones Balance c/d RWF 5,200 34,300 5,500 350 Balance b/d Cash Purchases Trade Payables Expenses Motor Vehicles Drawings 45,350 Step 3 RWF 1,000 23,200 8,900 5,300 1,750 5,200 45,350 Balance b/d 350 Prepare Trade Receivables and Trade Payables Accounts to find Sales and Purchase Balance Sales Bank Balance c/d Trade Receivables RWF 1,000 Bank 5,600 Bad debts Balance 6,600 Trade Payables RWF 8,900 Balance b/d 3,800 Purchases 12,700 Page 236 RWF 5,200 100 1,300 6,600 RWF 3,200 9,500 12,700 Step 4 Deal with Accruals and Payments Expenses Account Balance b/d Bank Balance c/d RWF 500 5,300 450 6,250 Balance b/d Statement of Comprehensive Income Balance c/d RWF 650 5,080 520 6,250 Eric Grewar Statement of Comprehensive Income for the Year ended 31st March 20X4 RWF RWF Sales (5,600 + 34,300) 39,900 Cost of Sales Opening Inventory 6,300 Purchases (W1) 32,60 0 38,90 0 Less Closing Inventory 5,850 Cost of Goods Sold 33,050 Gross Profit 6,850 5,080 Deduct Expenses Bad Debts 100 Loan Interest (7,000 x 10%) 700 Overdraft Interest 50 Depreciation 20% x 5,400 1,08 0 Motor Vehicles (W2) 910 1,990 Net Loss 7,920 RWF(1,070) W1 RWF Credit Purchases 9,500 Cash Purchases 23,200 32,700 Less Goods for Own Use 100 32,600 W2 RWF 2,800 1,750 4,550 Motor Vehicles at start of the year Acquired during the year Total Cost of Motor Vehicles Depreciation @ 20% 910 Page 237 Eric Grewar Statement of Financial Position as at 31st March 20X4 Cost Non-current Assets Goodwill Furniture & Equipment Motor Vehicles Accumulated RWF 2,000 5,400 4,550 11,950 Depreciation RWF RWF 2,680 1,610 4,290 Current Assets Inventories Trade Receivables Prepaid Expenses Net Book Value RWF 2,000 2,720 2,940 7,660 5,850 1,300 520 7,670 15,330 Represented by: Eric Grewar Capital 1/4/20X2 Less Loss for Year Drawings 5,200 + 100 9,350 1,070 5,300 Loan – Eric Grewar (5,500 + 1,500) Current Liabilities Trade Payables Accrued Expenses (W3) Bank Overdraft 6,370 2,980 7,000 3,800 1,200 350 5,350 15,330 W3 RWF 450 50 700 1,200 Accrued Expenses Bank Overdraft Loan Interest Page 238 BLANK Page 239 Study Unit 20 Company Accounts I Contents A. Introduction – Statement of Comprehensive Income B. Dividends C. Transfer to Reserve D. Statement of Financial Position E. Share Capital F. Corporation Tax / Income Tax Expense G. Issue of Shares H. Ultra Vires I. Returns, Statutory Books, Director’s Reports, Notices, Resolutions and Accounts to be Filed J. Ethical Obligations of Company Directors ___________________________________________________________________________ Page 240 A. INTRODUCTION – STATEMENT OF COMPREHENSIVE INCOME In England in 1897 the House of Lords ruled in the case, Salomon V Salomon & Co. Ltd, that a company is a separate legal entity from its owners. The owners’ liability to the company is limited to the amount of money the owner has invested in the company. This compares to the sole trader, who must make good all debts incurred by the business, even if he must provide funds from his own private resources. The owners of a company may walk away if the business is unable to pay its debts i.e. the members cannot be sued in their own right for the debts of the company. The exception to this is where a company traded fraudulently; the owners may be sued in their personal capacity. The owners are known as members or shareholders. A company which is registered at the Office of Registrar General as a limited liability company according to Law 7/2009 of 27/04/2009 Relating to Companies must have the word "limited" after its name which indicates to third parties that the liability of the owner is limited to the amount invested. A company may be limited by shares or by guarantee. For the most part, companies are limited by shares. The layout of the Statement of Comprehensive Income for a limited company for external reporting purposes is as follows: RWF 20,000 11,000 9,000 2,000 2,000 5,000 (1,000) 4,000 1,000 3,000 Revenue Cost of Sales Gross Profit Administration Expenses Distribution Expenses Operating Profit Finance Costs Profit before Taxation Income Tax Profit for Year Corporation Tax / Income Tax: The figure shown in the Statement of Comprehensive Income is a provision for tax, based on the profits for the period. To record this provision, the following journal is posted: DR Taxation (Statement of Comprehensive Income) CR Taxation (Liabilities payable within 1 year B/S) The corporation tax must be paid shortly after the year end. When it is paid, the journal to be posted is: DR Taxation (Current Liability) CR Bank Page 241 B. DIVIDENDS Dividends represent the return given to the shareholders/owners for investing money in the company. There are two major categories of shares - preference shares and ordinary shares. The preference shareholder is entitled to a dividend before the ordinary shareholder can receive anything. The directors of the company decide on the dividend to be paid to the ordinary shareholder, based on their assessment of the requirement of the company to hold on to its reserves for working capital purposes and for future expansion. Should the directors decide that no dividend is payable to the ordinary shareholder, the shareholder is powerless to alter this decision. The dividend to ordinary shareholders is expressed as Rwandan franc per share i.e. RWF.07 per share. The company may pay the dividend twice yearly - the interim dividend and the final dividend. When the interim dividend is paid, the necessary journal is: DR Dividends paid account (Retained Earnings) CR Bank The rule is that a company that has no profits including retained profits cannot pay a dividend. C. TRANSFER TO RESERVE As said earlier, the directors decide the level of profits which must be retained for future growth. The profits are transferred to reserves, by completing the following entry: DR Statement of Comprehensive Income CR Reserves in Statement of Financial Position D. STATEMENT OF FINANCIAL POSITION SEE CHAPTER 9 IAS 1 FOR DETAILS ON THE LAYOUT OF STATEMENT OF FINANCIAL POSITION. E. SHARE CAPITAL The total amount of share capital the company can issue is governed by the companys' own Memorandum and Articles of Association. This is known as the authorised share capital of the company. The Memorandum and Articles also state the minimum amount for which the shares can be issued. This figure is normally shown, by way of example, as follows: Authorised share capital - 100,000 shares of RWF1 each Note: Not all the authorised shares are issued and the value shown is the nominal share price or par value. When the company issues some of the shares, it must issue them at the par value or above. Where the shares are issued at par value, the double entry is: DR Bank Page 242 CR Share Capital Share Premium: When the company issues the shares above the minimum price, the journal entry is: DR Bank (Total received) CR Share Capital (with the par value) CR Share Premium (with the difference between the par value and the issued price) The share premium account is a capital reserve in the company. It cannot, be distributed to the members by way of dividend. The share premium account must be disclosed as part of the shareholders' funds in the Statement of Financial Position. This is achieved by: (i) Including the share premium account with the Capital Reserves in the Statement of Financial Position and showing by way of note, the make-up of the figure for Capital Reserves (including share premium), or, (ii) Showing the share premium account in the Statement of Financial Position separately from Share Capital and Capital Reserves F. CORPORATION TAX / INCOME TAX EXPENSE The tax levied on a company is generally referred to as Corporation Tax (or Income Tax Expense as referred to in International Accounting Standards). The accounting entries for this are as follows: DR Tax Charge – Statement of Comprehensive Income CR Corporation Tax / Income Tax (Accruals) - Statement of Financial Position Example XYZ Limited have profits before tax of RWF90,000 for the year ended 31 December, 20X4. The estimated tax liability for the year is RWF35,000 20X4 Statement of Comprehensive Income Extracts Profit before tax Taxation/Income Tax Profit after tax RWF 90,000 35,000 55,000 20X4 Statement of Financial Position Extracts Current Liabilities Corporation Tax/Income Tax RWF 35,000 Often in the subsequent year, the estimated corporation tax provided proves to be inadequate or excessive. To account for the change in estimate, the following journal is posted: Where there is an under provision: DR Tax Charge – Statement of Comprehensive Income CR Corporation Tax / Income Tax (Accruals) - Statement of Financial Position Page 243 Where there is an overprovision: DR Corporation Tax / Income Tax (Accruals) - Statement of Financial Position CR Tax Charge – Statement of Comprehensive Income Example In the year ended 31 December 20X5, XYZ Limited agreed and paid its tax liability for 31 December 2004 - the final agreed figure was RWF37,500 RWF x 20X5 Statement of Comprehensive Income Extracts Profit before tax Taxation Charge Under-provision of Corporation Tax/Income Tax Corporation Tax/Income Tax Profit after tax 2,500 x x Corporation Tax/Income Tax Payable Account (Extract) RWF 37,500 20X5 Bank 20X5 20X5 Balance b/d Statement of Comprehensive Income 37,500 RWF 35,000 2,500 37,500 Example If the tax liability finally agreed and paid had been RWF32,000, the overprovision would have been accounted for as follows: RWF x 20X5 Statement of Comprehensive Income Extracts Profit before tax Taxation Charge Under-provision of Corporation Tax/Income Tax Corporation Tax/Income Tax Profit after tax 3,000 x x Corporation Tax/Income Tax Payable Account (Extract) 20X5 Statement of Comprehensive Income 20X5 Bank RWF 3,000 20X5 32,000 35,000 Balance b/d RWF 35,000 35,000 G. ISSUE OF SHARES Introduction When a company issues shares, it may issue them in a number of different ways such as rights issue, par value, at a premium and a bonus issue. Page 244 Rights Issue If a company issues ordinary shares for cash, it must first offer them to its existing ordinary shareholders in proportion to their shareholdings. Par Value Shares issued at the same value to the value stated in the memorandum and articles of association i.e. authorised share capital RWF50,000 RWF1 shares - shares issued for RWF1 each. At a Premium Shares issued at a value above the par value - this premium is recorded in the share premium account, e.g. issue of 10,000 RWF1 shares at RWF1.50, the premium of RWF5000 is recorded in the Share Premium Account. Bonus Issue In issuing shares, a company may capitalise available reserves in paying up the shares wholly or in part. The effect is to convert the reserves into permanent capital. The members pay for their additional shares by foregoing whatever right they had to the reserves. A bonus issue is usually made at 1 share for every x owned as per the register Issue and Forfeiture of Shares The recording of an issue and forfeiture of shares is best explained by way of example. Issue of Shares Example 1 X Ltd issued 100,000 ordinary shares @ RWF1 each - at par value (potential shareholders apply for shares which are then allocated) We ultimately want the bank account and the issued share capital account to show an increase of RWF100,000. Journal Entry: DR Bank CR Applicants Account 100,000 DR Allotment Account CR Ordinary Share Capital 100,000 100,000 100,000 By joining the Applicants account and the Allotment account together to become the Applications and Allotment account, the above journal entry can be modified slightly to DR Bank Account CR Application and Allotment Account 100,000 DR Application and Allotment Account CR Issued Ordinary Share Capital Account 100,000 100,000 Page 245 100,000 Example 2 Several years later from example 1, the Statement of Financial Position of X Ltd. is as follows: RWF 150,000 Net Assets Issued Share Capital Reserves 100,000 50,000 150,000 The company decides to issue 100,000 shares at RWF1.50 - at a premium of RWF0.50 per share Journal Entry: DR Bank CR Application and Allotment Account 150,000 DR Application and Allotment Account CR Issued Ordinary Share Capital 100,000 150,000 DR Application and Allotment Account CR Share Premium Account 100,000 50,000 50,000 Example 3 Y Ltd issued 100,000 RWF1 shares at various stages - at par value On application RWF0.20 On allotment RWF0.30 On 1st call RWF0.10 On final call RWF0.40 Let us assume that the issue was not over-subscribed. Journal Entries: On Application: DR Bank CR Application and Allotment Account On Allotment: DR Bank CR Application and Allotment Account RWF 20,000 RWF 20,000 30,000 30,000 Then: DR Application and Allotment Account CR Issued Share Capital 50,000 50,000 Page 246 On First Call: DR Bank CR First and Final Call Account 10,000 10,000 On Final Call: DR Bank CR First and Final Call Account 40,000 40,000 Then: DR First and Final Call Account CR Issued Share Capital 50,000 50,000 Example 4 Z Ltd issued 100,000 RWF1 shares at various stages - at par value On application Rwf 0.2 On allotment Rwf 0.3 On final call Rwf 0.5 In this instance, the company received 1,200,000 applicants i.e. over-subscribed. Of the monies received on application, RWF100 per share is to be put against amounts due on allotment and the balance returned to the applicants. Journal Entry: On Application: DR Bank CR Application and Allotment Account RWF 24,000 RWF 24,000 Being 120,000 applicants received x Rwf 0.2 per share Return of Funds: DR Application and Allotment Account CR Bank 3,000 3,000 Being RWF4,000 over-subscribed and returning RWF3,000 to applicants as instructed On Allotment: DR Bank CR Application and Allotment Account 29,000 29,000 Being amounts due on allotment less RWF1 from application as instructed Then: DR Application and Allotment Account CR Issued Share Capital 50,000 50,000 Page 247 On Final Call: DR Bank CR First and Final Call Account 50,000 50,000 Then: DR First and Final Call Account CR Issued Share Capital 50,000 50,000 Forfeited Shares - Example 1 A Ltd. issued 100,000 shares @Rwf1 each - at par value. All application and allotment money were received. One shareholder who acquired 1,000 shares failed to pay First & Final Call monies due. On Application RWF0.20 On Allotment RWF0.30 On First & Final Call RWF0.50 Journal Entries: On Application: DR Bank CR Application and Allotment Account RWF 20,000 RWF 20,000 On Allotment: DR Bank CR Application and Allotment Account 30,000 30,000 Then: DR Application and Allotment Account CR Issued Share Capital 50,000 50,000 On Final Call: DR Bank CR First and Final Call Account 49,500 49,500 Being 99,000 shares @ RWF0.50 - i.e. actual amount received Then: DR First and Final Call Account CR Issued Share Capital 50,000 50,000 Being 100,000 shares @ RWF0.50 - i.e. the expected amount to be received This leaves a balance on the First & Final Call account of RWF500. This amount is referred to as calls in arrears and at the balance date is shown under current assets. In the event that the shareholder has not paid the balance due, the shares are not issued to him. The amounts paid by him on application and allotment are not refunded to him. This amounts to RWF500 Page 248 i.e. 1,000 shares @ RWF0.20 and @ RWF0.30. To complete the task, ultimately we want to show that the issued share capital has increased by RWF99,000 only i.e. 99,000 shares @ RWF1 each. The necessary journal entries are: RWF 1,000 DR Issued Share Capital Account CR Forfeited Share Account RWF 1,000 Being 1,000 shares not issued DR Forfeited Share Account CR First and Final Account 500 500 Being the first & final account being closed off DR Forfeited Share Account CR Share Premium 500 500 Being the amount received on application and allotment on shares which were not subsequently reissued. Example 2 Same details as above but the forfeited shares are re-issued at RWF1.10 per share. The journal entries as shown above as far as the first & final account are used here, thereafter, the journal entries are: RWF 1,000 DR Issued Share Capital Account CR Forfeited Share Account RWF 1,000 Being 1,000 shares not issued DR Forfeited Share Account CR First and Final Account 500 500 Being the first & final account being closed off DR Forfeited Share Account CR Reissued Forfeited Share Account 500 500 Being the necessary entry to close the Forfeited Share Account DR Reissued Forfeited Share Account CR Issued Share Capital 1,000 1,000 Being the forfeited shares being reissued DR Bank CR Reissued Forfeited Share Account 1,100 1,100 Being the proceeds for the reissued forfeited shares DR Reissued Forfeited Share Account CR Share Premium Account 600 600 Page 249 Being the premium on issue of the reissued forfeited shares (This can be calculated independently - RWF500 on application and allotment originally and RWF100 on the reissue - 1,000 shares @ RWF0.10 (RWF1.10 - RWF1) H. ULTRA VIRES A company is required to state the objects for which it has been incorporated in its memorandum of association. The company in the course of its business then pursues these objects. If the company pursues any object which is not in accordance with the provisions of the memorandum of association, it is beyond the company’s capacity and is termed ultra vires. Some cases in English Law have been used across the world and the two below are such: Case: Ashbury Railway Carriage and Iron Company V Riche 1875 In this case, it was held that if a company has a main or dominant object, than all other activities specified in the memorandum of association are deemed to be subordinate or ancillary to that main object. Case: German Date Coffee Ltd. 1882 A company was formed to obtain a German patent and carry on the business associated with that patent. The company failed to obtain a German patent but obtained a Swedish patent. The company traded using only the Swedish patent, although the memorandum specifically provided that the business of the company would be conducted once the German patent had been obtained. Held: The Company must be wound up, as it had not obtained the German patent and the main object of the company could only be conducted when the German patent had been obtained. The deciding factor in this case was that it was impossible for the company to carry on its main objective as the German patent had not been obtained and all other activities specified in the memorandum of association were subordinate or ancillary to that main object. The modern tendency is to state in substantial detail the objects of the company. But to ensure that the object clauses are not translated in too rigid a way certain clauses are inserted. These are: 1. Plenipotentiary Clause (means “catch all”) A clause is inserted which enables the directors in their absolute discretion to decide that a particular contract be entered into by the company as such a contract would be for the benefit of the company. 2. Independent Objects Clause The company incorporates a clause, which provides that all of the objects are to be independent of each other. By doing so, the rigid application of the objects without this clause can be circumvented so the first object will not be deemed to be the main object of the company and subsequent objects treated as ancillary thereto. Page 250 Where a contract is ultra vires, the third party may be able to enforce that contract against the company by virtue of the modification of the ultra vires rule. I. RETURNS, STATUTORY BOOKS, DIRECTORS’ REPORTS, NOTICES, RESOLUTIONS AND ACCOUNTS TO BE FILED From Law No. 7/2009 of 27/04/2009 Relating to Companies Article 258 : Filing financial statements Every company, other than a small private company, shall ensure that, within thirty (30) days after the financial statements of the company and any group financial statements are required to be signed, copies of those statements together with a copy of the auditor’s report on those statements are filed with the Registrar General for registration. Article 253 : Financial statement preparation The Board of Directors of every company shall ensure that, within three (3) months following the end of a financial statement the audit is made and signed by at least one representative of the company. Such an audit shall be submitted to the Registrar General. Article 254 : Standards for financial statement preparation The financial statements of a company shall comply with international standards. Members of the Board of directors shall provide such information and explanations as are necessary for auditing process to be conducted. Article 255 : Obligation to provide consolidated financial statement The Board of Directors of a company that has one or more subsidiaries, shall, ensure that, within six (6) months after the financial year, a consolidated balance is prepared. Such a consolidated financial statement shall be signed by at least one of the parent company’s shareholders. Such consolidated financial statements shall not be required for the case of a subsidiary of any company incorporated in Rwanda or for a virtually wholly owned subsidiary of any company incorporated in Rwanda which has obtained the approval of the minority shareholders. Article 259 : Providing a financial summary A small private company shall file with the Registrar General a financial summary for registration. Article 260 : Where a company does not have financial statement A company shall have a Statement of Financial Position date in each calendar year. A company may not have a Statement of Financial Position date in the calendar year in which it is incorporated where its first financial statement date is in the following calendar year and is not later than eighteen (18) months after the date of its formation or incorporation. Article 269 Format of the Annual Report Every annual report for a company shall be in writing and be dated and shall: 1. describe, so far as the Board believes is material for the shareholders to have an appreciation of the state of the company‟s affairs and is not harmful to the business of the company or of any of its subsidiaries, especially any change during the accounting period in: a) the nature of the business of the company or any of its subsidiaries; Page 251 b) the classes of business in which the company has an interest, whether as a shareholder of another company or otherwise; 2. include financial statements for the accounting period and any group financial statements for the accounting period completed and signed in accordance with this Law; 3. where an auditor’s report is required in relation to the financial statements or group financial statements, included in the report, include that auditor‟s report; 4. state particulars of entries in the interests register made during the accounting period; 5. state the amount which represents the total of the remuneration and benefits received by or due and receivable from the company and any related corporation by: a) executive directors of a company engaged in the full time employment of the company and its related corporations, including all bonuses and commissions received by them as employees; b) separate statement, the non-executive directors of the company; 6. state the total amount of donations made by the company and other subsidiaries during the accounting period; 7. state the names of the persons holding office as directors of the company as at the end of the accounting period and the names of any persons who ceased to hold office as directors of the company during the accounting period; 8. state the amounts payable by the company to the person or firm holding office as auditor of the company as audit fees and, as a separate item, fees payable by the company for other services provided by that person or firm; 9. be signed on behalf of the Board of Directors by two (2) directors of the company or, where the company has only one director, by that director; 10. disclose related party transactions and full information about the nature and extent of the conflict of interest; 11. Any other details which are necessary for the report to be well understood. Any company whose subsidiary companies are located outside Rwanda shall also comply with the provisions of this article within eight (8) weeks after the dates contained therein. The above is only a summary and guide. For full details, it is recommended the student acquires a copy of the Law No. 7/2009.of 27/04/2009 Relating to Companies. Statutory Books 1. Register of members. Gives names, addresses and amount of shares held by each shareholder. It enables those interested to establish the identities of the shareholders. 2. Register of debenture holders. Gives names, addresses and amount of debentures held. It enables those interested to establish the identities of the debenture holders. Page 252 3. Register of charges. Give details of charges on the company. It enables those interested to establish the amount of charges, what they have been secured on and the parties involved. 4. Register of Directors and Secretaries. Give particulars of those concerned. Open to those interested. 5. Register of Directors’ interests in shares and debentures. Gives details of shares and debentures held by directors or their close relatives. 6. Minute Book – General meetings. Gives account of items discussed and resolutions passed. 7. Minute Book – Directors’ meetings. Gives account of items discussed and decisions taken. It is not open for inspection. 8. Record of declarations by directors of interests in company contracts. Give details of declarations by directors of personal interests in company contracts. Its purpose is to avoid ethical problems and conflict of interest claims arising from directors having a personal interest in company business. DIRECTORS’ REPORT A copy of the directors’ report must be attached to its Statement of Financial Position and laid before the members of the company at the company’s annual general meeting. The directors’ report must refer to the state of affairs of the company and any of its subsidiaries. It must also refer to the amount, if any, which is to be paid by way of a dividend together with the amount of reserves, which it is proposed to carry. It must deal with any change during the financial year in the nature of the business of the company or of any of the company’s subsidiary companies. It must give a fair review of the development of the business of the company and of its subsidiaries, if any, during the financial year. It must give particulars of any important events affecting the company or any of its subsidiaries, if any, which have occurred since the end of the financial year. It must give an indication of likely future development in the business of the company and of its subsidiaries. It must give an indication of the activities, if any, of the company and its subsidiaries, in the field of research and development. Where shares in the company have been acquired by the company by forfeiture or acquired by another person which are subject to a lien or other charge, the directors’ report must state the number and nominal value of shares acquired, the maximum number and nominal value of shares held at any time during the year, the number and nominal value of shares disposed of during the year, the value or consideration of that disposal, the number and nominal value of shares as a percentage of the called-up share capital of the company and the amount of the charge (if relevant). The directors’ report must also distinguish between subsidiaries and associated companies. Two directors on behalf of the board must sign the directors’ report. Notices 1. Directors’ meetings – no provision for a specified period of notice to be given. 2. Annual meetings – minimum period of notice is not stated in the Law, but annual reports must be sent to shareholders 15 days before the Annual Meeting (Article 268). 3. The following persons are entitled to receive notice of Annual and Special meetings:(a) Every member of the company Page 253 4. (b) Personal representatives or the official assignee in bankruptcy if the member they represent would have been entitled to receive such notice (c) Auditors of the company If any of the rules relating to the giving of notice are breached in accordance with either the provisions of the laws relating to Companies or the articles of association of the company, it is possible for a shareholder to bring proceedings to have the meeting and the resolutions passed at that meeting rendered invalid. Resolutions 1. Directors’ meetings – all questions arising may be decided by a majority of votes. 2. Annual Meeting – two types of resolutions may be passed i.e. ordinary resolution or special resolution. An ordinary resolution is a resolution which requires a simple majority of the number of votes cast Ordinary resolutions 1. Rights and obligations of shareholders – changes by Board of Directors (BoD) to confirmed 2. Divide, subdivide or consolidate shares 3. Appointment of directors (unless provided otherwise by the memorandum of association 4. Removal from office of a director 5. A director of a private limited company may be removed from office by special resolution passed at a meeting called for that purpose. 6. Approval of the directors’ remuneration, 7. The rescinding of decisions made by the BoD regarding remunerarion of directors or compensation for loss of office. Shareholders with at least 10% of the shares can call the meeting to which the motion is put. An ordinary resolution will decide. 8. Per Article 238 – the appointment of an inspector to investigate the company’s affairs Article 142 : Powers exercised by special resolution The shareholders exercise a power to : 1. 2. 3. 4. adopt articles of association , if it has , to alter or to revoke them ; approve a major transaction - see Article 189 of Law 7/2009; approve an amalgamation of the company; put the company into liquidation; Such power shall be exercised by special resolution. A special resolution shall only be rescinded by a special resolution. Accounts to be Filed Accounts must be prepared for two purposes – for shareholders and for publication. Definitions of Criteria: Turnover – Income from sale of goods and services, net of trade discounts, VAT and other sales taxes. Statement of Financial Position Totals – Fixed assets and current assets Page 254 Employees – Total number of employees employed each week in the year divided by the number of weeks in the year. DISCLOSURE REQUIREMENTS FOR EMPLOYEES 1. Average number of staff under contracts of service and the aggregate amount respectively of wages and salaries, social welfare costs and other pension costs. 2. The average number of staff sub-divided into categories selected by the directors having regard to the manner in which the company’s activities are organised. DISCLOSURE REQUIREMENTS FOR DIRECTORS’ EMOLUMENTS The amount of 1. Emoluments (including fees, percentages, taxed allowances, pension contributions and estimated money value of taxed benefits-in-kind). 2. Directors’ and past directors’ pensions, except from a Pension scheme. 3. Particulars of commitments relating wholly or firstly to pensions payable to past directors. 4. Compensation to directors or past directors for loss of office. J. ETHICAL OBLIGATIONS OF COMPANY DIRECTORS Directors duties Company directors’ responsibilities are wide and diverse. Their duties arise primarily from:• • Statute Legislation Company Law Directors duties include:• • • • • • • • • • Exercising their powers in good faith and in the interests of the company as a whole Not allowed to make an undisclosed profit from their position as directors Carrying out their functions with due care, skill and diligence Maintaining proper books of account Preparing annual accounts Maintaining certain registrars and other documents Filing certain documents with the Office of the Registrar General (ORG) Disclosure of certain personal information Convening at general meetings of the company Transactions with the company Page 255 Study Unit 21 Company Accounts - 2 Contents A. Introduction B. Preparation of Limited Company Accounts C. Sample Question/Solution D. Questions/Solutions Page 256 A. INTRODUCTION The following is a checklist of frequent adjustments. Students should ensure that they understand fully the treatment of each one: 1. Depreciation of Non-Current Assets, 2. Write off of Bad Debts 3. Change to Bad Debt Provision 4. Dividend to Preference Shareholders 5. Debenture Interest 6. Accrual / Prepayment of expenses 7. Opening stock under/over stated 8. Provision of Goods on Approval 9. Cost of asset included in closing stock valuation 10. Insurance Due for damage to stock 11. Proceeds from sale of motor vehicle included in sales 12. Proceeds from issue of shares included in sales 13. Stock damaged – Include at lower of cost and net realisable value 14. Provision for discount on Trade Receivables 15. Extension to warehouse cost included in purchases and wages 16. 17. Goods supplied free of charge by way of promotion Revaluation of Land We will now work through each of the adjustments listed above then work through a number of full exam standard questions. Adjustment 1 Depreciation Trial Balance (Extract) at 31.12.20X4 RWF 500,000 150,000 120,000 Buildings Office Equipment Motor Vehicles Accumulated Depreciation Buildings Office Equipment Motor Vehicles 80,000 60,000 43,800 Additional Information: Depreciation should be charged at: • 2% on cost of Buildings • 20% on cost of Office Equipment RWF Page 257 • 20% on written down value of Motor Vehicles often referred to as the Reducing Balance Method. Solution to Adjustment 1 Cost As at 1 Jan 20X4 Additions Disposals As at 31 Dec 20X4 Buildings 500,000 Nil Nil 500,000 Office Equipment 150,000 Nil Nil 150,000 Motor Vehicles 120,000 Nil Nil 120,000 Accumulated Depreciation As at 1 Jan 20X4 Disposals Depreciation (W1) As at 31 Dec 20X4 80,000 Nil 10,000 90,000 60,000 Nil 30,000 90,000 43,800 Nil 15,240 59,040 Net Book Value 410,000 60,000 60,960 W1 Depreciation Calculation Buildings: 500,000 x 2% = 10,000 Office Equipment: 150,000 x 20% = 30,000 Motor Vehicles: Depreciation is calculated on the net book value: Cost 120,000 Less Accumulated (43,800) Depreciation Net Book Value 76,200 Depreciation 20% of Net Book Value 15,240 (76,200 x 20%) Adjustment 2 Write off Bad Debts Trial Balance (Extract) at 31.12.20X4 RWF Trade Receivables Bad Debts 1,250 Additional Information: A customer has been declared bankrupt owing RWF350. This is to be written off. Page 258 RWF 46,800 Solution to Adjustment 2 The bad debt expense has to be increased and the balance on Trade Receivables reduced. The accounting entries are: DR Bad Debt Expense CR Trade Receivables 350 350 Trade Receivables Statement of Financial Position RWF 46,800 (350) 46,450 Balance per Trial Balance Write off – Bankrupt (Cr) / Dr Bad Debts Statement of Comprehensive Income RWF 1,250 350 1,600 Adjustment 3 – Provision for Bad Debts Trial Balance (Extract) at 31.12.20X4 RWF Trade Receivables Bad Debts Provision for Doubtful Debts RWF 52,400 1,050 750 Additional Information: 1. A customer has been declared bankrupt owing RWF400. This is to be written off. 2. The provision for doubtful debts should be 2% of Trade Receivables. Solution to Adjustment 3 Trade Receivables RWF 52,400 (400) 52,000 1,040 (750) 290 Balance per Trial Balance Write off – Bankrupt Provision Required – 2% of 52,000 Current Provision Increase in Provision Bad Debts RWF 1,050 400 1,450 Statement of Comprehensive Income (Extract) RWF Expenses Bad Debts Increase 1,450 290 Statement of Financial Position (Extract) RWF Current Assets Trade Receivables Less Provision for Bad Debts 52,000 (1,040) Page 259 50,960 Note: Take the increase / decrease in the provisions for doubtful debts to the Statement of Comprehensive Income but deduct the full amount of the provisions from the Trade Receivables figure in the Statement of Financial Position. Adjustment 4 – Dividend on Preference Shares Trial Balance (Extract) at 31.12.20X4 RWF 6% Redeemable Preference Shares Preference Dividend RWF 20,000 400 Note: No adjustment will be listed in the additional information section of the question, so you must check whether the full amount of dividend due on the preference shares was paid if not the amount due will have to be accrued. Solution to Adjustment 4 RWF 1,600 (400) 1,200 Total Dividend Due – 20,000 x 8% Dividend Paid Amount outstanding Statement of Financial Position (Extract) RWF Current Liabilities Preference Dividend 1,200 Adjustment 5 – Debenture Interest Trial Balance (Extract) at 31.12.20X4 RWF 50,000 10% Debentures Note: No adjustment will be listed in the additional information section of the question, so you must check whether the full amount of the interest on the debentures has been paid. Look down through the Trial Balance for an amount of debenture interest paid, if there is no entry then no payment for the interest has been made as at the year end. Solution to Adjustment 5 RWF 5,000 Nil 5,000 Total Interest to be paid – 50,000 x 10% Less Interest paid per Trial Balance Amount of Interest to be paid Statement of Comprehensive Income (Extract) RWF Expenses Debenture Interest 5,000 Statement of Financial Position (Extract) Page 260 RWF Current Liabilities Interest Due (5,000) Adjustment 6 – Accrual / Prepayment Trial Balance (Extract) at 31.12.20X4 RWF 12,800 43,500 Rent and Rates Wages Additional Information: 1. The annual charge for Rent is RWF7,200 and this is paid up to 31st March 20X5. 2. Wages are outstanding at the Statement of Financial Position date of RWF2,750. Solution to Adjustment 6 Rent & Rates RWF 12,800 (1,800) 11,000 Balance per Trial Balance Prepayment 7,200 x 3/12 Wages RWF 43,500 2,750 46,250 Balance per Trial Balance Accrual Statement of Comprehensive Income (Extract) RWF Expenses Rent and Rates Wages 11,000 46,250 Page 261 Statement of Financial Position (Extract) RWF Current Assets Prepayments 1,800 Current Liabilities Accruals 2,750 Adjustment 7 – Opening Inventory Understated Trial Balance (Extract) at 31.12.20X4 RWF 59,750 Opening Inventory Revenue Reserves RWF 128,400 Additional Information: 1. Inventory on hand at 1st January 20X4 has been understated by RWF2,500 due to a clerical error. Solution to Adjustment 7 Inventory Balance per Trial Balance Write off – Bankrupt Revenue Reserves 128,400 2,500 130,900 59,750 2,500 62,250 The opening stock for this period was last year’s closing stock, so if this figure was understated it means profit was understated. A simple example clarifies the point. Sales Less Cost of Goods Sold Opening Inventory Purchases Closing Inventory Cost of Goods Sold Gross Profit 120,000 5,000 85,000 90,000 (10,000) 120,000 5,000 85,000 90,000 (15,000) (80,000 40,000 (75,000) 45,000 The only difference between the two Trading accounts above is the value of the Closing Stock, as the value of closing inventory increases from RWF10,000 to RWF15,000, the net profit increase by the same amount from RWF40,000 to RWF45,000. If the opening inventory is overstated then the value of closing inventory and revenue reserves should be decreased. Adjustment 8 – Goods on Approval Trial Balance (Extract) at 31.12.20X4 RWF Sales Trade Receivables 76,350 Page 262 RWF 457,300 Additional Information: 1. Stock on hand at 31st December 20X4 was valued at RWF32,650. 2. Included in sales is an amount of RWF1,800 for goods sent on approval to a customer. On 5th January 20X5 the customer decided to accept part of the goods paying RWF1,200 and returning the balance. The mark up on the goods was 20%. Solution to Adjustment 8 Inventory Balance per Trial Balance and Notes Goods on Approval 32,650 1,500 34,150 Trade Receivables 76,350 (1,800) 74,550 Sales 457,300 (1,800) 455,500 The above adjustments may seem to be confusing but a number of points need to be remembered: • In the records provided a sale has been recognised for goods that have been provided to a customer but no confirmation of a sale has been received from the customer at the Statement of Financial Position date. • In line with the prudence concept, revenue should not be recognised until the sale is a certainty; there is no certainty attaching at the Statement of Financial Position date therefore the sale should be reversed. • The only way the sale could have been accounted for would be as a credit sale : – Dr Sales – Cr Trade Receivables • The reversal against sales and Trade Receivables is for the full amount, that is, the cost of stock plus the mark up. • Closing inventory figure is based on a physical inventory take. Therefore, the closing stock figure does not include the goods sent on approval to the customer. The adjustment required to the closing inventory figure is to increase it by the cost of the goods RWF1,500 (1,800 x 20/120). Adjustment 9 – Asset included in stock Trial Balance (Extract) at 31.12.20X4 Purchases Office Equipment – Cost Office Equipment – Accumulated Depreciation RWF 198,500 140,000 RWF 56,000 Additional Information: 1. Inventory on hand 31st December 20X4 was RWF42,670, which included the following: (a) 2. A printer for the sales office. This was purchased for RWF500 in November 20X4. The invoice has been included in purchases. Depreciation is to be provided on office equipment held at the Statement of Financial Position date at a rate of 20% on cost. Page 263 Solution to Adjustment 9 Inventory 42,670 (500) 42,170 Per Trial Balance Less cost of Printer Cost As at 1 Jan 20X4 Additions Disposals As at 31 Dec 20X4 Purchases 198,500 (500) 198,000 Office Equipment 140,000 500 Nil 140,500 Accumulated Depreciation As at 1 Jan 20X4 Disposals Depreciation (140,500 x 20%) As at 31 Dec 20X4 Net Book Value 56,000 Nil 28,100 84,100 56,400 Adjustment 10 – Insurance Due Trial Balance (Extract) at 31.12.20X4 RWF 284,700 Purchases Additional Information: 1. Inventory on hand 31st December 20X4 was RWF34,500. 2. During November 20X4 a water pipe burst destroying inventory which had a cost of RWF1,500. Only one third of this amount will be recovered from the insurance company. Solution to Adjustment 10 RWF 284,700 (1,500) 283,200 Purchase per Trial Balance Less destroyed inventory Cost of Damaged Inventory not recoverable from Insurance (1,500 x 2/3) 1,000 Insurance Due (1,500 x 1/3) 500 Accounting Entries: DR Statement of Comprehensive Income – Damaged Inventory DR Current Assets – Insurance Due (Statement of Financial Position) CR Purchases Page 264 1,000 500 1,500 Adjustment 11 – Proceeds from Motor Vehicle included in sales Proceeds Trial Balance (Extract) at 31.12.20X4 RWF Sales Motor Vehicles – Cost Motor Vehicles – Accumulated Depreciation RWF 472,600 150,000 54,000 Additional Information: 1. Included in the sales figure is an amount of RWF8,500 which was the proceeds from the disposal of a van purchased in 20X1 for RWF20,000. 2. Depreciation is to be provided on Motor Vehicles at a rate of 20% on a reducing balance basis. Solution to Adjustment 11 Sales per Trial Balance Less proceeds from sale of van 472,600 (8,500) 464,100 Cost of asset purchased in 20X1 Depreciation – year end 31.12.X1 Net Bok Value Depreciation – year end 31.12.X2 Net Book Value Depreciation – year end 31.12.X3 Net Book Value 20,000 (4,000) 16,000 (3,200) 12,800 (2,560) 10,240 Proceeds Net Book Value Profit/(loss) on disposal 8,500 (10,240) (1,740) Cost As at 1 Jan 20X4 Additions Disposals As at 31 Dec 20X4 Motor Vehicle 150,000 Nil (20,000) 130,000 Accumulated Depreciation As at 1 Jan 20X4 Disposals (W1) Depreciation (W2) As at 31 Dec 20X4 54,000 (9,760) 17,152 61,392 Net Book Value 68,608 Page 265 20,000 x 20% 16,000 x 20% 12,800 x 20% W1: Disposed Asset Accumulated Depreciation 9,760 (4,000 + 3,200 + 2,560). W2: Depreciation (130,000 - 44,240) x 20% = 17,152 44,240 = 54,000 - 9,760 (Accumulated Depreciation at the start of the year less the accumulated depreciation for the asset disposed of during the year) Statement of Comprehensive Income (Extract) RWF Sales Less Expenses Loss on Disposal Depreciation – Motor Vehicles 1,740 17,152 Statement of Financial Position (Extract) Cost Acc Dep Non-Current Asset Motor Vehicle RWF 464,100 130,000 61,392 NBV 68,608 Adjustment 12 – Proceeds from Share Issue included in Sales Trial Balance (Extract) at 31.12.20X4 RWF 513,000 100,000 20,000 Sales Ordinary Shares – Rwf 0.5 each Share Premium 1. Additional Information: Included in the sales figure is RWF5,000 being the proceeds from the issue of ordinary shares. Solution to Adjustment 12 Sales Balance per Trial Balance Adjustment 513,000 (5,000) 508,000 Ordinary Shares 100,000 500 100,500 Share Premium 20,000 4,500 24,500 We issued 1,000 ordinary shares each having a nominal value of Rwf 0.5 each, the total nominal value of the shares issued is RWF1,000. However, we have received RWF5,000. The difference between the amount received and the nominal value is taken to the Share Premium Account. Statement of Financial Position (Extract) RWF Equity & Liabilities Shareholders’ Equity Share Premium Total Equity 100,500 24,500 125,000 Page 266 Adjustment 13 – Damaged Inventory Inventory on hand 31st December 20X4 was valued at RWF25,480, which included inventory costing and included at RWF250 (selling price RWF320). This was damaged on 25th November 20X4 while being moved in the stores. It will cost RWF50 to repair this item and then it will be sold for RWF290. Solution to Adjustment 13 Cost Net Realisable Value 250 240 (Selling price less costs to achieve selling price – 290 – 50) IAS 2 rule for valuing inventories is the lower of: • Cost and • Net Realisable Value. The valuation of the inventory item damaged should be reduced from RWF250 to RWF240. The value of closing inventory in the financial statements should be RWF25,470 (25,480 250 + 240). Adjustment 14 – Provision of Discounts Trial Balance (Extract) at 31.12.20X4 RWF Trade Receivables Bad Debts Provision for Doubtful Debts RWF 63,600 1,400 1,600 Additional Information: 1. A customer has been declared bankrupt owing RWF600. This is to be written off. 2. The provision for doubtful debts should be 2% of Trade Receivables. 3. A provision is to be raised for discounts at a rate of 1%. Solution to Adjustment 14 Trade Receivables 63,600 (600) 63,000 Balance per Trial Balance Write off – Bankrupt Provision Required – 2% x 63,000 Current Provision Decrease in Provision Bad Debts 1,400 600 2,000 1,260 (1,600) (340) Provision for Discounts Trade Receivables less provision for Bad Debts (63,000 – 1,260) Provision for Discounts – 61,740 x 1% Page 267 61,740 (617) 61,123 Statement of Comprehensive Income (Extract) RWF Expenses Bad Debts Decrease in Bad Debt Provision Provision for Discounts 2,000 (340) 617 Statement of Financial Position (Extract) RWF Current Assets Trade Receivables 61,123 Adjustment 15 – Extension to Warehouse Trial Balance (Extract) at 31.12.20X4 RWF 72,400 154,500 250,000 Wages Purchases Buildings – Cost Buildings – Accumulated Depreciation RWF 50,000 Additional Information: 1. Wages includes RWF5,400 and materials of RWF4,600 used for the construction of a warehouse extension. 2. Depreciation is to be provided at a rate of 2% on the cost of Buildings. Solution to Adjustment 15 Wages 72,400 (5,400) 67,000 Per Trial Balance Warehouse Construction Purchases 154,500 (4,600) 149,900 Cost As at 1 Jan 20X4 Additions (W1) Disposals As at 31 Dec 20X4 Buildings 250,000 10,000 Nil 260,000 Accumulated Depreciation As at 1 Jan 20X4 Disposals Depreciation (W2) As at 31 Dec 20X4 50,000 Nil 5,200 55,200 Net Book Value 204,800 W1: Additions 10,000 (Wages 5,400 + Purchases 4,600) Page 268 W2: Depreciation 260,000 x 2% = 5,200 Statement of Comprehensive Income (Extract) RWF Expenses Wages Purchases Depreciation – Buildings Statement of Financial Position (Extract) Cost Acc Dep Non-Current Asset Buildings 260,000 55,200 67,000 149,400 5,200 NBV 204,800 Adjustment 16 – Goods Supplied Free of Charge Inventory on hand 31st December 20X4 was valued at RWF33,670, which included at RWF290 were goods supplied free of charge by a supplier as a means of promoting a new product. The normal purchase price of these will be RWF400 and they are expected to retail at RWF500. Solution to Adjustment 16 Closing Inventory Less Goods supplied free of charge 33,670 (290) 33,380 It is not appropriate to include a cost of RWF290 for goods which we have received free of charge. Remember our valuation rule set out in IAS 2 is the lower of cost and net realisable value. Our cost in this situation is zero. Adjustment 17 – Revaluation of Land Trial Balance (Extract) at 31.12.20X4 RWF 250,000 Land – Cost Revaluation Reserve RWF 50,000 Additional Information: Surveyors Armitage & Co have provided a valuation of land of RWF400,000. Solution to Adjustment 17 Accounting Entries to be passed are: DR Land CR Revaluation Reserve 150,000 150,000 To record the increase in valuation of Land Page 269 B. PREPARATION OF LIMITED COMPANY ACCOUNTS To prepare the Statement of Comprehensive Income and Statement of Financial Position of a limited company the following steps should be followed: Step 1 Extract a trial balance from the nominal ledger. In the Formation Two Accounting Framework examination this is normally given in the question. Step 2 Ascertain the correct closing inventory figure. A closing inventory figure is usually given which requires certain adjustments: (a) Goods sold on a sale or return basis or on approval will have to be included in closing inventory at their cost. (b) Damaged inventory will be shown at the lower of cost and net realisable value. (c) Capital expenditure items incorrectly included in closing inventory. Step 3 The sales figure will need to be adjusted for any or all of the following: (a) Goods on a sale or return basis or on approval, these should be deducted from sales with a corresponding reduction in Trade Receivables. (b) The proceeds from the sale of property, plant and equipment. (c) Value added recoverable tax which should be brought to the value added tax account. Step 4 The opening inventory may be incorrectly stated. This can be dealt with by altering the opening inventory and the opening reserve figures. Step 5 Purchases for operating expenditure may have to be adjusted for: (a) The fact that some of the goods may have been used in the construction of property, plant and equipment, in which case the amount should be excluded from purchases and included in the cost of the property, plant and equipment. (b) It may include items which are of capital nature e.g. purchase of office equipment. Step 6 Wages should be adjusted if they include amounts paid to staff while involved in the construction of a property, plant and equipment. Step 7 Account for bad debts, the bad debt provision, the discount allowed provision and Trade Receivables. Step 8 Provide for depreciation as instructed in the question and calculate any profit/loss on disposal of property, plant and equipment. Page 270 Step 9 Account for accruals and prepayments including any interest accrual. Step 10 Provide for proposed final dividends. Step 11 Prepare a Statement of Comprehensive Income account. Step 12 Prepare a Statement of Financial Position. C. SAMPLE QUESTION/SOLUTION The following trial balance was extracted from the books of ABC Ltd, at the close of business on 31st December 20X4. DEBIT CREDIT RWF RWF Buildings 160,000 Plant and Machinery 75,000 Vehicles 52,000 Revenue Reserves 85,370 Ordinary Share RWF0.50 each 60,000 8% Preference Share Capital 10,000 Share Premium Account 10,000 10% Debentures 10,000 Provision for Depreciation: Buildings 20,000 Plant and Machinery 45,000 Vehicles 28,550 Inventory 27,500 Purchases/Sales 165,00 315,800 Trade Receivables/Payables 17,960 10,510 Returns 780 870 Discounts 2,300 3,200 Provision for Doubtful Debts 760 Bank 1,760 Ordinary Dividends 800 Preference Dividends 800 Rent and Rates 13,800 Postage and Stationery 3,200 Wages and Salaries 76,800 Bad Debts 2,360 600,060 600,060 The following additional information is available: 1. Inventory on hands at 31st December 20X4:RWF32,350. Page 271 2. Included in sales is an amount of RWF1,500 for goods sent on approval to a customer. On 10th January 20X5 the customer decided to accept part of the goods paying RWF1,000, and returning the balance. The mark up on the goods was 50%. 3. A customer has been declared bankrupt owing RWF460. This is to be written off. 4. It has been declared that a 2% provision for discounts allowed should be made. 5. The provision for doubtful debts should be 5% of Trade Receivables. 6. The annual charge for rates is RWF6,000 and these are paid up to 30th September 20X5. 7. Wages includes RWF3,650 for materials used on the construction of a warehouse extension. 8. Depreciation is provided on assets held at the Statement of Financial Position date as follows: (a) Buildings: 2% on cost (b) Plant and Machinery: (c) Vehicles: 20% on cost 25% reducing balance method. 9. It is proposed to pay a final dividend on the ordinary shares of RWF0.015 per share. 10. Included in the sales figure is an amount of RWF5,500 which was the proceeds from the disposal of a van purchased in 20X1 for RWF16,000. Requirement: Prepare for internal use a Statement of Comprehensive Income account for the year ending 31st December 20X4 and a Statement of Financial Position as at that date. Solutions – Workings RWF 1. 2. 3. 4. Closing Inventory Per Trial Balance Plus Goods on Approval 32,350 1,000 33,350 Sales Per Trial Balance Less Goods on Approval Less Sale Proceeds on Disposal of Van Purchases Per Trial Balance Less Goods used on Construction of Warehouse Extension Wages and Salaries Per Trial Balance Less Wages Paid on Construction of Warehouse Extension Page 272 315,800 (1,500) (5,500) 308,800 165,000 (3,650) 161,350 76,800 (4,350) 72,450 5. Bad Debts Etc (a) Trade Receivables Less Bad Debt 17,960 (460) 17,500 (1,500) 16,000 Less Goods on Approval (b) Provision at 5% Less Opening Provision Increase (c) Trade Receivables Less Provision 800 (760) 40 16,000 (800) 15,200 Discount Allowed provision @ 2% 6. Depreciation (a) Buildings: (b) Plant: (c) 304 RWF160,000 + RWF3,650 RWF168,000 @ 2% = RWF4,350 = RWF75,000 x 20% = RWF3,360 RWF15,000 Cost Motor Vehicles Disposal + RWF 52,000 Acc Depn RWF 28,550 (16,000) 36,000 (9,250) 19,300 Book Value RWF 23,450 (6,750) 16,700 @ 25% = RWF4,175 Van Disposal Account RWF 16,000 Cost Sale Proceeds Accumulated Depreciation Loss on Sale 16,000 RWF 5,500 9,250 1,250 16,000 Accumulated Depreciation: Cost DEPN 20X1 -25% DEPN 20X2 -25% DEPN 20X3 -25% RWF 16,000 (4,000) 12,000 (3,000) 9,000 2,250 6,750 Page 273 Acc Depn 4,000 7,000 9,250 7. Accruals and Prepayments (a) Debenture Interest RWF10,000 x 10% = (b) RWF1,000 Rent and Rates RWF 13,800 1,500 15,300 Per Trial Balance Add Accrual RWF6,000 x 3/12 ABC Ltd. Statement of Comprehensive Income Account for the year ending 31st December 20X4 RWF RWF Sales Less Returns Cost of Sales Inventory 1/1/20X4 Purchases Less Returns RWF 308,800 780 308,020 27,500 161,350 870 Less Inventory 31/12/20X4 Cost of Sales Gross Profit Discounts Received 160,480 187,980 33,350 154,630 153,390 3,200 156,590 Discounts Allowed Rent and Rates Post and Stationery Wages and Salaries Bad Debts Provision for Bad Debts Provision for Discounts Loss on Sale of Van Depreciation: Buildings Plant and Machinery Vehicles Debenture Interest Net Profit 2,300 15,300 3,200 72,450 2,820 40 304 1,250 3,360 15,000 4,175 1,000 Movement on Reserves: Net Profit Less Ordinary Dividends Paid Less Preference Dividends Due Retained for Year Balance Brought Forward Balance Carried Forward 121,199 35,391 35,391 800 800 Page 274 (1,600) 33,791 85,370 119,161 ABC Ltd. Statement of Financial Position as at 31st December 20X4 Cost Acc Depn RWF RWF Non-Current Assets Buildings 168,000 23,360 Plant and Machinery 75,000 60,000 Vehicles 36,000 23,475 279,000 106,835 Current Assets Inventories 33,350 Trade Receivables 16,000 Less: Provisions Bad Debts 800 Discounts 304 14,896 Cash and Cash Equivalents 1,760 NBV RWF 144,640 15,000 12,525 172,165 50,006 222,171 Equity and Liabilities Ordinary Share Capital Preference Share Capital Share Premium Account Revenue Reserves 60,000 10,000 10,000 119,161 Non-Current Liabilities 10% Debentures 199,161 10,000 Current Liabilities Trade Payables Rent Debenture Interest 10,510 1,500 1,000 13,010 222,171 Page 275 D. QUESTIONS/SOLUTIONS Question - TDR Ltd The following trial balance was extracted from the books of TDR Ltd as at 31st December 20X4. Buildings Office equipment Vehicles Revenue Reserves Ordinary shares 8% Redeemable Preference Share Capital Share Premium account 10% Debentures Provision for depreciation: Buildings Office equipment Vehicles Inventory Purchases/Sales Trade Receivables/Payables VAT Returns Discounts Provision for doubtful debts Bank Ordinary dividends Preference dividends Bad Debts Rent and rates Postage and stationary Wages and salaries Motor expenses DEBIT RWF 140,00 0 25,000 32,000 CREDIT RWF 35,270 40,000 10,000 10,000 20,000 30,000 15,000 8,500 31,700 135,60 0 20,400 690 3,200 1,760 400 400 900 13,800 3,200 56,800 2,760 468,61 0 283,700 11,220 1,100 960 2,300 560 468,610 The following additional information is available: 1. Inventory on hand at 31stDecember 20X4: RWF35,170, which included the following: (a) A printer for the sales office. This was purchased for RWF400 in May 20X4. The invoice had been posted to purchases. (b) Inventory costing and included at RWF200 (selling price RWF280). This was damaged on 15th November 20X4 while being moved in the stores. It will cost RWF60 to repair this item and then it will be sold for RWF250. (c) Also included at RWF320 were goods supplied free of charge by a supplier as a means of promoting a new product. The normal purchase price of these will be Page 276 RWF450 and they are expected to retail for RWF630 2. Inventory on hand at 1st January 20X4 had been overstated by RWF4,000 due to a clerical error. 3. A customer has been declared bankrupt owing RWF400. This is to be written off. 4. It has been decided that a 1% provision for discounts allowed should be made. 5. The provision for doubtful debts should be 2% of Trade Receivables. 6. The annual charge for rates is RWF6,000 and these are paid up to 30th September 20X4. 7. During November 20X4 water from a burst pipe destroyed inventory which had cost RWF2,000. Only half of this amount will be recovered from the insurance company. 8. Depreciation is provided on assets held at Statement of Financial Position date as follows: (a) Buildings: 2% on cost (b) Plant & machinery: 20% on cost (c) Vehicles: 25% Reducing Balance Method REQUIREMENT: Prepare for internal use, a draft Statement of Comprehensive Income account for the year ending 31st December 20X4 and a draft Statement of Financial Position as at that date. Solution 1. Closing Inventory Per Question Less Printer Less Damaged Inventory Cost Add Damaged Inventory Net Realisable Value (250-60) Less Goods Supplied Free RWF 35,170 (400) (200) 190 (320) 34,440 2 Opening Inventory This was overstated by RWF4,000, reduce opening inventory and reduce opening Revenue Reserves. 3. Purchases Per Trial Balance Less Printer Less Inventory Destroyed 4. 135,600 (400) (2,000) 133,200 Bad Debts etc (a) Trade Receivables per Trial Balance Bad Debts (b) Provision RWF20,000 @ 2% 20,400 (400) 20,000 400 Page 277 Less Opening Provision Decrease (c) 560 160 Provision for Discount Allowed Trade Receivables Less Bad Debt Provision 20,000 (400) 19,600 RWF19,600 x 1% = RWF196 5. Depreciation Buildings Plant Motors 6. 7. 2,800 5,080 5,875 Loss on Destroyed Inventory Cost of Inventory Less Insurance Debtor Loss Accruals and Prepayments (a) Debenture Interest: (b) 8. RWF140,000 @ 2% = RWF25,000 + 400 = @ 20% RWF32,000 – 8,500 = @ 25% 2,000 (1,000) 1,000 RWF20,000 x 10% = Rent and Rates per Trial Balance Add Accrual RWF6,000 x 3/12 Dividends Preference RWF10,000 x 8% Page 278 2,000 13,800 1,500 15,300 = RWF800 – paid RWF400 400 TDRs Ltd Statement of Comprehensive Income Account for the year ending 31st 20X4 RWF RWF RWF Sales 283,700 Less Returns 690 283,010 Cost of Sales Inventory 1/1/20X4 27,000 Purchases 133,200 Less Returns 960 132,240 159,940 Inventory 31/12/20X4 34,440 Cost of Sales 125,500 Gross Profit 157,510 Discounts Received 2,300 Provision for Bad Debts 160 159,970 Loss on Destroyed Inventory 1,000 Discounts Allowed 3,200 Rent and Rates 15,300 Post and Stationery 3,200 Wages and Salaries 56,800 Bad Debts (900 + 400) 1,300 Motor Expenses 2,760 Provision for Discounts 196 Depreciation: Buildings 2,800 Plant and Machinery 5,080 Vehicles 5,875 Debenture Interest 2,000 Preference Dividend 800 (100,311) 59,659 Movement on Reserves Profit Before Tax 59,659 Less Ordinary Dividends Ordinary Paid (400) 59,259 Balance Brought Forward 31,270 Balance Carried Forward 90,529 Page 279 TDR Ltd Statement of Financial Position as at 31st December 20X4 Cost Acc Depn RWF RWF Non-Current Assets Buildings 140,000 32,800 Plant and Machinery 25,400 20,080 Vehicles 32,000 14,375 197,400 67,255 Current Assets Inventories 34,440 Trade Receivables 20,000 Provision: Bad Debts (400) Discounts (196) 19,404 Insurance Due 1,000 Cash and Cash Equivalents 1,760 Equity and Liabilities Ordinary Shares Share Premium Revenue Reserves NBV RWF 107,200 5,320 17,625 130,145 56,604 186,749 40,000 10,000 90,529 140,529 Non-Current Liabilities 10% Debentures 8% Redeemable Preference Shares 20,000 10,000 Current Liabilities Payables Dividends Due Interest VAT Rates 11,220 400 2,000 1,100 1,500 Page 280 16,220 186,749 Question - HWNHWN Company Limited The following list of balances was extracted from the books of the HWN Co. Ltd at 31st December 20X4: RWF RWF1 Ordinary Shares 8% Redeemable Preference Shares 7% Debentures General Reserve Land at Cost Plant and Machinery at Cost Undistributed profit at 1 January 20X4 Share Premium Account Inventory at 1 January 20X4 Sales Discount Allowed and Received Trade Receivables and Payables Provision for depreciation – Plant and Machinery at 1 January 20X4 Bank Carriage Inwards Purchases Suspense Account Wages Lighting and Heating Office Salaries Debenture Interest Directors Fees Interim Dividends: Ordinary (5%) Preference (4%) Provision for Doubtful Debts General Expenses RWF 150,000 50,000 100,000 65,000 111,000 382,000 35,000 20,000 35,000 3,200 48,000 290,000 4,600 27,000 85,500 7,500 1,100 165,000 400 23,500 2,900 8,600 7,000 12,800 7,500 2,000 1,500 11,900 RWF829, 000 RWF829, 000 Inspection of the books and records of the company yields the following additional information: (a) On 31 December 20X4 the company issued bonus shares to the ordinary shareholders on a 1 for 10 basis. No entry relating to this has yet been made in the books. (b) The authorised share capital of the company is 200,000 RWF1 ordinary shares and 50,000 8% RWF1 irredeemable preference shares. (c) Inventory at 31 December 20X4 was valued at RWF41,000. (d) The suspense account (RWF400) relates to cash received for the sale of some machinery on 1 January 20X4. This machinery cost RWF2,000 and the depreciation accumulated thereon amounted to RWF1,500. Page 281 (e) The directors, on the advice of an independent valuer, wish to revalue the land at RWF180,000 thus bringing the value into line with current prices. (f) Wages owing at 31 December 20X4 amount to RWF150. (g) Depreciation is to be provided on plant and machinery at 10% on cost. (h) General expenses (RWF11,900) includes an insurance premium (RWF200) which relates to the period 1 April 20X4 to 31 March 20X5. (i) The provision for doubtful debts is to be reduced to 2½% of Trade Receivables. (j) The directors wish to provide for: (i) A final preference dividend. (ii) A transfer to general reserve of RWF5,000. You are required to prepare, in vertical form, the Statement of Comprehensive Income accounts of the HWN Company Ltd. for the period ended 31 December 20X4 and a Statement of Financial Position as at that date. Solution - HWN Company Limited Notes 1. The bonus share issue of 1/10 x 150,000 shares can be made out of the share premium: i.e. DR Share Premium Account CR Ordinary Share Account RWF15,000 RWF15,000 The issued share capital is now RWF165,000 and the share premium RWF5,000. 2. The sale of the plant and machinery has not yet been entered in the accounts, since the cash received has been debited to cash, but credited to a suspense account. Disposal of Plant and Machinery RWF RWF Plant & Machinery Suspense Account – Sale 400 Account price - Cost of Plant & 2,000 Provision for Depreciation of Machinery sold Plant & Machinery Account 1,500 Loss on Disposal – Statement 100 of Comprehensive Income RWF2,000 RWF2,000 3. Plant and machinery at cost is now RWF382,000 - RWF2,000 sold = RWF380,000. 4. Depreciation for the year on plant and machinery 10% of RWF380,000 = RWF38,000. Accumulated provision for depreciation RWF Per Trial Balance 85,500 Less Depreciation on Plant and Machinery Sold 1,500 Page 282 84,000 38,000 122,000 Add Depreciation for the year 5. RWF 180,000 111,000 69,000 Land and Revalued Amount Land at Cost* (per trial balance) Credit to Revaluation Reserve *The land is not depreciated so there is no net book value to consider. 6. The insurance premium paid includes a prepayment of 3/12 x RWF200 = RWF50, and so general expenses in the Statement of Comprehensive Income will be RWF11,900 RWF50 = RWF11,850. 7. Trade Receivables 48,000 Provision for Doubtful Debts required (2½%) Provision per Trial Balance Reduction in Provision (Credit Statement of Comprehensive Income) 8. 1,200 1,500 300 Since debenture interest (7% of RWF100,000) - RWF7,000 is included in the trial balance in full, this means that it must already have been paid for the year, and accounted for by: DR Debenture Interest CR Cash RWF7,000 RWF7,000 Page 283 HWN Limited Statement of Comprehensive Income Account for the period ended 31st December 20X4 RWF Sales Less: Cost of Sales Opening Inventory Purchases Carriage Inwards RWF RWF 290,000 35,000 165,000 1,100 201,100 41,000 Less Closing Inventory Cost of Sales Gross Profit Provision for Doubtful Debts Discounts Received 160,100 129,900 300 4,600 134,800 Less: Expenses Wages Office Salaries Directors Fee General Lighting Light and Heating Depreciation on Machinery Loss on Sale of Machinery Discounts Allowed Debenture Interest Net Profit Before Tax 23,650 8,600 12,800 11,850 2,900 38,000 100 3,200 7,000 Movement on Reserves: Profit Before Tax Dividends Paid (interim) 5% Ordinary 8% Preference x 6 months Dividends Due General Reserve Transfer 108,100 26,700 26,700 7,500 2,000 Undistributed Profit at 1 January 20X4 Undistributed Profit at 31 December 20X4 Page 284 9,500 2,000 5,000 (16,500) 10,200 35,000 45,200 HWN Limited Statement of Financial Position as at 31 December 20X4 RWF RWF Non-Current Assets Land (at valuation) 180,000 Plant and Machinery (cost) 380,000 Less Depreciation 122,000 258,000 438,000 Current Assets Inventories 41,000 Trade Receivables and Prepayments 46,850 Cash and Cash Equivalents 7,500 93,350 533,350 Equity & Liabilities Called Up and Issued Share Capital 165,000 RWF1 Ordinary Shares 165,000 50,000 8% Irredeemable Preference Shares 50,000 Share Premium 5,000 Revaluation Reserve 69,000 General Reserve (65,000 + 5,000) 70,000 Undistributed Profit 45,200 404,200 Non-Current Liabilities Loan Capital: 7% Debentures 100,000 Current Liabilities Payables and Accruals Dividends Accruals 27,150 2,000 Page 285 27,150 533,350 Question - WKS Ltd WKS Ltd. has an authorised capital of RWF550,000 divided into 400,000 ordinary shares of RWF1 each and 150,000 12% Irredeemable Preference shares of RWF1 each. The following trial balance was extracted from its books on 31/12/20X3. RWF RWF Issued Capital 300,000 Ordinary Shares @ RWF1 each 300,000 50,000 12% Irredeemable Preference Shares @ RWF1 Each 50,000 Freehold Premises (cost RWF250,000) 235,00 0 Delivery Vans (cost RWF57,000) 46,800 Machinery (cost RWF260,000) 200,00 0 Trade Receivables and Payables 40,500 32,000 15% Debentures 80,000 Calls in Arrear 200 Inventory (including stationery RWF200) at 1/1/20X3 47,700 Carriage on Sales 2,600 Salaries and General Expenses 95,000 Advertising 4,000 Carriage on Purchases 1,800 Rent Account 1/1/20X3 100 Rent 5,600 Debenture Interest (for first 3 mths) accrued 3,000 Debenture Interest 3,000 Purchases and Sales 570,00 800,000 0 Provision for Bad Debts 1,100 Stationery 1,500 Discounts 650 Interim Dividend on Preference Shares (1/4 yr) 1,500 Statement of Comprehensive Income Balance 2,000 Bank 19,350 1,271,70 1,271,700 0 The following information and instructions are to be taken into account: 1. Inventory at 31/12/20X3 is valued at RWF45,800 and included stock of stationery RWF300. 2. Provision is to be made for Debenture Interest due. 3. Advertising includes an amount of RWF2,100 which is full payment for an advertising campaign which will not end until 30th April 20X4 and which commenced on 1st May 20X3. 4. Goods with a sales value of RWF1,000 were sent out to a customer during December 20X3 on a “sale or return” basis. These goods had been treated in the books as a credit sale at a mark-up on cost of 25%. Page 286 5. On 1st January 20X3 a Delivery Van, which had cost of RWF4,800, was sold for RWF660 cash. At the date of sale the book value of the van was RWF500. This sale had been treated in the books as a sale of trading inventory. 6. A bad debt of RWF200 written off in 20X0 is now known to be recoverable in full. A further debt of RWF600 is to be written off and the provision for bad debts is to be adjusted to 4% of Trade Receivables. 7. The figure for bank in the trial balance has been taken from the firm’s cash book. However a bank statement dated 31/12/20X3 has subsequently arrived showing a balance of RWF6,700. A comparison of the cash book and bank statement has revealed the following discrepancies: (a) Trade Payables cheques not yet presented for payment RWF800. (b) Rent for 3 months ending 31/12/20X3 paid direct into firm’s bank account RWF1,600. (c) 8. Bank charges RWF50. The directors recommend that: (a) (b) Depreciation be provided for as follows: Machinery 20% of cost Delivery Vans 25% of cost The preference dividend due to be provided for. You are required to prepare a: (a) Statement of Comprehensive Income Account for the year ended 31/12/20X3 (b) Statement of Financial Position at 31/12/20X3. Page 287 Solution Workings: RWF 1. 2. 3. 4. 5. 6. 7. 8. 9. Sales As per Trial Balance Less: Goods on Sale or Return Proceeds from Sale of Van RWF RWF 800,000 1,000 660 (1,660) 798,340 Opening Inventory As per Trial Balance Less: Stationery Inventory 47,700 (200) 47,500 Closing Inventory As given in question Less Stationery Inventory 45,800 (300) 45,500 660 (500) 160 Profit on Sale of Van Proceeds Less: Book Value Rent Receivable: Received as per Trial Balance Add: Paid directly to Bank Account Less: Accrued due at 1/1/X3 Trade Receivables and Provision for Bad Debts Trade Receivables as per Trial Balance Add: Debt previously written off as bad Less: Goods on sale or return Written off as bad Provision for bad debts required: 4% x 39,100 Increase required to reach new provision (1,564 less 1,100) Bad debts written off (RWF600 less RWF200 previously written off and now recoverable Stationery: RWF1,500 Plus Opening Inventory Less Closing Inventory 5,600 1,600 (100) 40,500 200 (1,000) (600) 10. Bank: Page 288 39,100 1,564 464 400 200 (300) Advertising: RWF4,000 less 1/3 of RWF2,100 prepayment Delivery Vans and Depreciation thereof: Delivery Vans: Balance as per Trial Balance Less Disposal Depreciation: 25% x 52,200 7,100 1,400 3,300 57,000 (4,800) 52,200 13,050 Balance as per Trial Balance Add: Rent paid direct into bank Less: Bank Charges 19,350 1,600 (50) 20,900 WKS Limited Statement of Comprehensive Income for the Year Ended 31st December 20X3 RWF Sales Less: Cost of Sales Opening Inventory Purchases Carriage Inwards RWF 798,340 47,500 570,000 1,800 571,800 619,300 (46,300) Closing Inventory Cost of Sales Gross Profit Profit on Sale of Van Rent Receivable 573,000 225,340 160 7,100 232,600 Less: Expenses Salaries and General Expenses Bad Debts Written Off Provision for Bad Debts Stationery Depreciation on Premises Depreciation on Machinery Bank Charges Discount Allowed Debenture Interest Preference Dividend Carriage Outward Advertising Depreciation of Delivery Vans Profit Before Tax 95,000 400 464 1,400 5,000 52,000 50 650 12,000 6,000 2,600 3,300 13,050 Movement on Reserves: Profit Before Tax Balance brought forward Balance carried forward 191,914 40,686 40,686 (2,000) 38,686 Page 289 WKS Limited Statement of Financial Position as at 31st December 20X3 Non-Current Assets Freehold Premises Machinery Delivery Vans Current Assets Inventories (Trade) (Stationery) Trade Receivables and Prepayments Less Provision for Bad Debts Calls in Arrears Cash and Cash Equivalents Equity & Liabilities Share Capital Ordinary RWF1 each Retained Profit Cost Acc Depn RWF NBV RWF 250,000 260,000 52,200 562,200 (20,000) (112,000) (18,950) (150,950) 230,000 148,000 33,250 411,250 46,300 300 39,800 (1,564) Authorised RWF 400,000 46,600 38,236 200 20,900 Issued RWF 300,000 Non-Current Liabilities 15% Debentures 12% Redeemable Preference Shares 105,936 517,186 RWF 300,000 38,686 338,686 80,000 50,000 Current Liabilities Trade Payables Debenture Interest Proposed Dividends 32,000 12,000 4,500 Page 290 48,500 517,186 BLANK Page 291 Study Unit 22 Income and Expenditure Accounts Contents A. Income and Expenditure Accounts Introduction B. Sources of Income C. Expenditure D. Statement of Financial Position E. Question/Solution Page 292 A. INCOME AND EXPENDITURE ACCOUNTS INTRODUCTION Clubs, societies, credit unions and other non-profit organisations do not draw up Statement of Comprehensive Incomes; instead they prepare an INCOME AND EXPENDITURE ACCOUNT. Where income is greater than expenditure the excess is referred to as the surplus of income over expenditure. Where expenditure is greater than income the excess is referred to as the excess of expenditure over income. In the Statement of Financial Position commercial entities describe the net assets as CAPITAL whereas non-profit organisations describe net assets as accumulated funds. B. SOURCES OF INCOME The main sources of income for clubs and societies are: 1. Social events 2. Members subscriptions 3. Life members’ subscriptions 4. Special events e.g. annual dinner evening 5. Investment income 1. Social event - Example The RGT Sports and Social Club have provided you with the following information: RWF 4,552 2,674 Takings Payments for purchases At the start of the year Restaurant and Bar Inventory was And Trade Payables were 190 275 At the year-end Inventory was And Trade Payables were Staff wages 225 324 764 Requirement: Prepare a Statement of Comprehensive Income for the year assuming the steward is entitled to a bonus of 10% of the surplus after charging the bonus. Page 293 Solution Social events Statement of Comprehensive Income for the Year Ended ... RWF RWF Sales 4,552 Opening Inventory Purchases (324 + 2674 - 275) Closing Inventory Cost of Sales Gross Surplus Staff Wages Profit before Bonus Bonus RWF1,100 x 10/110 Surplus 2. 190 2,723 (225) 2,688 1,864 764 1,100 100 RWF 1,000 Members Subscriptions Members of clubs and societies usually pay an annual subscription to the club/society. The income received plus arrears of subscriptions for the current year, less arrears subscriptions for the previous year are treated as income in the income and expenditure account. Subscriptions received in advance are treated as an accrual in the Statement of Financial Position. Example The RGT Sports and Social Club has provided you with the following details in relation to its subscriptions:RWF Members subscriptions received 4,970 Members subscriptions owing at the start of the year 140 Members subscriptions owing at the end of the year 175 Members subscriptions received in respect of the forthcoming year 70 Solution Members Subscription Club Balance b/d Balance c/d Income and Expenditure Account RWF 140 70 4,935 Bank Balance c/d 5,145 Balance b/d 3. 175 RWF 4,970 175 5,145 Balance b/d 70 Life Members’ Subscription Often members of a club/society may pay a life members subscription, this should be recognised in the income and expenditure account over a defined period of time for example 10 years. The residue should be shown in the Statement of Financial Position beneath the accumulated fund. Page 294 Example The RGT Sports and Social Club received RWF12,000 in life members’ subscriptions during the year. It is the accounting policy of the club to amortise life members’ subscriptions to the income and expenditure account over 10 years. In the income and expenditure account RWF1,200 is recognised as income. In the Statement of Financial Position RWF12,000 - RWF1,200 i.e. RWF10,800 is shown beneath the accumulated fund and described as the life members fund account. 4. Special Events It is usual to show the surplus/deficit arising on special events as a separate item of income/expenditure in the income and expenditure account. Example The RGT Sports and Social Club has supplied you with the following information regarding its competitions: RWF Competition receipts 722 Competition prizes 311 Stock of competition prizes at the start of the year 40 Stock of competition prizes at the end of the year 48 Solution The surplus on competitions to be shown in the income and expenditure account is as follows: Income and Expenditure Account for the Year Ended ... Surplus on competitions RWF419 This is calculated as follows: RWF Competition receipts Competition Prizes: Opening Inventory Purchases/Payments Closing Inventory 40 311 (48) 303 419 Surplus 5. RWF 722 Investment Income The investment income accruing for the year should be included in the income and expenditure account. Example The RGT Sports and Social Club has a building society bank deposit account. Interest is credited by the bank to the deposit account on 2 January and 2 July. On 2 July 20X8, RWF25 was credited; RWF27 was credited on 2 January 20X9 and RWF31 on 2 July 20X9. The club’s year end is the 30 June 20X9. Page 295 Solution The investment income to be included in the income and expenditure account for the year ended 30 June 20X9 is RWF27 + RWF31 i.e. RWF58. The amount received on 2 July 20X8 relates to the year ended 30 June 20X8. C. EXPENDITURE The main items of expenditure for clubs and societies are: rent, rates, light and heat, postage and stationery, depreciation of equipment, staff wages and a secretary’s/treasurer’s honorarium. D. STATEMENT OF FINANCIAL POSITION The Statement of Financial Position of a club/society follows the same format as commercial entities. However, the net assets are represented by an accumulated fund rather than capital. E. QUESTION/SOLUTION The treasurer of the OT Social & Sports Club has produced the following receipts and payments account for the year ended 30 June 20X1. RECEIPTS Balance at Bank 1/7/20X0 Credit Union a/c 1/7/20X0 Members subscriptions Entrance fees Bar takings Competition receipts Interest received RWF 229 400 1,824 160 3,175 412 35 Payments Bar purchases Rent Rates Staff wages Electricity & water Competition prizes Postage & stationery Credit Union a/c 30/6/X1 Balance at bank 30/6/X1 6,235 RWF 2,642 600 120 840 435 210 320 835 233 6,235 The assets of the club on 1 July 20X0 were furniture and equipment RWF3,200, prizes RWF50 and bar inventory RWF180. Bar suppliers were owed RWF290. On 30 June 20X1 bar suppliers were owed RWF310; bar inventory amounted to RWF175 and prizes on hand had cost RWF30; subscriptions unpaid totalled RWF50. During the year ended 30 June 20X1 subscriptions received included RWF35 in respect of the previous year and RWF20 in respect of the year beginning 1 July 20X1. The Steward is to receive a bonus of 5% of the restaurant profits after deducting the bonus. Interest on the Credit Union account is credited on 2 January and 2 July each year. On 2 July 20X0 RWF15 was credited; RWF20 was credited on 2 January 20X1 and RWF25 on 2 July 20X1. Page 296 Furniture and equipment should be depreciated by 10%. The rent paid was for the year ending 31 December 20X1. The rent for 20X0 was RWF480. Requirement: (a) A Restaurant trading account for the year ending 30 June 20X1. (b) An income and expenditure account for the year ending 30 June 20X1. (c) A Statement of Financial Position as at 30 June 20X1. Solution Restaurant Trading Account for the Year Ended 30 June 20X1 RWF Sales Opening inventory Purchases (W1) RWF 3,175 180 2,662 2,842 175 Closing inventory Cost of Sales Gross profit Bonus Profit 2,667 508 24 484 OT SOCIAL AND SPORTS CLUB Income and Expenditure Account for the year ended 30 June 20X1 RWF Income Subscriptions (W2) Financial Institution Interest (W3) Entrance fees Surplus on competitions (W4) Restaurant profit RWF 1,819 45 160 182 484 2,690 Expenditure Rent (W5) Rates Staff wages Electricity & water Postage & stationery Depreciation (W6) Surplus 540 120 840 435 320 320 Page 297 2,575 115 Statement of Financial Position as at 30 June 20X1 RWF Non-Current Assets Furniture (3,200 – 320) Current Assets Inventory: bar 175 Prizes 30 Prepayment: Rent Subscription in arrears Credit Union account Interest due Bank Current Liabilities Bar Creditors Subscriptions in advance Bonus due to Steward 310 20 24 Accumulated fund: Balance 1/7/20X0 Surplus for year RWF 2,880 205 300 50 835 25 233 4,528 354 4,174 4,059 115 4,174 Workings 1. Restaurant Trade Payables Bank Balance c/d RWF 2,642 310 2,952 Balance b/d Purchases RWF 290 2,662 2,952 Subscriptions RWF 35 Cash 1,819 Balance c/d 20 1,874 RWF 1,824 50 2. Balance b/d Income and Expenditure Balance c/d Page 298 1,874 Statement of Opening Accumulated Fund RWF 229 400 240 3,200 180 15 50 35 4,349 290 4,059 Bank Credit Union Rent Furniture Bar inventory Interest due Prizes Subs. in arrears Owing 3. Credit Union Interest: RWF20 + 25 = RWF45 4. Surplus on Competitions RWF 412 Competition Receipts Competition Prizes Opening Inventory Purchases 50 21 0 26 0 30 Closing Inventory 230 182 Surplus on Competitions 5. 6. Rent Prepaid at start of Year RWF480 x 6/12 Paid for Year = Prepaid at end of Year RWF600 x 6/12 = RWF 240 600 840 300 540 Depreciation Furniture and Equipment RWF3,200 Depreciation at 10% RWF320 Study Unit 23 Page 299 IAS 7 – Cash Flow Statements Contents A. Cash Management B. Objective of IAS 7 C. Operating Activities D. Investing Activities E. Financing Activities F. Reporting Cash Flows from Operating Activities G. Worked Examples H. Disposal of a Tangible Fixed Asset I. Taxation J. Dividends K. Worked Example Page 300 A. CASH MANAGEMENT Cash management is concerned with maintaining a balance between servicing operating needs (liquidity) and earning maximum returns (profitability). Sound cash management is vital for the survival of a company. A company needs to ensure that it has sufficient working capital to fund the day-to-day operations of the company, while not holding excessive cash balances which have an opportunity costs as these funds could be invested elsewhere to earn a return. Cash management should focus on maximising equity holder return. This can be achieved by maximising the return that can be obtained from investing cash, with the costs associated with not maintaining an appropriate level of liquidity. Cash flows of a company are separately analysed for different stakeholders in a company’s annual report and financial statements. A cash flow statement is regarded as a key measure of performance. It presents information that is not available from the Statement of Comprehensive Income and the Statement of Financial Position. One of the main features of the cash flow statement is that is gives an indication of the relationship between the profitability of an entity and the cash generating ability of that entity. Profitability and cash generating ability are both important but distinct aspects of corporate performance. In addition, the cash flow statement provides information on how an entity has used the cash it has generated. B. OBJECTIVE The objective of IAS 7 is to require an entity to provide information about the historical changes in cash and cash equivalents by means of a cash flow statement. Cash flows are classified into: • Operating Activities • Investing Activities • Financing Activities Cash equivalents are short term highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. C. OPERATING ACTIVITIES The cash flow from operating activities is a key indicator of the extent to which the operations of the entity has generated cash to: • Repay loans • Maintain the operating capability • Pay dividends • Make new investments Without using external sources of finance. Page 301 Examples of Cash Flows from Operating Activities (a) Cash receipts from sale of goods and the rendering of services. (b) Cash payments to suppliers. (c) Cash payments to employees. (d) Cash payments/refunds of income tax. D. INVESTING ACTIVITIES It is important to disclose the cash flows from investing activities because these represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. Examples of Cash Flows from Investing Activities (a) Cash payments to acquire property, plant and equipment and intangibles. (b) Cash receipts from sales of property, plant and equipment and intangibles. (c) Cash payments to acquire an investment in shares or loans in other entities. (d) Cash receipts from sale of investments (e) Cash advances and loans made to other parties (non-financial institutions) (f) Cash receipts from the repayment of advances and loans made to other parties (again non-financial institutions) E. FINANCING ACTIVITIES The disclosure of cash flows arising from financing activities is useful in predicting claims on future cash flows by providers of capital. Examples of Cash Flows from Financing Activities (a) Cash proceeds from issuing shares. (b) Cash payments to owners to buy back shares. (c) Cash proceeds from issuing debentures and loans. (d) Cash repayments of amounts borrowed. F. REPORTING CASH FLOWS FROM OPERATING ACTIVITIES The reporting of cash flows from operating activities can be either by: (a) The Direct Method, whereby major classes of gross cash receipts and gross cash payments and cash receipts from customers, and cash payments to suppliers are disclosed OR (b) The Indirect Method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature and the accrual or deferral of past or future operating cash receipts Page 302 or payments e.g. profit adjusted for depreciation and any increase in trade payables and accruals. The standard encourages the use of the direct method as it provides information which may be useful in estimating future cash flows. Interest and Dividends Cash flows from interest and dividends received and paid should each be disclosed separately. IAS 7 does not specify the classification of these under operating, investing or financing activities. However, each should be classified in a consistent manner. Taxes on Income Cash flows from taxes on income should be separately disclosed and classified under operating activities unless they can be specifically identified with financing and investing activities. Page 303 Indirect Method Cash Flow Statement RWFm 3,450 Cash Flow from Operating Activities Profit before taxation Adjustments for: Depreciation Investment Income Interest Expense RWFm 470 (400) 350 3,870 (600) (1,120) 400 2,550 (270) (900) Increase in Trade Receivables Increase in Inventory Increase in Trade Payables Cash Generated from Operations Interest Paid Income Tax Paid Net Cash from Operating Activities 1,380 Cash Flow from Investing Activities Purchase of Property, Plant and Equipment Proceeds from Sale of Plant and Equipment Interest Received Dividends Received Net Cash Used in Investing Activities (900) 20 200 200 Cash Flow from Financing Activities Proceeds from Issue of Shares Proceeds from Long Term Borrowing Dividend Paid Net Cash Used in Financing Activities 250 160 (1,200) (480) (790) Net Increase in Cash and Cash Equivalents Cash and Cash Equivalents at Start of Year Cash and Cash Equivalents at End of Year 110 120 230 Direct Method Cash Flow Statement RWFm 30,150 (27,600) 2,550 (270) (900) Cash Flow from Financing Activities Cash Received from Customers Cash Paid to Suppliers and Employees Cash Generated from Operations Interest Paid Income Taxes Paid Net Cash Flow Operating Activities RWFm 1,380 The remainder of the cash flow statement is the same as the indirect method. Page 304 G. WORKED EXAMPLES A cash flow statement essentially links together the opening Statement of Financial Position, the Statement of Comprehensive Income and the closing Statement of Financial Position. Example 1 Z Ltd’s opening Statement of Financial Position had cash of RWF60,000 and ordinary shares of RWF60,000. Its trading activities for the year ended 31 December 20X4 are as follows: RWF Cash Sales Cash Purchases Closing Inventory Cost of Sales Gross Profit Cash Expenses Profit RWF 100,000 70,000 Nil (70,000) 30,000 (12,000) 18,000 The Statement of Financial Positions at the year end and at the start of the year are set out below: Non-Current Assets Cash (60 + 18) Shareholders’ Equity Ordinary Shares Retained Earnings Year End RWF’000 Nil 78 78 Start RWF’000 Nil 60 60 60 18 78 60 60 CASH FLOW STATEMENT - INDIRECT METHOD Profit Adjusted for depreciation and changes in inventory etc. Net cash from operating activities Net increase in cash Cash at Start of Year Cash at End of Year RWF 18,000 Nil 18,000 18,000 60,000 78,000 Cash Flow Statement – Direct Method Cash received from customers Cash paid to suppliers Cash paid to employers and other cash payments Net Cash from operating activities Net increase in Cash Cash at Start of Year Cash at End of Year Page 305 RWF 100,000 (70,000) (12,000) 18,000 18,000 60,000 78,000 Example 2 In the year ended 31 December 20X3, Z Ltd borrowed RWF40,000 on a long-term basis. It bought equipment for RWF20,000. Its trading activities for the year ended 31 December 20X3 are as follows: RWF RWF Cash sales 130,000 Cash purchases 90,00 0 Closing Inventory Nil Cost of sales (90,000) Gross profit 40,000 Cash expenses (14,000) Depreciation (5,000) 21,000 Interest paid 2,000 Profit before Taxation 19,000 The opening and closing Statement of Financial Positions are set out below:Statement of Financial Position Year End Start RWF RWF ’000 ’000 Non-Current Assets (20 – 5) 15 Nil Cash* 122 78 137 78 Liabilities Loan 40 40 Shareholders’ Equity Ordinary Shares 60 60 Retained Earnings 37 18 97 78 Total Liabilities and Equity 137 78 RWF ’000 78 130 (90) (14) 40 (2) (20) 122 *Cash at start Cash sales Cash purchases Cash expenses Loan Interest Paid Non-Current Asset Page 306 Cash Flow Statement – Indirect Method RWF 19,000 Cash Flows from Operating Activities Profit before Taxation Adjustments for: Depreciation Interest Expense Cash Generated from Operations Interest Paid Net Cash from Operating Activities RWF 5,000 2,000 26,000 (2,000) 24,000 Cash Flows from Investing Activities Purchase of Equipment Net Cash used in Investing Activities Cash Flows from Financing Activities Proceeds from Loan (20,000) (20,000) 40,00 0 Net Cash from Financing Activities 40,000 Net Increase in Cash Cash and Cash equivalents at Start of Year Cash and cash equivalents at End of Year 44,000 78,000 122,000 Cash Flow Statement – Direct Method Cash Received from Customers Cash Paid to Suppliers Cash Paid to Employees and Other Cash Payments Interest Paid Net Cash Inflow from Operating Activities RWF’ 000 130 (90) (14) (2) 24 Investing and Financing Activities as above. Example 3 In the year ended 31 December 20X3 Z Ltd had the following trading activities: RWF’000 RWF’000 Sales 175 Opening Inventory Nil Purchases 116 Closing Inventory (25) Cost of Sales (91) Gross Profit 84 Cash Expenses (22) Depreciation (5) Operating Profit 57 Interest Paid (4) Profit before Taxation 53 Income Tax Paid (14) Profit after Taxation 39 Page 307 The opening and closing Statement of Financial Positions are as follows: Statement of Financial Position Year End Start RWF’ RWF 000 ’000 Non-Current Assets 10 15 Inventory 25 Receivables 18 Bank* 139 122 182 122 Total Assets 192 137 Liabilities Trade Payables 16 Tax Payable 16 Loan 40 40 Total Liabilities 56 40 Shareholders’ Equity Ordinary Shares 60 60 Retained Earnings 76 37 Total Shareholders’ Equity 136 97 Total Liabilities and Shareholders’ Equity 192 137 *Bank at Start Received from Customers (175 – 18) Paid to Suppliers (116 – 16) Cash Expenses Interest Paid Tax Paid 122 157 (100) (22) (4) (14) 139 Page 308 Cash Flow Statement – Indirect Method RWF Cash Flows from Operating Activities ’000 Profit before Taxation 53 Adjustments for: Depreciation 5 Interest Expense 4 62 Increase in Inventory (25) Increase in Trade Receivables (18) Increase in Trade Payables 16 Cash Generated from Operations Interest Paid Income Tax Paid Net Cash from Operating Activities RWF ’000 35 (4) (14) 17 - Cash Flows from Investing Activities Cash Flows from Financing Activities Net Increase in Cash Cash at Start of Year Cash at End of Year Cash Flow Statement – Direct Method Cash Flows from Operating Activities Cash Receipts from Customers (175 – 18) Cash Paid to Suppliers (116 – 16) Cash Paid to Employees and Other Cash Payments Interest Paid Income Tax Paid Net Cash from Operating Activities 17 122 139 RWF ’000 157 (100) (22) (4) (14) Example 4 In the year ended 31st December 20X4 Z Ltd had the following trading activities: RWF’000 Sales Opening Inventory 25 Purchases 127 Closing Inventory (34) Cost of Sales Gross Profit Cash Expenses Depreciation Operating Profit Interest Expense Profit before Taxation Income Tax Profit after Taxation Dividend Paid Retained for Year Page 309 RWF ’000 17 RWF’000 220 (118) 102 (28) (5) 69 (4) 65 (22) 43 (10) 33 The opening and closing Statement of Financial Positions are as follows: Statement of Financial Position Year End Start RWF’000 RWF’000 Non-Current Assets 5 10 Inventory 34 25 Trade Receivable 23 18 Bank 186 153 243 196 Total Assets 258 206 Liabilities Trade Payables Interest Accrued Income Tax Payable Loan Total Liabilities Shareholders’ Equity Ordinary Shares Retained Earnings Total Liabilities and Shareholders’ Equity CASH FLOW STATEMENT – INDIRECT METHOD Cash Flows from Operating Activities Profit before Taxation Adjustments for: Depreciation Interest Expense Increase in Inventory Increase in Trade Receivable Increase in Trade Payable Cash Generated from Operations Interest Paid (4 – 2) Income Tax Paid Net Cash from Operating Activities 25 2 22 49 30 79 16 14 30 40 70 60 109 169 248 60 76 136 206 RWF’000 65 RWF’000 5 4 74 (9) (5) 9 69 (2) (14) 53 - Cash Flow from Investing Activities Cash Flow from Financing Activities Loan Repaid Dividend Paid Net Cash Used in financing Activities Net Increase in Cash Cash and Cash Equivalents at Start of Year Cash and Cash Equivalents at End of Year Page 310 (10) (10) (20) 33 153 186 H. DISPOSAL OF A TANGIBLE NET ASSET The disposal of a tangible net asset has two implications for a cash flow statement: (i) Adjust the profit before taxation for any profit or loss on disposal, if a loss, add to profit before taxation and if a profit deduct from profit before taxation and (ii) The sale proceeds will be included under the heading “investing activities”. Example Plant Yr 1 RWF’000 1,000 400 - cost - depreciation Yr 2 RWF’000 800 480 During the year plant costing RWF200,000 which had been depreciated by RWF120,000 was sold for RWF90,000. The depreciation charge and profit/loss on disposal can be ascertained using 'T' accounts: Disposal Balance c/f Plant – cost Profit on disposal (bal. figure) Plant – Depreciation RWF000 Balances b/f 120 Statement of Comprehensive Income (bal. Figure) 480 600 PLANT – DISPOSAL RWF000 200 Plant – depreciation 10 Bank 210 RWF000 400 200 600 RWF000 120 90 210 Cash Flow Statement (Extracts) Cash Flows from Operating Activities RWF ’000 X Profit before Taxation Adjustments for: Depreciation Profit on Disposal of Plant 200 (10) Cash Flow from Investing Activities Proceeds from Sale of Plant 90 Page 311 I. TAXATION The taxation paid figure in the cash flow statement is calculated as follows: Balance b/d ∴Bank tax paid J. Taxation Account RWF000 135 Balance b/d 120 Statement of Comprehensive Income 255 RWF000 120 135 255 DIVIDENDS The dividends paid figure in the cash flow statement is calculated in a similar fashion to the taxation paid: Balance c/d ∴Bank Dividend paid Dividend Account RWF000 100 Balance b/d 80 Statement of Comprehensive Income 180 RWF000 80 100 180 K. WORKED EXAMPLE The financial statements of E Ltd are set out below: E Ltd Statement of Comprehensive Income For The Year Ended 31 December Year 2 RWF000 2,553 1,814 739 125 264 350 25 75 300 140 160 100 60 Sales Cost of sales Gross profit Distribution costs Administrative expenses Operating profit Interest received Interest paid Profit before taxation Taxation Profit after taxation Dividends Retained profit for the year Page 312 Statement of Financial Positions As At 31 December Non-Current Assets Tangible Intangible Investments Current Assets Inventory Trade receivables Investments Cash in hand Total Assets Shareholders’Equity Share Capital Share Premium Retained Earnings Non-Current Liabilities Current Liabilities Trade Payables Bank Overdraft Income Tax Payable Dividend Payable Total Liabilities and Shareholders’Equity Yr 2 RWF000 Yr 1 RWF000 380 250 630 305 200 25 530 150 390 50 2 592 1222 102 315 1 418 948 200 160 260 620 100 520 150 150 200 500 500 127 85 190 100 1,222 119 89 160 80 948 Notes: (1) Non-current asset investments were sold in Yr 2 for RWF30,000. (2) Non-current assets (cost RWF85,000, net book value RWF45,000) were sold for RWF32,000 in Yr 2. (3) The following information relates to the fixed assets: 31.12.Yr 2 RWF000 720 340 380 Cost Depreciation Net book value 31.12.Yr 1 RWF000 595 290 305 (4) 50,000 ordinary RWF1 shares were issued at a premium of RWF0.2 per share during Yr 2. (5) The current asset investments are readily disposable. Page 313 Required: Prepare a cash flow statement for the year ended 31 December Yr 2 using the indirect method to comply with the provisions of IAS 7 Cash Flow Statements. E Ltd Cash Flow Statement for the Year Ended 31 December Year 2 RWF ’000 300 Cash Flows from Operating Activities Profit before Taxation Adjustments for: Interest Paid Interest Received Depreciation Profit on Disposal of Investment Loss on Disposal RWF’ 000 75 (25) 90 (5) 13 448 (48) (75) 8 333 (75) (110) Increase in Inventory Increase in Trade Receivables Increase in Trade Payables Cash Generated from Operations Interest Paid Income Tax Paid Net Cash from Operating Activities 148 Cash Flows from Investing Activities Payments for Tangible Non-Current Assets Payments for Intangible Assets Proceeds from Disposal of Tangibles Proceeds from Disposal of Investments Interest Received Net Cash Used in Investing Activities Cash Flows from Financing Activities Proceeds from Issue of Shares Proceeds from Long-Term Loan Dividend Paid Net Cash from Financing Activities Net Increase for Cash and Cash Equivalents Cash and Cash Equivalents at Start of Year (89 – 1) Cash and Cash Equivalents at End of Year Cash and Cash Equivalents at End of Year Investments Cash Bank Overdraft Page 314 (210) (50) 32 30 25 (173) 60 100 (80) 80 55 (88) (33) 50 2 (85) (33) Workings 1. Non-Current Assets Opening Additions RWF’000 595 210 805 Closing Disposal RWF’000 720 85 805 Accumulated Depreciation Closing Disposal RWF’000 340 40 380 Opening Depreciation RWF’000 290 90 380 Disposal Cost RWF’000 85 Accumulated Depreciation Bank Loss 85 RWF’000 40 32 13 85 2. Income Tax Closing Bank RWF’000 190 110 Opening Statement of Comprehensive Income 300 RWF’000 160 140 300 3. Dividends Closing Bank RWF’000 100 80 180 Page 315 Opening Statement of Comprehensive Income RWF’000 80 100 180 Study Unit 24 Ratio Analysis and Interpretation of Financial Statements Contents A. General B. Ratios on Return on Capital C. Ratios of Profitability D. Ratios of Activity E. Ratios of Liquidity F. Ratios of Gearing (Leverage) G. Limitations of Ratio Analysis H. Summary I. Checklist Page 316 A. GENERAL Accounting ratios provide a useful basis on which to review a company's performance from its accounts. The essence of the approach is to measure company performance by a criterion, which takes account of the profit generated by the company, and the resources utilised to generate that profit. This criterion is called return on capital which is referred to as the primary ratio. In essence, it is the return, which the shareholders earn for every RWF1 invested by them in the company for the time being. The ratio is compared from one period to the next. In order to establish the reasons for changes in the ratio i.e. improvement or deterioration in return on capital, the ratio is broken down into its component elements. The component elements are also ratios and are referred to as secondary ratios. The relationship between the primary ratio, return on capital, and the secondary ratios of which it is composed can be seen from the following ratio pyramid. Ratio on Return on Capital Ratios on Profitability Ratios on Activity Ratios on Gearing The mathematical relationship can be simply expressed as can be seen from the following: Profitability Profit Sales x Activity Sales x Total Assets x Gearing Total Assets x Capital Employed x Capital Employed Shareholders’ Funds A movement in any one of these four components will affect the return on shareholders’ funds. A fall in any one of the ratios will yield a lower return on shareholders’ funds. Correspondingly if any one of the ratios increases, there will be an increase in return to the shareholders. In addition to the categories of ratios referred to above, there are also ratios of liquidity which are used to gauge the solvency of the enterprise. Ratios, therefore, come under the following headings: • Ratios of Return on Capital • Ratios of Profitability • Ratios of Activity • Ratios of Gearing • Ratios of Liquidity Page 317 B. RATIOS ON RETURN ON CAPITAL The ratio that the shareholders are concerned with is: Net Profit Before Taxation Average Shareholders’ Funds Average shareholders’ funds would be the average amounts of the shareholders’ funds during the year, usually a simple average of the amounts shown by the opening and closing Statement of Financial Positions. This is the return to the shareholders, which is derived by the business. Another way of measuring return on capital is: Net Profit Before Interest and Taxation Average Capital Employed Average capital employed is again the average of the opening and the closing Statement of Financial Positions figures for capital employed. Capital employed, however, includes both shareholders’ funds and long-term liabilities. This ratio shows the average return generated by the company on all long term capital used by it. As such, it is of less significance to the shareholder. It is useful to management in assessing the overall performance of the company in utilising all of its long-term capital. C. RATIOS ON PROFITABILITY These ratios measure the profitability of the company's sales. They state the average amount of profit or the amount of specific expenses included per RWF1 of sales by the company. The following are the ratios commonly computed and their interrelationship. Ratios of Profitability - commonly computed (a) Cost of goods sold to Sales (Key ratio) (b) Net profit to Sales (c) Production materials to Sales (d) Direct Labour to Sales (e) Overhead costs to Sales (Key ratio) Page 318 Ratios of Profitability - Inter-relationship Trading Profit Sales Gross Profit Sales Administration Expenses Sales Selling Expenses Sales Individual Expenses Sales Individual Expenses Sales Raw Materials Costs Sales Labour Costs Sales Overhead Costs Sales Gross Profit to Sales This ratio is invariable expressed as a percentage. It reveals the gross profit as a percentage of the sales value. The figure obtained should be uniform for all firms in the same industry whether they are the largest or the smallest. Any significant deviation or change in the ratio may be due to: (i) Manipulation of Inventory, purchase or sales figures (ii) Changes in price policy (iii) Changes in the purchases or sales mix (iv) Changes in the cost of raw materials without a corresponding change in sales prices Businesses with a faster Inventory turnover usually have a low gross profit margin e.g. a supermarket. On the other hand the lower the Inventory turnover the higher the gross profit margin e.g. a furniture retailer. Net Profit to Sales The profit margin indicates the extent to which the business is protected against potential losses arising from increased costs or falling prices. A low ratio indicates that a firm's selling prices are too low or that its costs are too high or both. However, the ratio may be lowered by a high charge for depreciation on Non-Current Assets and raised by a low charge for depreciation. Page 319 Profit Margin on Sales Profit Before Interest and Taxation Sales Production Materials to Sales Production Materials Costs Sales Direct Labour to Sales Direct Labour Sales Other ratios, which may prove useful in the analysis of Operating Statements, include administration/sales, showing the percentage of administrative costs to sales; selling and distribution costs/sales showing the percentage of sales costs to sales. Care should be taken with the latter ratio, as high selling and distributive costs may be incurred in a new product launch. Questions prompted by the use of Profitability Ratios: (a) Manipulation of Inventories, purchases and sales figures (b) Changes in product mix (c) Changes in pricing policy (d) Changes in costs of raw materials (e) The velocity of Inventory turnover (f) The incidence of costs including depreciation in earning profits (g) The margin of safety (h) The proportions of materials, direct labour, administrative cost to sales D. RATIOS OF ACTIVITY Ratios of activity measure the extent of use made of the assets of the company measured in terms of turnover generated per RWF1 of asset used. Turnover is related to total assets and to each category of asset individually to establish by comparison from year to year if the efficiency of usage of any asset is declining. The following is the inter-relationship between the ratios: - Page 320 Sales Total Assets Sales Non-Current Assets Sales Plant Sales Current Assets Sales Premises Sales Inventory Sales Trade Receivables Sales Raw Materials Sales Work-in-Progress Sales Finished Goods The following should be noted about the individual ratios. Sales/Non-Current Assets This ratio is not of great value because the numerator and denominator are very often not comparable. Non-Current assets are stated at their cost, perhaps many years prior to the Statement of Financial Position date. Sales, however, are valued at prices prevailing in the current year and hence the two values are incomparable. Furthermore, non-Current assets will decline in value due to depreciation without any reduction in the capacity of the plant and equipment. However, the reduction in value of the denominator increases the ratio and gives a false impression of higher utilisation of non-current assets. For this reason, a ratio-measured in terms of tonnage produced per unit of plant capacity tends to be more meaningful than the sales to non-current assets ratio. Sales/Inventory There are three main ways of presenting the relationship of sales to Inventories (a) Cost of Sales (Cost of Goods Sold) Average Inventory This relationship expresses the frequency with which the average level of inventory investment was 'recouped' or 'turned over' through operations. Presumably, the higher the turnover, the better the performance by the firm, for it has managed to operate with a relatively small average commitment of funds. This, in turn, may indicate that the inventory Page 321 must be relatively 'current' and useful, and contains little unusable inventory. On the other hand, a high turnover could mean Inventory shortages and incomplete satisfaction of customer desires. The final judgement will depend upon the industry, company and the method of valuing inventory and any observable trends. (b) Sales Closing Inventory The ratio is a cruder standard for the same purposes as (a). The most important shortcoming is in the use of the ending inventory figure, which may not be representative of the level of inventory throughout the year. Furthermore, the investment in inventory corresponds in terms of value to the cost of goods sold, whereas sales contain the mark-up for other costs and profit over and above the recorded cost of the goods as carried in inventory. Thus, the relationship is not entirely that of comparable figures. Finally, comparability between companies may be impaired through differences in the gross margin taken on sales, which is more adequately represented by cost of goods sold. The Sales/Inventory ratio can also be broken down into:(a) Sales/Raw Materials Inventories (b) Sales/Work-in-Progress (c) Sales/Finished Goods Inventory Sales/Trade Receivables The result is expressed in terms of "days' sales represented by Trade Receivables" or, more commonly, as the "collection period". This measure can be compared to the credit terms granted to customers in the industry in question and a major deviation from this norm toward slower collections will be a warning signal, especially if there is a trend over a number of periods. The promptness with which accounts are collected is an indicator of the managerial effectiveness of the credit department, as well as a reflection of the quality of the Trade Receivables. Extremely close adherence to credit terms could, on the other hand, mean that the credit policies of the company are unduly strict and profits from sales to somewhat slower customers are being lost. The ratio can be computed as follows: Trade Receivables Credit Sales x 365 Days As pointed out before, the collection period is a rough measure of the overall quality of the Trade Receivables and of the credit policies of a business, but is subject to distortion, especially if sales fluctuate widely in a given period. Also, a business selling both for cash and on account presents a problem, since a separation of credit sales must be made. For a more exact picture, a detailed "ageing" of Trade Receivables can be prepared, through a classification of accounts into groups by dates of sale, in monthly or other relevant time intervals (depending on the credit terms) to see which portion is current and which is overdue. A ratio analysis of overdue accounts in proportion to outstanding accounts from selected or all periods can then be made. This information is not always available to the outsider, however. Page 322 E. RATIOS OF LEVERAGE/GEARING These ratios measure the extent to which the company has managed to finance its assets from sources of finance other than the shareholders and in particular from: (i) Trade Payables And (ii) Long term loan capital The inter-relationship between the ratios can be seen to be as follows: Total Assets Shareholders’Funds = Total Assets Capital Employed X Short Term Gearing (Trade Payables) Capital Employed Shareholders’Funds Long Term Gearing (Loan Capital) Capital employed is the total long-term finance of the business from shareholders and by way of loan capital. If total assets exceed capital employed, Trade Payables must finance them. A measure of the extent of the financing by Trade Payables is got from the total assets to Capital Employed ratio. It should be remembered that this form of finance is free since no interest would normally be paid to Trade Payables on their outstanding balances (as would be paid on Loan Capital finance). This ratio of capital employed to shareholders funds indicates the proportion of the long-term capital of the business provided by shareholders. Another important ratio of gearing is the average period of credit received from Trade Payables. Average Period of Credit Received Trade Payables x 365 Credit Days Purchases From the point of view of the creditor of a business, as well as the financial analyst, it is often desirable to apply a test to Trade Payables similar to the one for Trade Receivables. The basis of this measure is a comparison of the creditor balance with the purchases for the Page 323 period. Again, a detailed ageing of the accounts would yield the most exact picture of the way in which the business handles its obligations to Trade Payables, that is, how promptly its bills are paid. In the absence of such data, the rougher measure must suffice. This ratio can be compared to the credit terms extended by the suppliers of the business to see if any abuses of these terms are made, and trends may be significant. However, this ratio is seldom available to outsiders, since the amount of purchases are not commonly made public. In the case of a manufacturing firm, purchases may be approximated by taking the material cost from the Manufacturing Account, if available and adjusting for the change in the raw materials content of Inventories. Lacking such detail, some analysts take cost of goods sold, if available, and adjust for the change in Inventories. The latter measure is a very crude approximation, since usually cost of goods sold contains many cash charges, such as labour, repairs and so forth. It can be used without difficulty in the case of a wholesales or retailer, however. Another difficulty lies in the fact that Trade Payables often include debts incurred for purposes other than raw material purchases and such debts may vary greatly from time to time. Consequently, the ratio, if obtained, is usually less reliable than the Trade Receivables measure. Finally, the remaining gearing ratio to be considered is the coverage of fixed interest charges. This ratio tells the number of times by which profit before interest would have to fall before the company is unable to pay its interest on loan capital. It is computed as follows: Profit Before Interest Total Interest Payable F. RATIOS OF LIQUIDITY There are two key ratios of liquidity: (i) The Current Ratio (ii) The Acid Test Ratio The Current Ratio Current Assets Current Liabilities The current ratio is one of the most commonly used indices of financial strength, although it is a rather crude measure. The basic question underlying this ratio is the ability of the business to meet its current obligations with a margin of safety to allow for a possible shrinkage of value in its various current assets, such as Inventories and Trade Receivables. This test, applied at a single point in time, implies a liquidation approach rather than a judgement on the going concern, for it does not explicitly take into account the revolving nature of current assets and current liabilities. Page 324 The general impression regarding this measure is that the higher the ratio the better. In fact, there are many instances where financial managers try to improve the current ratio of periodic Statement of Financial Positions by paying off with cash as many of their current obligations as possible on the day prior to the Statement of Financial Position date. If the company has a current ratio of better than 1:1, this process will raise the current ratio, since the same amount will be deducted from both sides of the ratio. The process will worsen the picture if the ratio is less than 1:1. From the point of view of the Trade Payables, this may be true. From the standpoint of prudent management, there may be serious doubts about the wisdom of an excessive build-up, especially of redundant cash lying idle, or worse, a build-up of Inventories out of proportion to the needs of the business. Another distorting factor is the seasonal character of some businesses, which can be reflected to a great extent in a fluctuating current ratio. In the interpretation of this ratio thought should, therefore, be given to the components (for example, cash, Trade Receivables, Inventories, Trade Payables, and so forth) forming the ratio, the character of the business and the industry, as well as future expectations. A general popular rule of thumb for the current ratio is considered to be a 2:1 relationship. Used without caution and discrimination, however, such a vague overall standard is rather dangerous. A 2:1 current ratio or even a 10:1 current ratio does not of itself guarantee reserve strength to meet current obligations, or the ability to turn current assets (especially Inventories) into cash as needed liquidity. Much depends on the quality and character of the current assets. Furthermore, the type of industry involved plays a major role in the need for more or less current financial strength and liquidity. For instance, a public utility with a preponderance of Non-Current Assets and a steady cash flow faces a need for current payment much different from those of wholesalers whose primary investment is in Inventory and Trade Receivables subject to changes in value. A manufacturer has financial problems different from those of a rental store, because of differences in the character of investments and operations. A figure related to the current ratio is the item "net current assets" or "net working capital". This is simply the difference between current assets and current liabilities. The analyst (especially the credit analyst) looks upon this figure, and its movements over several periods, as an indicator of reserve strength to weather adversities. Bank loans are often tied to a minimum requirement for working capital (i.e. restrictive covenants). The Liquidity Ratio or "Acid Test" Trade Receivables, Cash, Marketable Securities Current Liabilities Current Assets – Closing Inventory Current Liabilities This ratio arises from the same basic desire to measure a business' ability to meet its current obligations through the use of its current assets as does the current ratio. It is, however, a far more severe test since it is an attempt is eliminate some of the disadvantages of the current ratio by concentrating on strictly liquid assets whose value is fairly certain. By excluding investors from consideration, the questions asked in fact become: "If the business were to stop selling today, what are its chances for paying off its current obligations with the readily Page 325 convertible funds on hand?" The acid test thus again backs away from the assumption of a going concern, by not considering future funds flows of the business. A rule of thumb of 1:1 is commonly applied here with a little more justification, since a preselection of presumable liquid assets has been made. A result far below 1:1 can be a warning signal, but a blind application of this rule should be avoided. G. LIMITATIONS OF RATIO ANALYSIS There are a number of points, which should be borne in mind when using ratio analyses in interpreting accounting information. (i) The source information on which ratios are based is usually the final accounts of a business comprising of the Statement of Comprehensive Income and the Statement of Financial Position of the concern in question. The Statement of Financial Position is a position of the firm at a specific point in time. If the Statement of Financial Position has been drawn up one month earlier or later it would perhaps have shown a completely different picture especially the Current Asset/Current Liability situation. The Statement of Financial Position is a static piece of accounting information and therefore any ratio based wholly or partly on Statement of Financial Position figures must suffer from the same defect. In addition seasonal variations must also be considered. (ii) The revenue accounts of a business i.e. the Statement of Comprehensive Income show a cumulative or dynamic situation. In other words, the underlying trends of the concern would be equally well shown by revenue accounts drawn up for periods of less than one year bearing in mind seasonal variation. Therefore, more reliability may be placed on those ratios computed wholly from revenue account figures. (iii) A ratio by itself may be almost worthless, a standard will, therefore, have to be established, this may be found either from a firm at a similar stage of development in the same industry, or from previous years accounts of the same firm.. As sources of information, these have their limitations as they are based on published accounts. (iv) Ratio analysis does not provide the answers to business problems. It is a tool, which enables the financial manager or investigator to ask the right questions. H. SUMMARY The prime objectives of analysis and interpretation of accounting information is to ascertain: (i) The operating performance of the firm in terms of how well the business is utilising its assets (ii) Whether there is excessive investment in Non-Current Assets (iii) If the business is adequately financed (iv) The Inventories position of the firm and find out if it carries excessive or obsolete Inventories (v) The liquidity position of the concern Page 326 (vi) Whether its profit margin are in line with comparable businesses In other words, the objective of ratio analysis is to discover the reality behind the situation. I. CHECKLIST Introduction The purpose of this checklist is to illustrate in a logical sequence the main points, which should be highlighted when analysing and interpreting financial information. It may be used in a general situation where an overall analysis is required or in a specialised situation where only particular information is needed by making reference to specific sections. SECTION 1 Liquidity (i) Current Ratio The ability of the firm to meet its current obligations. 1.5 to 1 leaves a reasonable margin: greater than 2 indicate idle assets. Less than 1 indicates inability to satisfy current obligation out of current assets. (ii) Liquidity Ratio 1 to 1.1 is ideal Compare with Current ratio to show incidence of Inventory as a current asset. General - Large Trade Receivables/Trade Payables, little cash or large overdraft may indicate overtrading. Overtrading - A firm is said to be 'overtrading' when it conducts a volume of trade far in excess of that justified by the proprietors "own funds", so that the substantial circulating assets needed to support the high level of trade are unduly dependent on outside finance. (iii) Trade Receivables Ratio (a) The question of Credit Control (b) Incidence of Bad Debts (c) Suggest preparation of age Analysis of Trade Receivables (d) Examine the mix of cash to credit sales (a) Trade Payables Ratio Easing or tightening of credit by suppliers (iv) (b) Mix of cash to credit purchases Express (iii) and (iv) above in terms of days. Take a year as being 365 days. In practice, it is customary to take the figure for Trade Receivables or Trade Payables at the year end and express the Trade Receivables/Trade Payables Ratios by the number of months’ sales or purchases the figure represents. Page 327 General - Trade Payables Ratio should exceed Trade Receivables Ratio so as to take maximum advantage of finance provided. However, take note nature of business e.g. in supermarket business, there are cash sales and, therefore, no Trade Receivables while in the professional business, there are few Trade Payables, but normally a high debtor’s figure. (v) Inventories (a) Over/undervaluation (b) Obsolete or slow moving Inventory (c) Second quality/sub-standard goods (d) Too much/too little to support level of business activity (e) Poor Inventory control Definitions Solvency A business is said to be SOLVENT when it can meet its CURRENT AND FIXED LIABILITIES out of its TOTAL ASSETS Liquid A business is said to be LIQUID when it can meet its CURRENT LIABILITIES out of its CURRENT ASSETS SECTION 2 Efficiency (i) Return on Capital Employed (a) Compute in terms of MARKET VALUE of assets (b) (ii) Prime yardstick for measuring EFFICIENCY of business Net Asset Turnover (a) Utilisation of assets, but note incidence of costs to achieve this objective (b) Compute in conjunction with Profit/Sales Ratio to achieve (i) above (iii) Fixed Asset Turnover (a) High Ratio - Greater efficiency in fixed asset utilisation (b) Low Ratio - Poor efficiency. Remedy dispose of idle assets (iv) Sales to Net Current Assets The amount of capital required achieving an additional RWF1 of sales, given no shortage of capacity SECTION 3 Profitability (i) Gross Profit to Sales (a) Use of comparison with previous years and other firms in the same industry (b) Deviations – Manipulations in Inventory, purchases, sales Page 328 (ii) – Changes in purchases/sales mix – Changes in raw materials costs with a corresponding – Change in sales prices – Poor cut-off Profit Margin on Sales (a) Compute with Net Asset Turnover above (b) Selling price too low/costs too high (iii) Other ratios, which are Significant in Analysis of Operating Statements. i.e. (i) Production Materials/Sales (ii) Direct Labour/Sales (iii) Employee Ratio - Sales per employee Page 329 Study Unit 25 Manufacturing Accounts Contents A. General ___________________________________________________________________________ B. Division of Costs ___________________________________________________________________________ C. Layout of a Manufacturing Account ___________________________________________________________________________ Page 330 A. GENERAL A manufacturing account is prepared in addition to the trading and profit and loss accounts. It is produced for internal use, mainly for the owners and managers of organisations. B. DIVISION OF COSTS Costs in a manufacturing business are divided into different types. These can be defined as Prime Costs and Production Costs. Cost of Production = Prime Cost + Factory Overheads+ Opening Work in Progress- Closing Work in Progress. A direct cost is known as a prime cost, Examples: direct materials direct labour direct expenses. If a cost cannot easily be traced to the item being manufactured, then it is an indirect cost and will be included under indirect manufacturing costs. Examples of Indirect Costs: Wages to Cleaners Rent of a factory Factory lighting Factory Power Administration expenses include manager and administrative salaries, legal and accountancy fees, depreciation of machinery. Selling and distribution expenses include sales staff salaries and commission, carriage outwards, depreciation of delivery vans, promotion and display expenses. Financial charges include expenses items such as bank charges and discounts allowed, bad debts. Administration expenses, selling and distribution expenses and financial charges are charged to the Profit and Loss account part of the manufacturing account. Rent can be allocated as following in the manufacturing account: Selling and Distribution Factory Part Administration Buildings Only one figure of rent may be paid, and can be apportioned using a range of methods including Floor area Property valuations of each part of the buildings and land Page 331 C. LAYOUT OF A MANUFACTURING ACCOUNT Company Name Manufacturing, Trading and Profit and Loss Account for the year ended 31 December 200X RWF RWF Raw Materials Opening Stock Purchases (Raw Materials) Add : Carriage Inwards xxxx xx Less Return Outwards xxxx (xx) RWF Xxx Xxxx Xxxx (xx) Less: Closing Stock (Raw Materials) Cost of Raw Materials consumed Direct Materials Direct Expenses (Royalty) xxxx xxx xxx PRIME COST FACTORY OVERHEADS: Factory rent and rates Fuel and power Indirect wages Lubricants ( ) Depreciation of plant and machinery XXXX Xxx Xxx Xx Xxx Xxx XXXX XXXX WORK-IN-PROGRESS Opening Work-in-Progress (1.1.200x) Less: Closing Work-in-Progress (31.12.200y) Xxxx (xxx) XXX PRODUCTION COST OF GOODS COMPLETED c/d Page 332 XXXX (Trading Account) Finished Goods Sales Less: Cost of Goods Sold Opening Stock Add: Production Cost of Goods Completed b/d Less: Closing Stock GROSS PROFIT Less: Expenses Administrative Expenses (Office expenses) e.g. Office rent and rates Administrative salaries General administration expenses Depreciation of office furniture, office equipment Selling and Distribution Expenses e.g. Advertising expenses Sales Commissions Carriage Outwards Financial Expenses e.g. Discounts allowed Bad Debts Provisions for Bad Debts xxxx xxx xxxx xxxx (xxx) (xxx) XXX (xxx) NET PROFIT FOR THE YEAR XXX Page 333 Statement of Financial Position as at 31 December 200X FIXED ASSETS Cost Accumulated Depreciation Machinery Office Equipment CURRENT ASSETS Stock: Raw Materials Work in Progress Finished Goods Debtors Less: Provisions for Bad Debts xxxxx xxxx Xxx Xxx Net Book Value xxxx xxxx xxxxx Xxx xxxx Xxx Xx Xxx xxx (xxx) Xxx Xx Xxx Xxx Prepaid Expenses Bank Cash Xxxx Less: CURRENT LIABILITIES Creditors Accrued expenses xxx xx (xxx) Working Capital xxx xxxx FINANCED BY: Capital on 1.1.200x Add: Net Profit for the year xxxx xxx xxxx (xxx) Less: Drawings xxxx Page 334 BLANK Page 335 Study Unit 26 IPSAS Contents A. Introduction ___________________________________________________________________________ B. IPSAS 1 ___________________________________________________________________________ C. IPSAS 2 ___________________________________________________________________________ D. IPSAS 12 ___________________________________________________________________________ E. IPSAS 3 F. IPSAS 14 ___________________________________________________________________________ G. IPSAS 17 H. IPSAS 31 ___________________________________________________________________________ I. IPSAS 16 ___________________________________________________________________________ J. IPSAS 19 K. IPSAS 9 and 23 ___________________________________________________________________________ Page 336 A. INTRODUCTION International Public Sector Accounting Standards (IPSASs) Recent years have seen ongoing efforts to codify a set of accounting standards that can be applied specifically to the public sector. Most of these have focused on variations of private sector accounting based on the IFRS regime. In some countries, such as the United Kingdom, New Zealand and Australia a national version of the IFRSs for the public sector has been prepared. However a set of international –public sector standards have also been developed, the IPSASs, and these are gaining increasing credibility across the globe. They have been adopted by a number of countries, including Rwanda, in theory although there is still a considerable amount of practical work to be done before they may be considered to be practically implemented. They have also been adopted by some leading international organisations such as the United Nations and the World Food Programme. IPSASs have been in existence from 2000 but a major updating process on them took place in 2009. Recognising that cash accounting is still in place for the public sectors of many countries, there is a Cash-Basis IPSAS. There are also 32 accruals-based IPSASs in existence as at the end of 2011. Recognising that there are many countries that plan to transition from a cash to an accruals based method of accounting in the public sector, there is also a section of the IPSAS devoted to disclosures that could be made under a modified cash basis, which essentially provides guidance on the data that could be collected and disclosed as part of an interim step from one to the other. The IPSAS are published by the IPSAS Board (IPSASB) which is part of the IFAC (International Federation of Accountants) organisation based in New York. In the same way as would be the case with an IFRS there will be a consultation process involving the issuance of an Exposure Draft for public comment before publication. The 32 accruals-based IPSAS are: IPSAS 1—Presentation of Financial Statements IPSAS 2—Cash Flow Statements IPSAS 3—Accounting Policies, Changes in Accounting Estimates and Errors IPSAS 4—The Effects of Changes in Foreign Exchange Rates IPSAS 5—Borrowing Costs IPSAS 6—Consolidated and Separate Financial Statements IPSAS 7—Investments in Associates IPSAS 8—Interests in Joint Ventures IPSAS 9—Revenue from Exchange Transactions IPSAS 10—Financial Reporting in Hyperinflationary Economies IPSAS 11—Construction Contracts IPSAS 12—Inventories IPSAS 13—Leases IPSAS 14—Events after the Reporting Date IPSAS 15—Financial Instruments: Disclosure and Presentation IPSAS 16—Investment Property IPSAS 17—Property, Plant, and Equipment Page 337 IPSAS 18—Segment Reporting IPSAS 19—Provisions, Contingent Liabilities and Contingent Assets IPSAS 20—Related Party Disclosures IPSAS 21—Impairment of Non-Cash-Generating Assets IPSAS 22—Disclosure of Financial Information about the General Government Sector IPSAS 23—Revenue from Non-Exchange Transactions (Taxes and Transfers) IPSAS 24—Presentation of Budget Information in Financial Statements IPSAS 25—Employee Benefits IPSAS 26—Impairment of Cash-Generating Assets IPSAS 27—Agriculture IPSAS 28—Financial Instruments: Presentation IPSAS 29—Financial Instruments: Recognition and Measurement IPSAS 30—Financial Instruments: Disclosures IPSAS 31—Intangible Assets IPSAS 32 – Service Concessions There is an increasing recognition that good accounting is good accounting whether it be in the private or public sector, though there is also an understanding that the uses for which financial information is used is often different in each case. For example, financial information in the private sector is frequently prepared with the aim of meeting the needs of investors including shareholders whereas in the public sector it is more an aid to assisting in holding spenders of public funds accountable for their actions. There are though many similarities in good practice. As a result, most of the accruals-based IPSASs are derived from an IFRS (the sequencing of this is important: normally an IFRS will come first and will be followed by an IPSAS that is derived from it). Whilst there will be some redrafting to take account of the specific needs of the public sector in a number of cases the most marked difference between an IFRS and its connected IPSAS is one of terminology (for example whereas an IFRS will talk about a Statement of Comprehensive Income an IPSASs will discuss a Statement of Financial Position or an IFRS will mention equity whereas an IPSAS will discuss net assets). Each IPSAS will explain how it is different in any material way from the IFRS from which it is derived. In common with IFRS, the IPSAS regime is an accounting and reporting tool, explaining both how to account for various transactions and also the level of disclosures that are required. The exceptions to the general rule that an IPSAS is normally linked to an IFRS are as follows: IPSAS 21: Impairment of Non-Cash Generating Assets – non-cash-generating assets are those which are not used for a commercial purpose, which covers many in the public sector IPSAS 22: Disclosure of Financial Information about the General Government Sector IPSAS 23: Revenue from non-exchange transactions, which gives guidance on how to account for taxes and transfers as revenues IPSAS 24: Presentation of budget information in financial statements, which recognises that budgeting is an important method of ensuring accountability in the public sector whereas in the private sector it is more a method of internal control Page 338 B. IPSAS 1 Presentation of Financial Statements - IPSAS 1 IPSAS 1 (“Presentation of Financial Statements”) gives general guidance as to the types of financial statements to be prepared in the public sector (along with IPSAS 2 on the cash flow statement). It is drawn primarily from IAS 1. It should be applied to all general purpose financial statements prepared and presented under the accrual basis of accounting in accordance with IPSASs. In common with most IPSASs, it applies to all public sector entities other than Government Business Enterprises which use IFRSs for their financial reporting. It outlines that there are six basic components of financial statements namely a Statement of Financial Position, a Statement of Financial Performance, a statement of changes in net assets/equity, a cash flow statement, a comparison of budget and actual amounts (only if the budget is made publicly available) and the notes to the financial statements. It is important to emphasise that the disclosures in the notes are considered a fundamental part of the financial statements – but detailed guidelines on what should go into the notes for specific elements of the financial statements are found in individual IPSASs on the topics involved and not in IPSAS 1, which sets out high level contents only. Many of these financial statements are similar to those in use within the private sector. One important difference however is the comparison of budget and actual amounts. This reflects the fact that in the public sector the budget has a greater and different significance than it does in the private sector. In particular it is a tool to help ensure accountability of those responsible for the control of resources and their effective, efficient and economic use. IPSAS 1 does not give detailed guidance on the budget v actual comparison statement which is covered in more detail within IPSAS 24, “Presentation of Budget Information in Financial Statements” (this is one of the few IPSASs for which there is no equivalent IFRS). Entities are encouraged to present other information than that included in the financial statements to assist users in assessing the performance of the entity, its stewardship of assets and making an informed evaluation about decisions on the allocation of resources. Such information might include performance indicators, statements of service performance, program reviews and other reports by management. These areas will be further covered in the “Conceptual Framework” which is currently being prepared by IFAC to provide a framework within which future IPSASs will be prepared and current IPSASs possibly revised. IPSAS 1 states that financial statements shall present fairly the financial position, financial performance, and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events, and conditions in accordance with the definitions and recognition criteria for assets, liabilities, revenue, and expenses set out in IPSASs. The application of IPSASs, with additional disclosures when necessary, is presumed to result in financial statements that achieve a fair presentation. An entity whose financial statements comply with IPSASs shall make an explicit and unreserved statement of such compliance in the notes. Financial statements shall not be described as complying with IPSASs unless they comply with all the requirements of IPSASs – in other words selective application of IPSASs is not permitted. Page 339 In addition to the over-arching consideration of ‘fair presentation’ other important concepts are included, for example; that the financial statements are prepared on the basis that the entity is a ‘going concern’ that there is in normal circumstances consistency of presentation from one reporting period to the next the concept of materiality and aggregation of large numbers of transactions into classes for reporting purposes that the offsetting of assets and liabilities, or revenue and expenses, is not permitted unless specifically allowed or required by an IPSAS that comparative information for previous periods will be included in the financial statements unless an IPSAS allows or requires its non-inclusion (e.g. in the first reporting period for a new entity) Much of the detailed guidance in IPSAS 1 replicates that found in IAS 1 and is therefore not replicated here. The main differences between the two are shown below: • • • • • • Commentary additional to that in IAS 1 has been included in IPSAS 1 to clarify the applicability of the Standard to accounting by public sector entities, e.g., discussion on the application of the going concern concept has been expanded. IAS 1 allows the presentation of either a statement showing all changes in net assets/equity, or a statement showing changes in net assets/equity, other than those arising from capital transactions with owners and distributions to owners in their capacity as owners. IPSAS 1 requires the presentation of a statement showing all changes in net assets/equity. IPSAS 1 uses different terminology, in certain instances, from IAS 1. The most significant examples are the use of the terms “statement of financial performance,” and “net assets/equity” in IPSAS 1. The equivalent terms in IAS 1 are “Statement of Comprehensive Income,” and “equity”. IPSAS 1 does not use the term “income,” which in IAS 1 has a broader meaning than the term “revenue.” IPSAS 1 contains commentary on timeliness of financial statements, because of the lack of an equivalent Framework in IPSASs (paragraph 69). However this may be revised once the Conceptual Framework is finalised. IPSAS 1 contains an authoritative summary of qualitative characteristics (based on the IASB framework) in Appendix A. Again, this may be revised once the Conceptual Framework is finalised. C. IPSAS 2 Cash Flow Statements – IPSAS 2 IPSAS 2 is drawn primarily from International Accounting Standard (IAS) 7, Cash Flow Statements. You should note that although cash flow statements are discussed in detail in IPSAS 2, IPSAS 1 on the presentation of financial statements also makes reference to them. Page 340 In practice, there are no significant differences between IPSAS 2 and IAS 7. However there are some differences in the detail, namely: • • • Commentary additional to that in IAS 7 has been included in IPSAS 2 to clarify the applicability of the standards to accounting by public sector entities. IPSAS 2 uses different terminology, in certain instances, from IAS 7. The most significant examples are the use of the terms “revenue,” “statement of financial performance,” and “net assets/equity” in IPSAS 2. The equivalent terms in IAS 7 are “income,” “Statement of Comprehensive Income,” and “equity.” IPSAS 2 contains a different set of definitions of technical terms from IAS 7 (paragraph 8). In common with IAS 7, IPSAS 2 allows either the direct or indirect method to be used to present cash flows from operating activities. Where the direct method is used to present cash flows from operating activities, IPSAS 2 encourages disclosure of a reconciliation of surplus or deficit to operating cash flows in the notes to the financial statements (paragraph 29). D. IPSAS 12 Inventories - IPSAS 12 IPSAS 12 (“Inventories”) is drawn substantially from IAS 2. As the name suggests, its objective is to prescribe the accounting treatment for inventories. Specifically it provides guidance on the calculation of cost and the subsequent recognition of inventories as expenses when they are consumed or sold. They also provide guidance on the write-down of inventories to their Net Realisable Value (in the case of inventories held for re-sale, defined as the future sales proceeds of any inventory less any future costs that would be incurred to make that sale happen). The IPSAS outlines a number of situations where the rules outlined do not apply, for example: • Work-in-progress on construction contracts (specific rules are in IPSAS 11) • Financial instruments (see IPSASs 28 and 29) • Biological assets (IPSAS 27) The basic rule, as it is in IAS 2, is that inventories should be carried in the Statement of Financial Position (sometimes known as the Statement of Financial Position) until it is used or sold, at which point the inventory will be charged to the Statement of Financial Performance. The accounting is quite simple as the following example shows: Entity X, a public sector education establishment buys 20,000,000 RwF of fuel oil in December 2012, which it does not plan to use until 2013: In the financial statements, the double entry for this transaction (assuming it is paid for in cash when purchased is): DEBIT Inventories (Statement of Financial Position) CREDIT Cash Page 341 20,000,000 (20,000,000) When it is then used in 2013, the double entry would be: DEBIT Expenses (Statement of Financial Performance) CREDIT Inventories 20,000,000 (20,000,000) Inventories in the public sector may take a number of different forms, some of them quite unusual. These include: • • • • • Ammunition Consumable stores Maintenance materials Energy reserves Stocks of unissued currency The cost of inventories shall comprise all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. Costs of purchase includes any non-reclaimable taxes and import duties. If there are any conversion costs, such as would be the case with a publicly-owned manufacturing environment which takes raw materials and turns them into finished goods then any attributable overheads may also be added to the cost as long as these overhead costs are allocated in a systematic fashion. The accounting treatment in IPSAS 12 is similar to that in IAS 2. Basically, when inventories are sold, exchanged, or distributed, the carrying amount of those inventories shall be recognized as an expense in the period in which the related revenue is recognized. If there is no related revenue, the expense is recognized when the goods are distributed or the related service is rendered. There are only a few differences between IPSAS 12 and IAS 2. IPSAS 12 requires that where inventories are provided at no charge or for a nominal charge, they are to be valued at the lower of cost and current replacement cost (in the public sector it is not as unusual for inventories to move from one organisation to another on a free-of-charge basis as it is in the private sector). In addition the financial statement known as the ‘Statement of Financial Performance’ is known as the ‘Statement of Comprehensive Income’ in IAS 2, which also uses the term ‘income’ rather than ‘revenue’. E. IPSAS 3 Accounting Policies, Changes in Accounting Estimates and Errors - IPSAS 3 IPSAS 3 (“Accounting Policies, Changes in Accounting Estimates and Errors”) is drawn from IAS 8. The objective of this Standard is to prescribe the criteria for selecting and changing accounting policies, together with the (a) accounting treatment and disclosure of changes in accounting policies, (b) changes in accounting estimates, and (c) the corrections of errors. This Standard is intended to enhance the relevance and reliability of an entity’s financial statements, and the comparability of those financial statements over time and with the financial statements of other entities. Page 342 In the public, as in the private, sector an entity has some discretion as to the accounting policies it adopts to most fairly represent the financial transactions of the business. Therefore it is important that there is some guidance laid out to ensure that there is an appropriate methodology for the adoption of accounting policies and also around how they are changed. Equally, mistakes will from time to time be made in the preparation of financial statements and they may not always be picked up in the audit subsequently. Therefore guidance is also required to ensure that if errors are not discovered until after the financial statements have been formally approved then there are appropriate measures adopted to react to the situation. It should be noted that one of the allowable reasons for changing an accounting policy is the publication of a new IPSAS. Entities will always have a transition period during which they may move from the existing accounting treatment to that which is required by the new IPSAS. On the other hand the management of the entity may feel that a different policy is required because of changes that have taken place within the entity itself. Changes of accounting policy, which usually require restatement of comparative figures and opening balances should not be confused with changes in accounting estimate, which do not. Estimates may often be used in government accounting for example estimated amounts of tax revenues, estimated bad debt provisions for uncollected debts or the obsolescence of inventory. When these estimates turn out to be in need of correction – and remember that an estimate is almost certain to be incorrect to some extent because the outcome is uncertain. These estimates should be corrected in the current financial period and not previous ones. Errors can arise in respect of the recognition, measurement, presentation, or disclosure of elements of financial statements. Financial statements do not comply with IPSASs if they contain either material errors, or immaterial errors made intentionally to achieve a particular presentation of an entity’s financial position, financial performance, or cash flows. Nevertheless some financial statements may inadvertently contain material errors which are not picked up. If they do and the financial statements have not yet been finalised then the drafts of these should of course be collected before publication. However if they are only picked up once the financial statements are approved then the correct accounting treatment is to adjust the comparative figures in the next year’s financial statements and adjust the opening balances accordingly. Once more the major differences between IPSAS 3 and IAS 8 mainly revolve around terminology. IPSAS 3 uses the terms ‘Statement of Financial Performance’, accumulated surplus or deficit and net assets/equity whereas in IAS 8 these are termed ‘Statement of Comprehensive Income’, ‘retained earnings’ and ‘equity’. Also IPSAS 3 talks of ‘revenue’, which is called ‘income’ in IAS 8. In addition, unlike IAS 8 IPSAS 3 does not require disclosures about earnings per share, which are not normally relevant in a public sector context. F. IPSAS 14 Events after the reporting date - IPSAS 14 IPSAS 14, “Events after the reporting date”, is drawn from IAS 10, “Events after the Reporting Period”. Its objective is to prescribe; Page 343 a) When an entity should adjust its financial statements for events after the reporting date; and b) The disclosures that an entity should give about the date when the financial statements were authorized for issue, and about events after the reporting date. It also requires that an entity should not prepare its financial statements on a going concern basis if events subsequent to the reporting date mean that this is not appropriate. Events after the reporting date may be analysed into adjusting and non-adjusting in nature. Adjusting events occur when information is received after the reporting date which gives more evidence about a condition that already existed at the reporting date. One example would be when a court case has been commenced against the entity where, say, a provision of 30,000,000 RwF has been established. If the court case is decided after the reporting date but before the financial statements are organised and the court finds that the entity is liable to make payments of 40,000,000 RwF then the financial statements should be adjusted accordingly. Non-adjusting events are those which occur after the reporting date and, although significant, do not normally give evidence of a condition existing at the Statement of Financial Position date. Examples given by IPSAS 14 include a major fire after the reporting date that destroys a substantial asset, a major acquisition or disposal, changes in tax rates or tax laws, large falls in asset values or big foreign exchange losses. These non-adjusting events do not require the financial statements to be re-stated but they should be disclosed in the notes to the financial statements if they are material. There are no major differences in principle between IPSAS 14 and IAS 10, although some extra guidance is given in the former to explain better how it applies to the private sector. Other than that the differences are once more largely in terminology. G. IPSAS 17 Property, Plant and Equipment - IPSAS 17 IPSAS 17 (“Property, Plant and Equipment”) is drawn primarily from IAS 16, which has the same name. It provides one of the major challenges when public sector accounting moves from a cash to an accruals basis for the first time. It is often a major exercise to assemble all the information required to accurately state an entity’s Property, Plant and Equipment (PPE) values for the first time. It is also necessary to establish policies on depreciation, that is allocating the cost of the asset over the period in which it is expected to have a useful life and amortisation, which is effectively a write-down that must be made when an asset suffers a permanent diminution in value. The objective of IPSAS 17 is to prescribe the accounting treatment for property, plant, and equipment so that users of financial statements can discern information about an entity’s investment in this and the changes in such investment. The principal issues in accounting for property, plant, and equipment are (a) the recognition of the assets, (b) the determination of their carrying amounts (a carrying amount is the value that the asset has in the Statement of Page 344 Financial Position), and (c) the depreciation charges and impairment losses to be recognized in relation to them. The Standard applies to all assets (except some which are specifically dealt with by other IPSAS) including some that are quite specific to the public sector such as specialist military equipment and infrastructure assets (these would be for example roads or bridges). It does not however apply to mining activities when mineral reserves such as oil or gas are depleted by uses. It does not apply either to biological assets (these include animals kept for resale or slaughter or crops grown for harvesting) which are dealt with by IPSAS 27. Other IPSAS also deal with assets in specific situations, such as IPSAS 16, which deals with properties held for investment purposes, or IPSAS 13 on leased assets. As in private sector accounting, the general rules are that the cost of an item of property, plant, and equipment shall be recognized as an asset if, and only if: (a) It is probable that future economic benefits or service potential associated with the item will flow to the entity; and (b) The cost or fair value of the item can be measured reliably (fair value is the price at which the property could be exchanged between knowledgeable, willing parties in an arm’s length transaction). The cost of an item of property, plant, and equipment comprises: (a) Its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates. (b) Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. (c) The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired, or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. Only directly attributable costs may be capitalised as part of the asset value. IPSAS 17 says that these include: (a) The costs of employee benefits (as defined in the relevant international or national accounting standard dealing with employee benefits – the IPSAS dealing with this is IPSAS 25) arising directly from the construction or acquisition of the item of property, plant, and equipment; (b) Costs of site preparation; (c) Initial delivery and handling costs; (d) Installation and assembly costs; (e) Costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment); and (f) Professional fees. An important element of IPSAS 17 is that entities that are making the transition to accruals accounting based on IPSAS for the first time have a five-year period to make that transition Page 345 as far as the recognition of plant, property and equipment under this particular Standard is concerned. Further, an entity that adopts accrual accounting for the first time in accordance with IPSASs shall initially recognize property, plant, and equipment at cost or fair value. For items of property, plant, and equipment that were acquired at no cost, or for a nominal cost, cost is the item’s fair value as at the date of acquisition (this might be the case if for example an asset was gifted as part of a legacy or was transferred at no cost from another government department). In such situations, the entity shall recognize the effect of the initial recognition of property, plant, and equipment as an adjustment to the opening balance of accumulated surpluses or deficits for the period in which the property, plant, and equipment is initially recognized. Although IPSAS 17 is drawn primarily from IAS 16, Property, Plant and Equipment, as amended by IAS 16 (part of the Improvements to IFRSs which was issued in May 2008) there are some differences between the private and public sector versions of the Standard. As one detailed example, at the time of issuing IPSAS 17, the IPSASB has not yet considered the applicability of IFRS 5, Non-current Assets Held for Sale andDiscontinued Operations to public sector entities; therefore, IPSAS 17 does not reflect amendments made to IAS 16 consequent upon the issue of IFRS 5. However, the main differences between IPSAS 17 and IAS 16 (2003) are as follows: • • • • • IPSAS 17 does not require or prohibit the recognition of heritage assets. An entity that recognizes heritage assets is required to comply with the disclosure requirements of this Standard with respect to those heritage assets that have been recognized and may, but is not required to, comply with other requirements of this Standard in respect of those heritage assets. IAS 16 does not have a similar exclusion. (A heritage asset is one which has particular historic or cultural significance, such as a Parliament building or an archaeological site which makes the use of conventional asset valuation rules of limited relevance) IAS 16 requires items of property, plant, and equipment to be initially measured at cost. IPSAS 17 states that where an item is acquired at no cost, or for a nominal cost, its cost is its fair value as at the date it is acquired. IAS 16 requires, where an enterprise adopts the revaluation model and carries items of property, plant, and equipment at revalued amounts, the equivalent historical cost amounts should be disclosed. This requirement is not included in IPSAS 17. Under IAS 16, revaluation increases and decreases may only be matched on an individual item basis. Under IPSAS 17, revaluation increases and decreases are offset on a class of asset basis (this could make a significant difference). IPSAS 17 contains transitional provisions for both the first time adoption and changeover from the previous version of IPSAS 17. IAS 16 only contains transitional provisions for entities that have already used IFRSs. Specifically, IPSAS 17 contains transitional provisions allowing entities to not recognize property, plant, and equipment for reporting periods beginning on a date within five years following the date of first adoption of accrual accounting in accordance with IPSASs. The transitional provisions also allow entities to recognize property, plant, and equipment Page 346 • • at fair value on first adopting this Standard. IAS 16 does not include these transitional provisions. This is an important concession in that it can sometimes be very difficult to assemble all the necessary data to allow the transition to an accruals-based approach to asset accounting and it allows public sector entities a significant amount of time to do so. IPSAS 17 contains definitions of “impairment loss of a non-cash-generating asset” and “recoverable service amount.” IAS 16 does not contain these definitions. This is an important distinction. A non-cash generating asset is one that is not held for the generation of a commercial return and there are a number of these in use in the public sector which would not be the case in the private sector. IPSAS 17 uses different terminology, in certain instances, from IAS 16. The most significant examples are the use of the terms “statement of financial performance,” and “net assets/equity” in IPSAS 17. The equivalent terms in IAS 16 are “Statement of Comprehensive Income” and “equity.” IPSAS 17 does not use the term “income,” which in IAS 16 has a broader meaning than the term “revenue.” H. Intangible Assets – IPSAS 31 This is one of the most recent IPSASs to be created and is based on International Accounting Standard (IAS) 38, Intangible Assets published by the International Accounting Standards Board (IASB). It also contains extracts from the Standing Interpretations Committee Interpretation 32 (SIC 32), Intangible Assets—Web Site Costs. It includes useful application guidance on how to deal with website costs and has a number of illustrative examples which show how accounting for intangible assets could be applied in various situations such as when a patent, copyright or license is acquired from a public sector entity. The main differences between IPSAS 31 and IAS 38 are as follows: • • • • • IPSAS 31 incorporates the guidance contained in the Standing Interpretation Committee’s Interpretation 32, Intangible Assets—Web Site Costs as Application Guidance to illustrate the relevant accounting principles. IPSAS 31 does not require or prohibit the recognition of intangible heritage assets (as is also the case with tangible assets dealt with by IPSAS 17). An entity that recognizes intangible heritage assets is required to comply with the disclosure requirements of this Standard with respect to those intangible heritage assets that have been recognized and may, but is not required to, comply with other requirements of this Standard in respect of those intangible heritage assets. IAS 38 does not have similar guidance. IAS 38 contains requirements and guidance on goodwill and intangible assets acquired in a business combination. IPSAS 31 does not include this guidance. IAS 38 contains guidance on intangible assets acquired by way of a government grant. Paragraphs 50–51 of IPSAS 31 modify this guidance to refer to intangible assets acquired through non-exchange transactions. IPSAS 31 states that where an intangible asset is acquired through a non-exchange transaction, the cost is its fair value as at the date it is acquired. IAS 38 provides guidance on exchanges of assets when an exchange transaction lacks commercial substance. IPSAS 31 does not include this guidance. Page 347 • • The examples included in IAS 38 have been modified to better address public sector circumstances. IPSAS 31 uses different terminology, in certain instances, from IAS 38. The most significant examples are the use of the terms “revenue,” “statement of financial performance,” “surplus or deficit,” “future economic benefits or service potential,” “accumulated surpluses or deficits,” “operating/operation,” “rights from binding arrangements (including rights from contracts or other legal rights),” and “net assets/equity” in IPSAS 31. The equivalent terms in IAS 38 are “income,” “statement of comprehensive income,” “profit or loss,” “future economic benefits,” “retained earnings,” “business,” “contractual or other legal rights,” and “equity.” I. IPSAS 16 Investment Property – IPSAS 16 IPSAS 16 is drawn primarily from International Accounting Standard (IAS) 40 (Revised 2003), Investment Property. In common with some other IPSASs, there are some transitional arrangements that apply when an entity adopts accrual accounting for the first time in accordance with IPSASs. These state that in such circumstances the entity shall initially recognize investment property at cost or fair value. For investment properties that were acquired at no cost, or for a nominal cost, cost is the investment property’s fair value as at the date of acquisition. The entity should recognize the effect of the initial recognition of investment property as an adjustment to the opening balance of accumulated surpluses or deficits for the period in which accrual accounting is first adopted in accordance with IPSASs. In terms of the comparison of IPSAS 16 to IAS 40 (2003), Investment Property, the IPSAS notes that the IPSASB has not yet considered the applicability of IFRS 4, Insurance Contracts, and IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, to public sector entities; therefore IPSAS 16 does not reflect amendments made to IAS 40 consequent upon the issue of those IFRSs. The other main differences between IPSAS 16 and IAS 40 are as follows: • • • • IPSAS 16 requires that investment property initially be measured at cost and specifies that where an asset is acquired for no cost or for a nominal cost, its cost is its fair value as at the date of acquisition. IAS 40 requires investment property to be initially measured at cost. There is additional commentary to make clear that IPSAS 16 does not apply to property held to deliver a social service that also generates cash inflows. Such property is accounted for in accordance with IPSAS 17, Property, Plant, and Equipment. IPSAS 16 contains transitional provisions for both the first time adoption and changeover from the previous version of IPSAS 16. IAS 40 only contains transitional provisions for entities that have already used IFRSs. IFRS 1 deals with first time adoption of IFRSs. IPSAS 16 includes additional transitional provisions that specify that when an entity adopts the accrual basis of accounting for the first time and recognizes investment property that was Page 348 • • previously unrecognized, the adjustment should be reported in the opening balance of accumulated surpluses or deficits. Commentary additional to that in IAS 40 has been included in IPSAS 16 to clarify the applicability of the standards to accounting by public sector entities. IPSAS 16 uses different terminology, in certain instances, from IAS 40. The most significant example is the use of the term “statement of financial performance” in IPSAS 16. The equivalent term in IAS 40 is “Statement of Comprehensive Income.” In addition, IPSAS 16 does not use the term “income,” which in IAS 40 has a broader meaning than the term “revenue.” J. IPSAS 19 Provisions, Contingent Liabilities and Contingent Assets – IPSAS 19 This International Public Sector Accounting Standard (IPSAS) is drawn primarily from International Accounting Standard (IAS) 37 (1998), Provisions, Contingent Liabilities and Contingent Assets. It includes guidance on what action should be taken when transitioning to using IPSAS 19 for the first time, namely that the effect of adopting this Standard shall be reported as an adjustment to the opening balance of accumulated surpluses/(deficits) for the period in which the Standard is first adopted. Entities are encouraged, but not required, to (a) adjust the opening balance of accumulated surpluses/(deficits) for the earliest period presented, and (b) to restate comparative information. If comparative information is not restated, this fact shall be disclosed. There are some differences between IPSAS 19 and IAS 37 as follows: • IPSAS 19 includes commentary additional to that in IAS 37 to clarify the applicability of the standards to accounting by public sector entities. In particular, the scope of IPSAS 19 clarifies that it does not apply to provisions and contingent liabilities arising from social benefits provided by an entity for which it does not receive consideration that is approximately equal to the value of the goods and services provided directly in return from recipients of those benefits (this is to take account of the fact that public sector entities often provide goods or services that are “free at the point of delivery” to the end user or at least provided in return for consideration that is below normal market values). However, if the entity elects to recognize provisions for social benefits, IPSAS 19 requires certain disclosures in this respect. • The scope paragraph in IPSAS 19 makes it clear that while provisions, contingent liabilities, and contingent assets arising from employee benefits are excluded from the scope of the Standard, the Standard, however, applies to provisions, contingent liabilities, and contingent assets arising from termination benefits that result from a restructuring dealt with in the Standard. • IPSAS 19 uses different terminology, in certain instances, from IAS 37. The most significant examples are the use of the terms “revenue” and “statement of financial performance” in IPSAS 19. The equivalent terms in IAS 37 are “income” and “Statement of Comprehensive Income.” • The Implementation Guidance included in IPSAS 19 has been amended to be more reflective of the public sector. • IPSAS 19 contains an Illustrated Example that illustrates the journal entries for recognition of the change in the value of a provision over time, due to the impact of Page 349 the discount factor (the discount factor measures the way that time affects the value of money and is built into the calculations of long-term provisions). K. IPSASs 9 and 23 Accounting for revenues in the public sector (IPSASs 9 and 23) There are two IPSASs in particular that focus on accounting for revenues in the public sector. IPSAS 9 deals with accounting for what is known as exchange transactions and IPSAS 23 deals with accounting for non-exchange transactions, especially taxes and transfers. As IPSAS 23 has no IFRS equivalent it will be necessary to discuss this in more detail than some other IPSASs. What is the difference between exchange and a non-exchange transactions? Exchange transactions are transactions in which one entity receives assets or services, or has liabilities extinguished, and directly gives approximately equal value (primarily in the form of cash, goods, services, or use of assets) to another entity in exchange. This might be thought of as being equivalent to a commercial transactions which explains why this IPSAS is based on an IFRS (IAS 18, Revenue). So when, for example, a public sector provides goods and/or services for which it receives in return a payment that is related to their market value then it should apply IPSAS 9 in its accounting treatment. If on the other hand there is no exchange of approximately equal value then IPSAS 23 will apply – such transactions will be described as ‘non-exchange’ in nature. This will be the case for many public sector transactions. For example when governments raise taxation revenues, there is no direct correlation between them and consequent expenditures. Although the taxpayer will rightly expect ‘value’ from their tax contributions, it is not normally possible to directly match their individual contributions to say expenditures on health, education, defence or many other public services. IPSAS 9 – Exchange Transactions As already mentioned these have a similar nature to commercial transactions and are therefore based on IAS 18. IPSAS 9 reminds us that revenue is recognised when it is probable that future economic benefits or service potential will flow to the entity and when such benefits can be measured reliably. There are no significant variations between IPSAS 9 and IAS 18, with the differences in detail being as follows: • • • The title of IPSAS 9 differs from that of IAS 18, and this difference clarifies that IPSAS 9 does not deal with revenue from non-exchange transactions. The definition of “revenue” adopted in IPSAS 9 is similar to the definition adopted in IAS 18. The main difference is that the definition in IAS 18 refers to ordinary activities (IPSAS 9 makes no such distinction). Commentary additional to that in IAS 18 has also been included in IPSAS 9 to clarify the applicability of the standards to accounting by public sector entities. Page 350 • IPSAS 9 uses different terminology, in certain instances, from IAS 18. The most significant example is the use of the term “net assets/equity” in IPSAS 9. The equivalent term in IAS 18 is “equity.” IPSAS 23 – Non-Exchange Transactions The introduction to IPSAS 23 notes that the majority of government revenues is generated in the form of taxes and transfers but that, until the passing of the Standard, there was no specific guidance in how to deal with transactions involving such items. In summary, IPSAS 23: (a) Takes a transactional analysis approach whereby entities are required to analyse inflows of resources from non-exchange transactions to determine if they meet the definition of an asset and the criteria for recognition as an asset, and if they do, determine whether a liability is also required to be recognized; (b) Requires that assets recognized as a result of a non-exchange transaction initially be measured at their fair value as at the date of acquisition; (c) Requires that liabilities recognized as a result of a non-exchange transaction be recognized in accordance with the principles established in IPSAS 19, Provisions, Contingent Liabilities and Contingent Assets; (d) Requires that revenue equal to the increase in net assets associated with an inflow of resources be recognized; (e) Provides specific guidance that addresses: (i) Taxes; and (ii) Transfers, including: a. Debt forgiveness and assumption of liabilities; b. Fines; c. Bequests; d. Gifts and Donations, including goods in-kind; e. Services in-kind; (f) Permits, but does not require, the recognition of services in-kind; and (g) Requires disclosures to be made in respect of revenue from non-exchange transactions. An entity will recognize an asset arising from a non-exchange transaction when it gains control of resources that meet the definition of an asset and satisfy the recognition criteria. Contributions from owners do not give rise to revenue, so each type of transaction is analysed, and any contributions from owners are accounted for separately. Consistent with the approach set out in this Standard, entities will analyse non-exchange transactions to determine which elements of general purpose financial statements will be recognized as a result of the transactions. Two kinds of revenue transaction are relevant within the framework of IPSAS 23. The first is when an asset comes under the control of an entity without an approximately equivalent exchange taking place in return. This would be the case when for example an asset is transferred to an organisation free of charge (or, if there is a charge, it is significantly below market value). In such circumstances a simple yes/no decision tree needs to be followed which is illustrated below. Page 351 Simplistically summarised, the flowchart shows that in certain circumstances when a nonexchange transaction takes place then it creates both an asset and also revenue. For example, if an entity were given an asset for which they paid nothing but its market value was worth 5,000,000 RwF then the double entry for this would be to create an asset of 5,000,000 RwF and to recognise revenue (as a credit entry) also of 5,000,000 RwF. However, if the entity incurs a liability for that asset which is below its market value then the revenue should be reduced to the extent of that liability. Page 352 Revenue from taxes The general rule is that an entity shall recognize an asset in respect of taxes when the taxable event occurs and the asset recognition criteria are met. The definition of an asset is met when the entity controls the resources as a result of a past event (the taxable event) and expects to receive future economic benefits or service potential from those resources. In addition, it must be probable that the inflow of resources will occur and that their fair value can be reliably measured. Taxation revenue arises only for the government that imposes the tax, and not for other entities. For example, where the Rwandan government imposes a tax that is collected by the RRA, assets and revenue accrue to the government, not the taxation agency which is effectively acting as a collection agency on behalf of government. Taxes do not satisfy the definition of contributions from owners, because the payment of taxes does not give the taxpayers a right to receive (a) distributions of future economic benefits or service potential by the entity during its life, or (b) distribution of any excess of assets over liabilities in the event of the government being wound up. Nor does the payment of taxes provide taxpayers with an ownership right in the government that can be sold, exchanged, transferred, or redeemed. On the other hand, taxes satisfy the definition of a non-exchange transaction because the taxpayer transfers resources to the government, without receiving approximately equal value directly in exchange. While the taxpayer may benefit from a range of social policies established by the government, these are not provided directly in exchange as consideration for the payment of taxes. Recognition of taxation revenue is based on the time at which the taxable event takes place, examples of which are when: (a) Income tax is the earning of assessable income during the taxation period by the taxpayer; (b) Value-added tax is the undertaking of taxable activity during the taxation period by the taxpayer; (c) Goods and services tax is the purchase or sale of taxable goods and services during the taxation period; (d) Customs duty is the movement of dutiable goods or services across the customs boundary; (e) Property tax is the passing of the date on which the tax is levied, or the period for which the tax is levied, if the tax is levied on a periodic basis. Other types of non-exchange revenue Fines are economic benefits or service potential received or receivable by a public sector entity, from an individual or other entity, as determined by a court or other law enforcement body, as a consequence of the individual or other entity breaching the requirements of laws or regulations. Page 353 Fines normally require an entity to transfer a fixed amount of cash to the government, and do not impose on the government any obligations which may be recognized as a liability. As such, fines are recognized as revenue when the receivable meets the definition of an asset and satisfies the criteria for recognition as an asset which have already been discussed. Where an entity collects fines in the capacity of an agent, the fine will not be revenue of the collecting entity. Assets arising from fines are measured at the best estimate of the inflow of resources to the entity. Sometimes a bequest may be made to a government entity. A bequest is a transfer made according to the provisions of a deceased person’s will. The past event giving rise to the control of resources embodying future economic benefits or service potential for a bequest occurs when the entity has an enforceable claim, for example on the death of the person making the bequest. . Bequests that satisfy the definition of an asset are recognized as assets and revenue when it is probable that the future economic benefits or service potential will flow to the entity, and the fair value of the assets can be measured reliably. Determining the probability of an inflow of future economic benefits or service potential may be problematic if a period of time elapses between the death of the testator and the entity receiving any assets. The entity will need to determine if the deceased person’s estate is sufficient to meet all claims on it, and satisfy all bequests. If the will is disputed, this will also affect the probability of assets flowing to the entity. Therefore it can be seen that asset and revenue recognition is not always a straightforward situation with bequests. It is necessary to obtain an estimate of the fair value of bequeathed assets, for example by obtaining the latest market values for assets bequeathed. Disclosures Both IFRSs and IPSASs are as much about disclosure as they are about accounting treatment. IPSAS 23 has a list of disclosure requirements that apply specifically to non-exchange transactions. These include a requirement to disclose the following details: • Either on the face of, or in the notes to, the general purpose financial statements: UBLIC SECTOR (a) The amount of revenue from non-exchange transactions recognized during the period by major classes showing separately: (i) Taxes, showing separately major classes of taxes; and (ii) Transfers, showing separately major classes of transfer revenue. (b) The amount of receivables recognized in respect of non-exchange revenue; (c) The amount of liabilities recognized in respect of transferred assets subject to conditions (d) The amount of assets recognized that are subject to restrictions and the nature of those restrictions; and (e) The existence and amounts of any advance receipts in respect of non-exchange transactions. • An entity shall disclose in the notes to the general purpose financial statements: Page 354 (a) The accounting policies adopted for the recognition of revenue from non-exchange transactions; (b) For major classes of revenue from non-exchange transactions, the basis on which the fair value of inflowing resources was measured; (c) For major classes of taxation revenue that the entity cannot measure reliably during the period in which the taxable event occurs, information about the nature of the tax; and (d) The nature and type of major classes of bequests, gifts, and donations. Page 355
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