FAC1502E1_70539340 3..367 FAC1502 Study Guide

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University of South Africa
Muckleneuk, Pretoria
FAC1502/1/2018
70539340
3B2
ACN-Style
CONTENTS
Introduction and overview of the module (v)
Topic A THE BASIC PRINCIPLES AND SPHERES OF ACCOUNTING 1
STUDY UNIT 1: THE NATURE OF ACCOUNTING THEORY, PRINCIPLES,
ACCOUNTING POLICY, PRACTICE AND PROCEDURES 3
STUDY UNIT 2: THE FINANCIAL POSITION 12
STUDY UNIT 3: THE FINANCIAL PERFORMANCE (RESULT) 18
STUDY UNIT 4: THE DOUBLE-ENTRY SYSTEM AND THE ACCOUNTING
PROCESS 22
Topic B COLLECTING AND PROCESSING THE ACCOUNTING DATA OF
ENTITIES 57
STUDY UNIT 5: PROCESSING ACCOUNTING DATA 59
STUDY UNIT 6: ADJUSTMENTS 98
STUDY UNIT 7: THE CLOSING-OFF PROCEDURE, DETERMINING
PROFIT OF AN ENTITY AND PREPARING
FINANCIAL STATEMENTS 116
Topic C ACCOUNTABILITY FOR CURRENT AND NON-CURRENT ASSETS 167
STUDY UNIT 8: CASH AND CASH EQUIVALENTS 169
STUDY UNIT 9: TRADE AND OTHER RECEIVABLES 191
STUDY UNIT 10: INVENTORY 220
STUDY UNIT 11: PROPERTY, PLANT AND EQUIPMENT 230
STUDY UNIT 12: OTHER NON-CURRENT ASSETS 259
Topic D ACCOUNTABILITY FOR CURRENT AND NON-CURRENT LIABILITIES 263
STUDY UNIT 13: CURRENT LIABILITIES 265
STUDY UNIT 14: NON-CURRENT LIABILITIES 277
Topic E ACCOUNTING REPORTING 285
STUDY UNIT 15: FINANCIAL STATEMENTS OF A SOLE
PROPRIETORSHIP 287
STUDY UNIT 16: NONPROFIT ENTITIES 314
STUDY UNIT 17: INCOMPLETE RECORDS 342
FAC1502/1/1/2018 (iii)
Aims of this module
After having studied this module, you should be able to
.apply the basic principles of accounting
.gather, process and record relevant information and prepare basic statement of profit or loss
and other comprehensive income (income statement), statement of changes in equity and
statement of financial position (balance sheet)
.record assets properly and be accountable for assets
.record liabilities properly and be accountable for liabilities
.keep proper records to ascertain the financial performance and financial position of sole
proprietors and non-profit entities
.prepare proper books from incomplete records
NOTE
ALL REFERENCES TO ‘‘ACCOUNTING’’ IN THIS STUDY GUIDE MEANS ‘‘FINANCIAL
ACCOUNTING’’.
(iv)
INTRODUCTION AND OVERVIEW
OF THE MODULE
We would like to welcome you as a student to Module I (FAC1502) of the Accounting I course.
This is the second module of a series of modules presented by the Department of Financial
Accounting at UNISA. The title of this module is Accounting concepts, principles and
procedures.
The courses in the Department of Financial Accounting are presented to degree level (i.e. with
Accounting III as a major subject). This, together with another major and other subjects, will
enable you to obtain either the BCom or BCompt degree. You may, having completed the
BCom or BCompt degree, study further in accounting by studying the BCom/BCompt (honours)
degree and thereafter the MCom/MCompt and DCom/DCompt degrees. This will take quite a
number of years and hard work, but it is possible! The ultimate goal of many students in
accounting is to become accountants and to follow the BCompt route.
Your first milestone will, however, be to master (i.e. to pass) Accounting FAC1502. You must,
therefore, ensure that you understand and know everything contained in this module as
everything is important. It is not only required of you to know it for the examination, but you WILL
need it in future modules or in your everyday walk of life (if you do not study accounting further).
You may ask: Why is it necessary to study accounting? The most important reason will be: To
account for income and expenditure, and for assets and liabilities. You may say: I do not earn
an income or incur expenses, or I do not owe money or own assets. Our question will be in turn:
What about your pocket money, remuneration for work or part time work, your study bursary or
study loan (which is not an income, but a liability) or what about your clothes, books and
stationery you had to buy for your studies? You have to account for the value of all of it. This
does not only apply to your personal case, but especially to the business you own or the
organisation where you work.
Many persons and/or organisations fall into financial difficulties or even go bankrupt and people
land in jail as a result of their lack of knowledge of accounting. We would like to help you to
prevent this.
Now that you know WHY you must study Accounting, what are the aims of the Accounting
FAC1502 module?
Refer again to the Aims of this module, specified above.
FAC1502/1 (v)
Study activities
In this study guide a variety of exercises are given. You should do these exercises by yourself
also and compare your attempt with the solutions given in the study guide. It also contains self-
evaluation questions, to encourage your active participation in the learning process. These are
a combination of reading, studying, doing and thinking activities that are presented in a flexible
manner. This will enable you to absorb the knowledge content of the topic, to practice your
understanding and to direct your thoughts.
This is important because as you encounter these study activities and actually perform them,
you will become directly involved in controlling the extent and the quality of your learning
experience. In short, how much and how well you learn, will depend on the extent of your
progress through the study activities, and the quality of your effort.
In cases where exercises are given, the questions should be answered without reference to
the study material. You should then mark your answer against the answer given in the study
guide. Where your answer differs from that given in the study guide, ask yourself why?, how?,
when?, where? what did I do wrong? If more than 25% is incorrect, try again to answer the
question without referring to the study guide or your previous attempt. Accounting is very much
a practical subject; the more you practice, the better.
Meaning of words
Outcomes are communicated and assessment criteria are phrased in terms of what you should
be able to do. This involves the use of action words, describing what you must do in the
learning activity.
The following list of words includes examples of the action words that you will encounter in this
module. (You need not study this.)
Meaning of action words
WORD MEANING
1 Read So as to obtain a broad and basic background, knowledge or
information; do not study.
2 Read thoroughly Necessary theory that needs to be clearly understood. You may be
assessed on this theory through short questions.
3 Study Learn with the view of gaining the highest level of understanding
and mastery which is necessary for examinations, further study
and/or career.
You will not be required to give a definition of a concept in the
examinations. You will, however be required to apply the theory in
the correct accounting format and to follow the correct steps/
procedures. For example, the layout and terminology to be used in
the preparation of financial statements are prescribed. You may not
use any other formats.
4 Prepare You must make ready or complete what is required on the basis of
previous study.
(vi)
TOPIC A
THE BASIC PRINCIPLES AND SPHERES
OF ACCOUNTING
Learning outcome
The learner should be able to describe, calculate and record the financial performance and
financial position of a sole proprietor, by using the basic accounting equation and the
double-entry system to record the various types of transactions.
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CONTENTS
Study unit Page
1 THE NATURE OF ACCOUNTING THEORY, PRINCIPLES,
ACCOUNTING POLICY, PRACTICE AND PROCEDURES 3
2 THE FINANCIAL POSITION 12
3 THE FINANCIAL PERFORMANCE (RESULT) 18
4THE DOUBLE-ENTRY SYSTEM AND THE ACCOUNTING
PROCESS 22
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STUDY UNIT
1
The nature of accounting theory,
principles, accounting policy, practice
and procedures
Learning outcome
You are able to explain what is meant by the nature of accounting theory, principles,
accounting policy, practice and procedures.
Contents Page
Key concepts 4
1.1 Introduction 4
1.2 What is accounting? 5
1.2.1 Definition 5
1.2.2 The nature of accounting 5
1.3 Universal accounting denominator 6
1.4 Forms of ownership 6
1.5 Users of financial information 6
1.5.1 Investors 7
1.5.2 Employees 7
1.5.3 Lenders 7
1.5.4 Suppliers and other trade payables 7
1.5.5 Customers 7
1.5.6 Government and their agencies 7
1.5.7 Public 7
1.6 The fields of accounting 7
1.6.1 Financial accounting 7
1.6.2 Management accounting 7
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1.7 Accounting principles 8
1.8 Accounting policy 8
1.9 Disclosure of accounting policy 8
1.10 International Financial Reporting Standards (IFRS) 8
1.11 Accounting standards and statements 9
1.11.1 Introduction 9
1.11.2 The Conceptual Framework for Financial Reporting 2010 9
1.11.2.1 The objective of financial statements 9
1.11.2.2 Underlying assumption 9
1.11.2.3 The qualitative characteristics of financial statements 9
1.11.2.4 The elements of financial statements 9
1.11.2.5 Recognition and measurement of the elements of financial
statements 10
1.12 Exercise and solution 10
Self-assessment 11
KEY CONCEPTS
.financial information
.decision making
.nature of accounting
.unit of measurement
.forms of ownership
.fields of accounting
.accounting principles
.international financial reporting standards
.accounting statements
.accounting policy
.going concern
.qualitative characteristics
.elements of financial statements
BEFORE CONTINUING, STUDY TUTORIAL LETTER 101 UP TO THE FIRST ASSIGN-
MENT.
1.1 Introduction
In this module, we introduce you to the concepts, principles and procedures of accounting. The
first two study units are included mainly to give you some background knowledge. At first, the
information may appear to be rather confusing, but if you follow the study guide step by step,
working through all the examples in the prescribed book and exercises in this study guide, the
methods and procedures will become clear. To master this subject, you must get as much
practise as you can – so start early in the semester.
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Over the centuries, accounting developed in conjunction with and as part of the economic
system and it performs an extremely useful and important function in society.
Through the ages, records were always kept by hand, but nowadays computers are being used
increasingly. Whichever method is used, the basic principles remain unchanged, since all
activities in a business are still expressed in terms of money and are recorded. However, it is
necessary to know the procedures used in a manual system in order to understand how a
computerised accounting system works.
Read paragraph 1.1 of the prescribed book.
GOLDEN RULE
Accounting CAN NOT be studied by merely reading/memorising. You need to practise,
practise and practise again!
1.2 What is accounting?
1.2.1 Definition
Study paragraph 1.2 of the prescribed book.
Accounting is therefore a process consisting of the following three activities:
.identifying those events that are evidence of economic activity (transactions) relevant to the
particular business or entity
.recording the monetary value of the economic events (transactions) in order to provide a
permanent history of the financial activities of a business. Recording involves keeping a
chronological diary of measured events in an orderly and systematic manner and classifying
and summarising economic events
.communicating the recorded information to interested users. This information is commu-
nicated through the preparation and distribution of accounting reports, the most common of
which are known as financial statements.
Read paragraphs 1.3 and 1.4 of the prescribed book.
GOLDEN RULE
Accounting records transactions in order to provide useful information for decision making.
1.2.2 The nature of accounting
Accounting is a specialised means of communication which is used to convey a specialised
message about an entity’s finances. The recipient of this specialised message (the user of
financial information) must understand it otherwise the information that is conveyed has no
value.
Accounting uses words and figures to convey financial information to the users of such
information. As you progress with your study of accounting you will become familiar with the
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meaning of these words and figures, which are also known as the concepts, principles and
procedures of accounting. This knowledge will ultimately help you understand the message
contained in financial statements.
Each and every person who is involved in an entity uses financial information to a greater or
lesser degree. Each of us also needs to know something about accounting to manage our
personal financial affairs. Financial resources are limited or scarce, and if we are going to
spend them we must plan properly. Knowledge of accounting is therefore also useful in this
area.
Accounting is therefore a ‘‘language’’ used to convey financial information to interested parties.
Read paragraph 1.7 in the prescribed book thoroughly.
1.3 Universal accounting denominator
The common unit of measurement in accounting is money and in the RSA, the currency is
known as the rand. All an entity’s transactions are converted into monetary values before being
processed. Using money as the common denominator, however, gives rise to two important
limitations:
.Not all events can be expressed in monetary terms.
.The value of money is unstable and is influenced by many economic factors such as
inflation.
1.4 Forms of ownership
The form of a business ownership refers to the way in which a business is owned and
managed – how the original funds for starting the business were raised and how the profits,
losses and risks in the business are divided.
In the RSA, there are four main forms of ownership, namely:
.sole traders
.partnerships
.close corporations
.companies
Apart from these main forms of entities, non-profit entities can also be distinguished.
Study paragraph 1.5 and read paragraph 1.6 thoroughly in the prescribed book.
1.5 Users of financial information
Financial information is required by many users, who analyse the information for various
decision-making purposes. The following are the most common users of this information:
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1.5.1 Investors
1.5.2 Employees
1.5.3 Lenders
1.5.4 Suppliers and other trade creditors
1.5.5 Customers
1.5.6 Government and their agencies
1.5.7 Public
Study paragraphs 1.8 to 1.11 in the prescribed book.
1.6 The fields of accounting
Users of financial information can be subdivided into the following two categories:
.internal users – for example, management and employees
.external users – for example, investors, creditors and government
Two fields of accounting have developed as a result of this distinction between the users of the
information. Financial accounting is concerned with the provision of financial information to
mainly external parties, while management accounting is concerned with the provision of
financial information to people within the entity.
1.6.1 Financial accounting
This field of accounting is concerned with recording transactions and preparing the financial
statements for the entity as a whole. Financial accounting is governed by international financial
reporting standards (IFRS), which consists of external standards which must be adhered to.
These standards ensure the comparability of financial statements between entities.
1.6.2 Management accounting
Management accounting provides financial information for specific purposes. Managers use
this information in their decision making, which leads to the attainment of the objectives of the
entity. Without this financial information, it would be difficult for management to manage
effectively.
In this course we will be concentrating on financial accounting.
Study paragraph 1.12 and read paragraph 1.18 in the prescribed book.
GOLDEN RULE
Financial statements must reveal a fair presentation of the financial position, financial
performance and cash flow of an entity.
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1.7 Accounting principles
In this study unit we turn our attention to the theory of accounting. You may well ask: ‘‘Why?
Accounting is supposed to be a practical subject’’. This is true, but no subject that is logically
structured can exist without a theoretical foundation.
The techniques used in the practice of accounting are based on conceptual and theoretical
ideas. These ideas are generally known as accounting principles.
1.8 Accounting policy
Situations often occur in our everyday lives that are repetitive (ie they are always the same),
but they would each have a different outcome if we were to act differently each time. If we do
not have some kind of guideline on how we should act in such cases, our actions would
probably be inconsistent. Our friends would think we were unreliable. If we lay down a guideline
so that we always act the same way in a particular situation, we can say that we are
determining a policy for our actions, which will result in our actions being consistent.
We encounter precisely the same situation in accounting. Transactions of a repetitive nature
frequently occur, and the requirement of consistency means that an entity has to establish an
accounting policy to determine exactly how such transactions should be treated. Accounting
policy is thus a set of decisions about how the entity will handle the same type of transaction in
order to achieve a consistent result.
1.9 Disclosure of accounting policy
Since an accounting policy represents an entity’s decisions about situations which it could deal
with in various ways, it has to disclose its accounting policy in its financial statements. For
example, an entity has to indicate what basis it has used to deal with the depreciation of
property, plant and equipment.
1.10 International Financial Reporting Standards (IFRS)
This is the next important concept that you will encounter in your accounting studies. For the
sake of conciseness, we will refer to this as IFRS.
If everyone were to develop his or her own language and grammatical rules, communication
would break down. We therefore have generally applicable language and grammar rules.
Accounting, as a specialised medium of communication, has precisely the same problem. If
each entity were to prepare financial reports according to its own accounting rules and its
interpretation of accounting theory and principles, chaos would result in the world of economics
and business.
Afoundation has therefore been developed over the years for the measurement and
disclosure of the results of financial events (transactions).
This foundation is a general framework and encompasses, in broad terms, accounting
concepts, principles, methods and procedures collectively known as IFRS.
In this study guide, we will sometimes disclose more information in the financial statements
than is required by IFRS. This is done to provide more detail and to help you understand
certain concepts.
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1.11 Accounting standards and statements
1.11.1 Introduction
The objective of creating accounting standards for particular issues (eg for the treatment of
taxation in financial statements) is to limit the variety of available accounting practices, but
without striving for strict uniformity or creating a set of rigid rules for all circumstances. The
ultimate aim of accounting standards is to encourage widespread use of particular standards in
financial reporting and to eliminate undesirable alternatives.
1.11.2 The Conceptual Framework for Financial Reporting 2010
Bear in mind that the framework is not a standard. It is a framework ‘‘... which sets out the
objectives and concepts which underlie the preparation and presentation of financial
statements ...’’.
1.11.2.1 The objective of financial statements
Study paragraph 1.9 in the prescribed book again.
1.11.2.2 Underlying assumption
According to the framework, there is one underlying assumption for financial statements.
This is:
(1) the going concern.
Study paragraph 1.13 in the prescribed book.
1.11.2.3 The qualitative characteristics of financial statements
The fundamental qualitative characteristics are:
(1) relevance
(2) faithful representation
Further enhancements to the qualitative characteristics of financial information are:
(1) comparability
(2) verifiability
(3) timeliness
(4) understandability
Study paragraph 1.14 in the prescribed book.
1.11.2.4 The elements of financial statements
GOLDEN RULE
The following are elements of financial statements:
.Elements that measure the financial position (assets = equity + liabilities):
(1) assets
(2) liabilities
(3) equity
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.Elements that measure profitability (profit or loss = increase or decrease in equity):
(4) income
(5) expenses
Study paragraph 1.15 in the prescribed book.
1.11.2.5 Recognition and measurement of the elements of financial statements
Study paragraphs 1.16 to 1.18 in the prescribed book.
1.12 Exercise and solution
We end this study unit with a few revision questions. It is in your own interest to try to answer
these by referring to the study unit or prescribed book.
Exercise
(1) Discuss the nature of accounting.
(2) What is the common unit of measurement in accounting?
(3) Name the four main forms of ownership.
(4) Discuss the different users of financial information.
(5) Differentiate between financial accounting and management accounting.
(6) Name the qualitative characteristics of financial information.
(7) Define the concept of accounting policy.
(8) What is meant by disclosure of accounting policy?
(9) Describe the concept of international financial reporting standards.
(10) Discuss the underlying assumption of financial statements.
(11) Name the fundamental qualitative characteristics of financial statements.
(12) Name the elements of financial statements.
Solution
(1) Refer to paragraph 1.2.2.
(2) The common unit of measurement in accounting is money.
(3) Sole trader
Partnership
Close Corporation
Company
(4) See section 1.5.
(5) See section 1.6.
(6) See section 1.14.3 in the prescribed text book.
(7) See section 1.8 in the study guide.
(8) See section 1.9 in the study guide.
(9) See section 1.10 in the study guide.
(10) See section 1.13 in the prescribed book.
(11) Relevance
Faithful representation
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(12) Assets
Liabilities
Equity
Income
Expenses
SELF-ASSESSMENT
Now that you have studied this study unit, can you:
.describe the importance of financial information as a basis for decision making?
.discuss the different users of financial information and their needs?
.state the different forms of ownership?
.discuss the nature of accounting?
.explain the difference between financial and management accounting?
.name the qualitative characteristics of financial statements?
.explain what is meant by the accounting policy?
.explain what is meant by the disclosure of the accounting policy?
.explain what is meant by the international financial reporting standards?
.explain what is meant by the accounting standards and statements?
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STUDY UNIT
2
The financial position
Learning outcome
Students should be able to describe what the primary purpose of accounting is and what is
understood by the double entry system. They should also be able to calculate the financial
position of an entity and the elements of the basic accounting equation.
Contents Page
Key concepts 12
2.1 Introduction 13
2.2 Accounting entity 13
2.3 Financial position 13
2.4 Net asset value 13
2.5 Application of the basic accounting equation (BAE) 13
2.6 The double-entry system 15
2.7 Revision exercises and solutions 15
2.7.1 Revision exercise 1 15
2.7.2 Revision exercise 2 16
Self-assessment 17
KEY CONCEPTS
.Accounting entity
.Accounting equation
.Financial position
.Assets
.Liabilities
.Equity
.Double-entry
.Net worth
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2.1 Introduction
The primary purpose of accounting is to give information on the financial position and the
financial result of an entity. This study unit deals with the key elements of the financial position.
Read paragraph 2.1 of the prescribed book.
2.2 Accounting entity
Every entity for which separate financial records are kept is an accounting entity. It is extremely
important to see the business as a separate entity from its owners because transactions
entered into by the entity have to be dealt with from the point of view of the entity whose books
are being done.
Study paragraph 1.6 (again) as well as paragraph 2.2 of the prescribed book.
2.3 Financial position
The financial position of the entity is described in terms of assets and interests at a given time.
They are reflected in a statement of financial position, which is essentially an accounting report
on the financial position of an entity. The statement of financial positon communicates relevant
financial information to the owners, creditors and other interested parties.
Study paragraph 2.6 of the prescribed book.
2.4 Net asset value
The difference between the value of assets owned by an entity and the liabilities it has incurred
represents net asset value. If we express this as an equation, then
ASSETS 7LIABILITIES = NET ASSET VALUE
The net asset value represents the portion by which the assets exceed the liabilities. Net asset
value is therefore also called EQUITY.
Study paragraph 2.3 of the prescribed book.
2.5 Application of the basic accounting equation (BAE)
Exercise 1
The assets of Maxi Services amount to R30 000 and its liabilities (creditors) to R5 000.
Calculate the equity.
We use the BAE. The amounts which are given are substituted for the appropriate symbol and
the unknown symbol is calculated.
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A = E + L
E = A – L
= R30 000 7R5 000
= R25 000
Exercise 2
T Tom is the owner of Zebra Services which offers a carpet cleaning service. On
30 November 20.1 Zebra Services owns equipment amounting to R100 000. Clients owe
R40 000 for services rendered and Zebra Services owes R20 000 to a supplier for parts
purchased. Zebra Services also has R10 000 in cash in the bank.
Show the BAE for Zebra Services and determine the equity.
Step 1: Identify the assets
Step 1: Equipment = R100 000
Step 1: Trade receivables = R40 000
Step 1: Cash = R10 000
Step 2: Identify the liabilities
Step 1: Trade payables = R20 000
Substitute these amounts into the equation:
A = E + L
E = A – L
= R(100 000 + 40 000 + 10 000) 7R20 000
= R130 000
Zebra Service’s financial position can also be presented in the form of statement of financial
position (previously known as balance sheet) as follows:
ZEBRA SERVICES
STATEMENT OF FINANCIAL POSITION (BALANCE SHEET) AS AT 30 NOVEMBER 20.1
ASSETS R EQUITY AND LIABILITIES R
Equipment 100 000 Equity 130 000
Trade receivables 40 000 Trade payables 20 000
Cash in bank 10 000
150 000 150 000
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COMMENT
This statement of financial position (balance sheet) is in a basic form. Later we will deal
with statements of financial positions (balance sheets) in more detail.
Study paragraph 2.5 and 2.6 of the prescribed book.
2.6 The double-entry system
The double-entry system is based on the fact that every transaction affects two or more items
in the BAE. In principle it means that each transaction must be recorded in such a way that the
equation remains in balance. The dual effect which each transaction has on the elements of the
BAE is the fundamental principle on which all entries in an accounting system are based.
Study paragraphs 2.4, 2.6 and 2.7 of the prescribed book.
2.7 Revision exercises and solutions
2.7.1 Revision exercise 1
(1) Define the concept of an accounting entity.
(2) Describe the financial position of an entity in terms of the BAE.
(3) Explain the nature of
(a) assets
(b) equity
(c) liabilities
(4) Name two sources of financing.
(5) What is meant by the double-entry system?
Solution: Revision exercise 1
(1) An accounting entity is any entity for which separate financial records are kept.
(2) ASSETS = EQUITY + LIABILITIES
(3) (a) Assets are the possessions of the entity.
(b) Equity is the interest which the owner has in the business and which the entity
therefore owes to him.
(c) Liabilities are creditors’ interests or interests of parties other than the owner(s).
Liabilities are therefore the debts of the entity.
(4) The owner
Trade payables
(5) In principle it means that every transaction has a dual effect on the elements of the BAE
and that after every transaction the BAE must remain in balance.
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2.7.2 Revision exercise 2
Calculate the missing figures using the BAE.
R
(1) Bank = 4 000
Vehicles = 5 000
Equipment = 7 000
Capital = ?
(2) Capital = 150 000
Loan = 50 000
Bank = ?
Machinery = 190 000
(3) Bank = 5 000
Trade receivables = 15 000
Buildings = 100 000
Furniture = 40 000
Trade payables = 50 000
Capital = ?
(4) Capital = 60 000
Loan = 10 000
Trade payables = 6 000
Assets = ?
Solution: Revision exercise 2
(1) A = E + L
E = A – L
= R(4 000 + 5 000 + 7 000) 7R0
= R16 000
(2) A = E + L
R190 000 + Bank = R(150 000 + 50 000)
R190 000 + Bank = R(150 000 + 50 000) 7R190 000
= R10 000
(3) A = E + L
E = A – L
= R(5 000 + 15 000 + 100 000 + 40 000) 7R50 000
= R160 000 7R50 000
= R110 000
(4) A = E + L
= R60 000 + R(10 000 + 6 000)
= R76 000
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SELF-ASSESSMENT
Now that you have studied this study unit, can you:
.describe the primary purpose of accounting?
.describe an entity?
.describe the financial position of the entity?
.describe the double-entry system?
.calculate the elements of the basic accounting equation?
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STUDY UNIT
3
The financial performance (result))
Learning outcome
Students should be able to apply the concepts of income and expenditure to determine the
gross and net profits (or losses) and the effect thereof on equity.
Contents Page
Key concepts 18
3.1 Introduction 19
3.2 The financial performance (result) 19
3.3 Income 19
3.4 Expenditure 19
3.5 Influence of profit or loss on equity 19
3.6 Statement of profit or loss and other comprehensive income (income
statement) (financial performance) 20
3.7 Statement of changes in equity 20
3.8 Accounting policies and explanatory notes 20
3.9 Revision exercises and solutions 20
3.9.1 Revision exercise 1 20
3.9.2 Revision exercise 2 21
Self-assessment 21
KEY CONCEPTS
.Financial result
.Profit/loss
.Income
.Expenditure
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3.1 Introduction
In paragraph 2.3 we discussed the first component of the primary goal of accounting, which is
to determine the financial position of an entity as it is reflected in the statement of financial
position. In this study unit we discuss the second component of this primary goal, namely the
financial performance of the entity, and indicate how it is reflected in the form of a statement
of profit or loss and other comprehensive income.
Study paragraph 3.1 in the prescribed book.
3.2 The financial performance (result)
The financial result of an entity is measured in terms of the profit or loss which the entity has
made over a specific period, which is referred to as the financial period and which is normally
a year. An entity makes a profit when the income it has earned is more than the expenditure it
has incurred in generating or producing that income. The difference between the income and
expenditure is known as the profit or loss. Profit is the owner’s reward for the capital he or she
has invested and the entrepreneurial spirit he or she has shown. It therefore increases the
equity.
3.3 Income
The objective of every entity is to earn as large an income as possible.
Study paragraph 3.2.1 of the prescribed book.
3.4 Expenditure
Expenditure is incurred to earn income.
Study paragraph 3.2.2 of the prescribed book.
3.5 Influence of profit or loss on equity
Income (profit) increases and expenditure (losses) decreases the owner’s interest.
Study paragraph 3.3 of the prescribed book.
Exercise
The financial position (BAE) of T Payn, an attorney, on 28 February 20.0 is as follows:
A = E + L
R50 000 = R30 000 + R20 000
For the year ended 28 February 20.1 he had the following income and expenditure:
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R
Income received 180 000
Salaries expense 100 000
Administrative costs 20 000
Insurance expense 10 000
Calculate T Payn’s equity on 28 February 20.1.
We use the equation which we discussed in paragraph 2.4 and 4.3:
Profit = Income 7Expenditure
= R180 000 7R(100 000 + 20 000 + 10 000)
= R180 000 7R130 000
= R50 000
E = R30 000 + R50 000
= R80 000
COMMENTS
.Capital plus profit together form the equity of the owner. See the above exercise —
R(30 000 + 50 000) = R80 000.
.Profit is income minus expenditure.
3.6 Statement of profit or loss and other comprehensive
income (income statement) (financial peformance)
The financial performance is measured in the statement of comprehensive income of an entity
(previously known as the income statement).
Study paragraph 3.4 of the prescribed book.
3.7 Statement of changes in equity
Study paragraph 3.5 of the prescribed book.
3.8 Accounting policies and explanatory notes
Study paragraphs 3.6 and 3.7 of the prescribed book.
3.9 Revision exercises and solutions
3.9.1 Revision exercise 1
(1) How is the financial performance (result) calculated in accounting terms? Which financial
report reflects the financial performance?
(2) Give three examples of income.
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(3) Give three examples of expenditure.
(4) How is profit/loss determined for a financial period?
(5) Does a loss increase or decrease the equity of the owner?
Solution: Revision exercise 1
(1) Income minus expenditure. The statement of profit or loss and other comprehensive
income reflects the financial performance.
(2) Refer to paragraph 3.3.
(3) Refer to paragraph 3.4.
(4) Expenditure is subtracted from income. Refer to paragraph 3.2.
(5) A loss decreases equity.
3.9.2 Revision exercise 2
On 28 February 20.2 Alpha Services showed the following income and expenditure for the
financial year.
R
Income received 850 000
Salaries 520 000
Wages 50 000
Telephone expenses 4 000
Stationery 2 000
Interest received 1 000
Insurance 12 000
Calculate the net profit/loss of Alpha Services on 28 February 20.2.
Solution: Revision exercise 2
Income = Income received + Interest received
= R(850 000 + 1 000)
= R851 000
Expenditure = Salaries + Wages + Telephone + Stationery + Insurance
= R(520 000 + 50 000 + 4 000 + 2 000 + 12 000)
= R588 000
Profit = Income 7Expenditure
= R851 000 7R588 000
= R263 000
SELF-ASSESSMENT
Now that you have studied this study unit, can you:
.describe the concept income?
.describe the concept expenditure?
.calculate the profit (or loss)?
.calculate the effect of profit/loss on equity?
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STUDY UNIT
4
The double-entry system and the
accounting process
Learning outcome
Students should be able to analyse and record transactions in the books of an entity and
prepare financial statements.
Contents Page
Key concepts 23
4.1 Introduction 23
4.2 The double-entry system 23
4.3 The effect of transactions on the basic accounting equation (BAE) 24
4.4 Transactions which affect only assets, equity and liabilities 24
4.4.1 Capital contributions 24
4.4.2 Acquisition of loans 25
4.4.3 Purchase of assets for cash 26
4.4.4 Buying assets on credit (debt) 26
4.4.5 Payments to creditors 27
4.4.6 Withdrawals by owner 27
4.5 Transactions which give rise to income and expenditure 28
4.5.1 Income (cash) 28
4.5.2 Expenditure (cash) 29
4.5.3 Income (credit) 29
4.5.4 Expenditure (credit) 30
4.5.5 Payments received from debtors 31
4.6 Summary of transactions 31
4.7 Basic form of a statement of financial position 32
4.8 Revision exercises and solutions 32
4.8.1 Revision exercise 1 32
4.8.2 Revision exercise 2 34
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4.9 The general ledger account 36
4.9.1 Assets 36
4.9.2 Equity and liabilities 36
4.10 Balancing an account 36
4.11 Schematic representation 37
4.12 Recording of transactions in ledger accounts 38
4.13 The general ledger 40
4.14 The trial balance 43
4.15 Preparing financial statements 44
4.15.1 The statement of profit or loss and other comprehensive
income 44
4.15.2 The statement of changes in equity 45
4.15.3 The statement of financial position 46
4.15.4 Notes 47
4.16 Summary 47
4.17 Revision exercises and solutions 48
4.17.1 Revision exercise 1 48
4.17.2 Revision exercise 2 48
4.17.3 Revision exercise 3 49
4.17.4 Revision exercise 4 51
4.17.5 Revision exercise 5 53
Self-assessment 55
KEY CONCEPTS
.Debit and credit .Ledger
.Transactions .Contra account
.Effect on financial position .Folio number
.T-account .Trial balance
4.1 Introduction
We mentioned the double-entry system in paragraph 2.6 in the study guide — read that
paragraph again. To make a double-entry correctly, you need a good working knowledge of the
appropriate names for different things in accounting and particularly the concepts of ‘‘debit’’
and ‘‘credit’’. It is very important that you master this study unit since it explains the foundation
on which the accounting system is built.
Read paragraph 4.1 of the prescribed book.
4.2 The double-entry system
At this stage we are simply using the accounting equation as a teaching aid to explain the
analysis of transactions. The BAE does not form part of a formal accounting system.
To make a double-entry you must:
.Think about what the effect of the transaction is going to be on the BAE, in other words, how
it is going to affect the financial position of the entity.
.Identify the components (accounts) which are involved, that is the components which will
have the desired effect on the equation.
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.Determine which account(s) has/have to be debited and which account(s) has/have to be
credited.
.Be sure that the amount(s) debited are equal to the amount(s) credited.
.Be able to indicate the date of the transaction.
.Indicate the name of the contra ledger account in the account in which you are doing the
entry. The contra account is the other account which is involved in the transaction: the one
account refers to the other.
.Indicate the folio number of the subsidiary journal.
4.3 The effect of transactions on the basic accounting
equation (BAE)
A transaction is an agreed upon transfer of value from one party to another which affects
(changes) the amount, nature or composition of an entity’s assets, liabilities or equity. In other
words it affects the BAE. Entering into a transaction gives rise to the first step in the accounting
cycle, namely the completion of a source document.
Transactions may
.affect assets and/or equity and/or liabilities
.generate income or give rise to expenditure
Study paragraph 4.2 of the prescribed book.
4.4 Transactions which affect only assets, equity and
liabilities
Below we give practical examples of transactions which affect only assets or interests. (A ‘‘+’’
indicates an increase and a ‘‘7’’ indicates a decrease.)
Study paragraphs 4.2.1 to 4.2.4 of the prescribed book.
4.4.1 Capital contributions
Transaction
1 Feb 20.1
T Tom decided to start a carpet-cleaning business called Fix-’n-Mat. He
withdrew R130 000 from his personal savings account and deposited it in
Fix-’n-Mat’s bank account.
Analysis (1) The asset ‘‘Bank’’ increases by R130 000 and there is now money in
Fix-’n-Mat’s bank account.
(2) The owner, T Tom, provides Fix-’n-Mat with funds and increases his
interest in Fix-’n-Mat. The equity ‘‘Capital’’ increases by R130 000.
ASSETS =EQUITY +LIABILITIES
Bank Capital
RRR
Previous balances 0 0 0
This transaction + 130 000 + 130 000 0
New balances 130 000 =130 000 +0
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COMMENTS
.In an entity which has not yet entered into any transaction, the elements of the
equation will always be 0.
.The terms ‘‘bank’’ and ‘‘capital’’ in the analysis are actually names of accounts.
.The investment of capital is usually the first transaction.
.Capital may be contributed in the form of cash or any other asset (eg furniture).
‘‘Furniture’’ instead of ‘‘Bank’’ will then increase.
.The BAE balances after the transaction.
4.4.2 Acquisition of loans
Transaction
2 Feb 20.1
Fix-’n-Mat obtained a loan of R25 000 with a payback period of more than a
year from ABC Bank. The amount was paid into its bank account.
Analysis (1) The asset ‘‘Bank’’ increases by R25 000.
(2) ABC Bank now has a claim against or an interest in Fix-’n-Mat and a
liability, namely a ‘‘Loan: ABC Bank’’, comes into being.
ASSETS =EQUITY +LIABILITIES
Bank Capital Loan:
ABC Bank
RRR
Balances brought
down
130 000 130 000 0
Transaction + 25 000 0 + 25 000
New balances 155 000 =130 000 +25 000
COMMENTS
.The results of the first transaction form the balances which are brought down in this
transaction.
.Liabilities arise when another party or institution supplies funds (make loans) to the
entity.
.Amounts (in this case R25 000) are added to both the left-hand side and the right-
hand side of the BAE.
.The BAE balances after the transaction.
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4.4.3 Purchase of assets for cash
Transaction
6 Feb 20.1
Fix-’n-Mat bought equipment from XY Furnishers for R100 000 and paid by
cheque.
Analysis (1) The asset ‘‘Bank’’ decreases by R100 000 since money has been
withdrawn.
(2) The asset ‘‘Equipment’’ increases.
ASSETS = EQUITY + LIABILITIES
Equip- Loan:
ment Bank Capital
ABC Bank
R R R R
Balances brought down 0 155 000 130 000 25 000
Transaction +100 000 7100 000 0 0
New balances 100 000 55 000 = 130 000 + 25 000
COMMENTS
.Assets now consist of bank and equipment.
.The left-hand side of the equation increases and decreases. One asset is exchanged
for another asset.
.The BAE balances after the transaction.
4.4.4 Buying assets on credit (debt)
Transaction
10 Feb 20.1
Fix-’n-Mat bought furniture for R2 000 on credit from Joc Limited.
Analysis (1) The asset ‘‘Furniture’’ increases by R2 000.
(2) A liability, ‘‘Trade payables’’, comes into being.
EQUITY LIABILITIESASSETS = +
Furniture Equipment Bank Capital Loan:
Trade
ABC pay-
Bank ables
R R R R R R
Balances
brought down 0 100 000 55 000 130 000 25 000 0
Transaction +2 000 0 0 0 0 +2 000
New balances 2 000 100 000 55 000 = 130 000 + 25 000 2 000
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COMMENTS
.Assets may also be bought on credit and a creditor comes into being.
.The transaction is recorded when it is entered into and not when the payment is made.
.The left-hand side and the right-hand side of the BAE increase.
.The BAE balances after the transaction.
4.4.5 Payments to creditors
Transaction
11 Feb 20.1
Fix-’n-Mat paid Joc Limited’s account of R2 000.
Analysis (1) The asset ‘‘Bank’’ decreases by R2 000.
(2) The liability, ‘‘Trade payables’’ (liability), decreases by R2 000.
EQUITY LIABILITIESASSETS = +
Furniture Equipment Bank Capital Loan:
Trade
ABC pay-
Bank ables
R R R R R R
Balances brought
down 2 000 100 000 55 000 130 000 25 000 2 000
Transaction 0 0 72 000 0 0 72 000
New balances 2 000 100 000 53 000 = 130 000 + 25 000 0
COMMENTS
.The left-hand side and the right-hand side of the BAE decrease.
.The BAE balances after the transaction.
4.4.6 Withdrawals by owner
Transaction
12 Feb 20.1
The owner withdrew R1 000 for his own use.
Analysis (1) Fix-’n-Mat’s ‘‘Bank’’ decreases by R1 000.
(2) T Tom’s ‘‘Capital’’ (equity) in Fix-’n-Mat decreases by R1 000.
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EQUITY LIABILITIESASSETS = +
Furniture Equipment Bank Capital Loan:
Trade
ABC pay-
Bank ables
R R R R R R
Balances brought
down 2 000 100 000 53 000 130 000 25 000 0
Transaction 0 0 71 000 71 000 0 0
New balances 2 000 100 000 52 000 = 129 000 + 25 000 0
COMMENTS
.Withdrawals are the opposite of capital contributions and reduce capital. Remember,
withdrawals are not expenditure.
.Where the entity pays personal expenses of the owner’s, it is also treated as a
withdrawal.
.The left-hand side and the right-hand side of the BAE are reduced.
.The BAE balances after the transaction.
4.5 Transactions which give rise to income and expenditure
4.5.1 Income (cash)
Transaction
13 Feb 20.1
Fix-’n-Mat provided services for a client S Silver and received a cheque for
R1 000.
Analysis (1) The asset ‘‘Bank’’ increases by R1 000.
(2) The fee which Fix-’n-Mat earns is an income. Equity therefore
increases by R1 000.
ASSETS = EQUITY + LIABILITIES
Furniture Equipment Bank Capital Income/ Loan: Trade
Expend- ABC pay-
iture Bank ables
R R R R R R R
Balances
brought down 2 000 100 000 52 000 129 000 0 25 000 0
Transaction 0 0 +1 000 0 +1 000 0 0
New balances 2 000 100 000 53 000 = 129 000 1 000 + 25 000 0
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COMMENTS
.Income earned increases the equity. It is the objective of the entity to earn income for
the entrepreneur.
.The left-hand side and the right-hand side of the BAE increase.
.The BAE balances after the transaction.
4.5.2 Expenditure (cash)
Transaction
16 Feb 20.1
Fix-’n-Mat paid wages by cheque, R800.
Analysis (1) The asset ‘‘Bank’’ decreases by R800.
(2) Wages are an expenditure item and the equity decreases by R800.
ASSETS = EQUITY + LIABILITIES
Furniture Equipment Bank Capital Income/ Loan: Trade
Expenditure ABC pay-
Bank ables
R R R R R R R
Balances
brought down 2 000 100 000 53 000 129 000 1 000 25 000 0
Transaction 0 0 7800 0 7800 0 0
New balances 2 000 100 000 52 200 = 129 000 200 + 25 000 0
COMMENTS
.In essence expenditure incurred decreases income and therefore also decreases the
equity.
.The left-hand side and the right-hand side of the BAE decrease.
.The BAE balances after the transaction.
4.5.3 Income (credit)
Transaction
18 Feb 20.1
Fix-’n-Mat provided services worth R6 000 to C Canon on credit.
Analysis (1) C Canon becomes a debtor of Fix-’n-Mat. The asset ‘‘Trade
receivables’’ comes into being and increases by R6 000.
(2) ‘‘Income received’’ are an income item and equity increases by
R6 000.
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ASSETS = EQUITY + LIABILITIES
Income/ Trade
Trade Furniture Equipment Bank Capital Expenditure
Loan:
payables
receivables ABC Bank
R R R R R R R R
Balances brought
down 0 2 000 100 000 52 200 129 000 200 25 000 0
Transaction + 6 000 0 0 0 0 +6 000 0 0
New balances 6 000 2 000 100 000 52 200 = 129 000 6 200 + 25 000 0
COMMENTS
.Organisations or clients who owe money to an entity are known as debtors and arise
from the entity rendering services or goods on credit.
.The left-hand side and the right-hand side of the BAE increase.
.The realisation principle applies here, and the income is shown as having been earned
on 18 February when the service was provided and not when the cash is received.
4.5.4 Expenditure (credit)
Transaction
21 Feb 20.1
Fix-’n-Mat placed an advertisement in a local newspaper for R200.
Payment was due only in 30 days.
Analysis (1) The liability ‘‘Trade payables’’ increases by R200.
(2) ‘‘Advertisements’’ are an expenditure item and the equity decreases
by R200.
ASSETS = EQUITY + LIABILITIES
Income/ Trade
Trade Furniture Equipment Bank Capital Expenditure
Loan:
payables
receivables ABC Bank
R R R R R R R R
Balances brought
down 6 000 2 000 100 000 52 200 129 000 6 200 25 000 0
Transaction 0 0 0 0 0 7200 0 + 200
New balances 6 000 2 000 100 000 52 200 = 129 000 6 000 + 25 000 200
COMMENTS
.Expenditure may also be incurred on credit (for goods/services received).
.The organisations to which money is owed are known as creditors.
.The right-hand side of the BAE increases and decreases.
.The expenditure is shown on 21 February 20.1 and not only when it is paid.
.The BAE balances after the transaction.
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{
{
{
4.5.5 Payments received from debtors
Transaction
28 Feb 20.1
C Canon settled his account in part, R2 000.
Analysis (1) The asset ‘‘Bank’’ increases by R2 000.
(2) The asset ‘‘Trade receivables’’ decreases by R2 000.
ASSETS = EQUITY + LIABILITIES
Income/ Trade
Trade Furniture Equipment Bank Capital Expenditure
Loan:
payables
receivables ABC Bank
R R R R R R R R
Balances brought
down 6 000 2 000 100 000 52 200 129 000 6 000 25 000 200
Transaction 72 000 0 0 + 2 000 0 0 0 0
New balances 4 000 2 000 100 000 54 200 = 129 000 6 000 + 25 000 200
COMMENTS
.This transaction affects assets only.
.The left-hand side of the BAE increases and decreases.
.The BAE balances after the transaction.
4.6 Summary of transactions
Fix-’n-Mat’s transactions for February 20.1 can now be summarised as follows:
ASSETS = INTERESTS
EQUITY + LIABILITIES
Trade Income/ Loan: Trade
Date receivables Furniture Equipment Bank Capital Expenditure ABC Bank payables
20.1 R R R R R R R R
Feb
1 +130 000 +130 000
2 +25 000 +25 000
6 +100 000 7100 000
10 +2 000 +2 000
11 72 000 72 000
12 71 000 71 000
13 +1 000 +1 000
16 7800 7800
18 +6 000 +6 000
21 7200 +200
28 72 000 +2 000
+4 000 +2 000 +100 000 +54 200 = +129 000 +6 000 + +25 000 +200
160 200 = 135 000 + 25 200
= 160 200
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COMMENT
.Note that these totals correspond to the closing balances in paragraph 4.5.5 above.
4.7 Basic form of a statement of financial position (previously
known as the balance sheet)
Now we are going to prepare a statement of financial position using the totals of the BAE (see
paragraph 4.6). The basic form of the statement of financial position is based on the BAE. You
have already come across a very simple statement of financial position in paragraph 2.5. A
statement of financial position is a report and in essence is a formal presentation of the
elements of the BAE.
FIX-’N-MAT
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1
ASSETS Note R
Non-current assets 102 000
Equipment 100 000
Furniture 2 000
Current assets 58 200
Trade and other receivables 4 000
Cash and cash equivalents 54 200
Total assets 160 200
EQUITY AND LIABILITIES
Total equity 135 000
Capital 135 000
Non-current liabilities 25 000
Long-term borrowings 25 000
Current liabilities 200
Trade and other payables 200
Total equity and liabilities 160 200
COMMENTS
.The statement of financial position balances and shows the same totals as the BAE.
.Note the heading — the statement of financial position is prepared to reflect the
financial position on a specific date.
.The withdrawals are subtracted from the capital. As mentioned, withdrawals are not
an expenditure item.
.The equity in the BAE is also R135 000.
4.8 Revision exercises and solutions
4.8.1 Revision exercise 1
D Paulus started a television antenna installation business on 1 June 20.1. The following
transactions took place during the first month:
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{
Transactions:
June 1 Cash in the bank deposited as opening capital, R25 000.
2 D Paulus made his private equipment available to the business, R9 000.
3 Additional equipment purchased and paid for by cheque, R12 000.
4 Installation fees for work done on account for Kannadrift Municipality, R4 200.
6 Vehicle purchased on credit from Virginia Cars Limited, R22 400. This vehicle
was financed by obtaining a loan from Crown Bank at an interest rate of 9% per
annum.
17 Kannadrift Municipality paid R2 200 on their account.
28 Wages paid, R4 000.
29 Cheque drawn for private use, R1 300.
30 Paid R9 000 to Virginia Cars Limited on their account.
Required:
Using the basic accounting equation, analyse the abovementioned transactions as
follows:
NB: (1) Show the effect of each transaction on the basic accounting equation with a plus
sign (+) for an increase and a minus sign (7) for a decrease.
(2) Balance the equation.
Example: On 1 July 20.1 D Paulus received R2 000 in cash for an installation done for Cook
Financing Corporation.
Date Basic accounting equation
A = E + L
20.1 R R R
July 1 + 2 000 + 2 000 0
Solution: Revision exercise 1
D PAULUS
Date Basic accounting equation
A = E + L
20.1 R R R
June 1 + 25 000 +25 000
Jun e 2 + 9 000 + 9 000
Jun e 3 + 12 000
712 000
Jun e 4 + 4 200 + 4 200
Jun e 6 + 22 400 +22 400
Ju ne 17 + 2 200
72 200
Ju ne 28 74 000 74 000
Ju ne 29 71 300 71 300
Ju ne 30 79 000 79 000
Total 46 300 32 900 13 400
46 300
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4.8.2 Revision exercise 2
The following transactions during January 20.1 relate to F Fox, an attorney.
Date Transactions Amount
20.1 R
Jan 3 F Fox deposited as opening capital 20 000
Jan Paid rental for January 20.1 2 300
Jan 4 Bought law library on credit from Book Limited 24 000
Jan 5 Bought a computer for cash from Leo Limited 1 700
Jan 6 Provided services for cash 7 200
Jan 9 Debited D Dunn with fees for services rendered 8 318
Jan 10 Leo Limited repaired equipment on credit 100
Jan 13 F Fox drew a cheque for private use 1 234
Jan 18 F Fox received commission on a property transaction 1 350
Jan 29 Paid the following by cheque
i(i) Salaries 8 350
(ii) Leo Limited (on account) 100
Jan 30 Received payment from D Dunn on his account 1 500
Required:
(1) Analyse the above transactions in tabular form as follows:
ASSETS = EQUITY + LIABILITIES
Library Trade Income/
Date and receiv- Bank Capital Expendi- Trade payables
Equip- ables ture
ment
Total = +
(2) Prepare the statement of financial position of F Fox at 31 January 20.1.
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{
{
Solution: Revision exercise 2
F FOX
(1) ACCOUNTING EQUATION
ASSETS =EQUITY +LIABILITIES
Library Trade Income/
Date and receiv- Bank Capital Expendi- Trade payables
Equip- ables ture
ment
20.1 R R R R R R
Jan 3 +20 000 +20 000
72 300 72 300
Jan 4 +24 000 + 24 000
Jan 5 + 1 700 71 700
Jan 6 +7 200 +7 200
Jan 9 +8 318 +8 318
Jan10 7100 + 100
Jan13 71 234 71 234
Jan18 +1 350 +1 350
Jan29 78 350 78 350
7100 7100
Jan30 71 500 +1 500
Total +25 700 +6 818 +16 366 = +18 766 +6 118 + +24 000
R48 884 R48 884
F FOX
(2) STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY 20.1
ASSETS Note R
Non-current assets 25 700
Equipment 1 700
Library 24 000
Current assets 23 184
Trade and other receivables 6 818
Cash and cash equivalents 16 366
Total assets 48 884
EQUITY AND LIABILITIES
Total equity 24 884
Capital 24 884
Current liabilities 24 000
Trade and other payables 24 000
Total equity and liabilities 48 884
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4.9 The general ledger account
Up to now we have dealt only with asset, liability and equity items appearing in a statement of
financial position or BAE.
We recorded transactions in columns in the summary of the BAE to show their effect on a
specific asset, equity or liability item. We had columns for debtors, furniture, equipment, capital
and so on. But it is impractical to prepare a new equation after every new transaction — just
think what would happen in a business with thousands of transactions! To avoid this we are
now going to open an account in the general ledger for every column of the BAE. We speak of
the general ledger because there are also subsidiary ledgers, which we will explain later.
An account is opened in the general ledger for every asset, liability and equity item. Every
account appears on its own on a page in the ledger and each account is given a number, which
is known as a folio number.
An account is an accounting record in which all transactions relating to a specific item are
recorded.
Study paragraphs 4.3 to 4.3.1 in the prescribed book.
4.9.1 Assets
Study paragraph 4.3.1 in the prescribed book.
4.9.2 Equity and liabilities
Study paragraphs 4.3.2 to 4.3.5 in the prescribed book.
4.10 Balancing an account
With what you have learnt about an account, we now know that an account may have entries
on the debit or the credit side or on both sides.
Study paragraph 4.4 in the prescribed book.
NB:
The closing balance of the previous period becomes the opening balance of the next period.
.c/d = carried down, which indicates the amount to be carried down to the following month
.b/d = brought down, which indicates that the amount has been brought down from the
previous month
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statement of financial position and Notes
in equity to changes
4.11 Schematic representation
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~~
~~
COMMENTS
.The top level of the schematic representation shows the basic accounting equation
(BAE).
.The second level of the schematic representation shows how each of the components
of the BAE becomes part of the account system. The left-hand side of the account is
known as the debit side (Dr) and the right-hand side as the credit side (Cr).
.The total of the amounts on the debit side of an asset account is usually larger than
that on the credit side. The account will therefore usually have a debit balance
(brought down). The total of the amounts on the credit side of a liability account is
usually larger than that on the debit side. The account will therefore usually have a
credit balance (brought down).
.The capital account reflects the equity of the owner at the date of the statement of
financial position. The balance on this account is the result of income, expenditure,
drawings and capital investment. These components are all dealt with separately in
the accounting system.
.Additional capital contributions and income increase equity.
.Drawings and expenditure decrease equity.
.But note: drawings is not an expenditure and therefore does not reduce
the profit.
.The left hand side (Equity section) forms the basis for the preparation of the statement
of profit or loss and other comprehensive income and the statement of changes in
equity.
.The capital (Equity section) and the right hand side (ASSETS and LIABILITIES) form
the basis for the preparation of the statement of financial position.
4.12 Recording of transactions in ledger accounts
When we enter a transaction in a ledger account, we have to ask ourselves: Which accounts
are affected? In answer to this question, we are now going to record the transactions in
paragraphs 4.4 and 4.5 in the ledger accounts (T-accounts).
Transaction
(4.4.1)
Bank Capital
130 000 130 000
(4.4.2)
Bank Loan
25 000 25 000
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~~
~ ~
~~
~ ~
~~
~ ~
(4.4.3)
Equipment Bank
100 000 100 000
(4.4.4)
Furniture Trade payables (Joc Ltd)
2 000 2 000
(4.4.5)
Bank Trade payables (Joc Ltd)
2 000 2 000
(4.4.6)
Bank Drawings
1 000 1 000
COMMENT
All drawings by the owner are recorded in a separate account, namely ‘‘Drawings’’, and
not directly in the capital account. Drawings is a disbursement of the profit to the owner
and is not expenses resulting from business operations.
(4.5.1)
Bank Income (fees)
1 000 1 000
(4.5.2)
Bank Wages
800 800
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~ ~
~~
~~
(4.5.3)
Trade receivables (C Canon) Income (fees)
6 000 6 000
(4.5.4)
Trade payables Advertisements
200 200
(4.5.5)
Bank Trade receivables (C Canon)
2 000 2 000
4.13 The general ledger
In the previous example two accounts were opened each time for each transaction. In practice
all transactions which affect, say, bank are summarised in one account for bank. Given the
information we have above, the accounts will take the following form. Each one is closed off
and the balance determined.
GOLDEN RULE
Assets (eg Bank) increase on the Debit (Dr) side and decrease on the Credit (Cr) side of
the account.
Dr Bank Cr
Date Details Fol Amount Date Details Fol Amount
20.1 R 20.1 R
Feb 1 Capital 130 000 Feb 6 Equipment 100 000
Feb 2 Loan:ABC Bank 25 000 Feb 11 Trade payables 2 000
Feb 13 Income received 1 000 Feb 12 Drawings 1 000
Feb 28 Trade receivables 2 000 Feb 16 Wages 800
Feb 28 Balance c/d 54 200
158 000 158 000
20.1
Mar 1 Balance b/d 54 200
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Dr Equipment Cr
20.1 R
Feb 6 Bank 100 000
Dr Furniture Cr
20.1 R
Feb 10 Creditors 2 000
Dr Trade receivables Cr
20.1 R 20.1 R
Feb 18 Income received 6 000 Feb 28 Bank 2 000
Balance c/d 4 000
6 000 6 000
20.1
Mar 1 Balance b/d 4 000
GOLDEN RULE
Equity (eg Capital) and Liabilities (eg Creditors) increase on the credit (Cr) side and
decrease on the debit (Dr) side of the account.
GOLDEN RULE
Income (eg Sales) increases equity and are credited (Cr) to the particular income account.
GOLDEN RULE
Expenses (eg Wages) decreases equity and are debited (Dr) to the particular expense
account.
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Dr Capital Cr
20.1 R
Feb 1 Bank 130 000
Dr Drawings Cr
20.1 R
Feb 12 Bank 1 000
Dr Loan: ABC Bank Cr
20.1 R
Feb 2 Bank 25 000
Dr Trade payables Cr
20.1 R 20.1 R
Feb 11 Bank 2 000 Feb 10 Furniture 2 000
28 Balance c/d 200 21 Advertisements 200
2 200 2 200
20.1
Mar 1 Balance b/d 200
Dr Wages Cr
20.1 R
Feb 16 Bank 800
Dr Advertisements Cr
20.1 R
Feb 21 Creditors 200
Dr Income (fees) Cr
20.1 R
Feb 13 Bank 1 000
18 Debtors 6 000
7 000
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COMMENT
.Note that the details of an item in a ledger account is simply the name of the other
ledger account involved in the transaction. This other ledger account is known as the
contra ledger account.
4.14 The trial balance
Study paragraph 4.5 of the prescribed book.
A trial balance is a list of the balances brought down (b/d) of the accounts in the general ledger
on a specific date.
GOLDEN RULE
The balance ‘‘brought down’’ (b/d) must be used to prepare the trial balance.
The following trial balance has been prepared from the ledger accounts in paragraph 4.13.
FIX-N-MAT
TRIAL BALANCE AS AT 28 FEBRUARY 20.1
Dr Cr
R R
Bank 54 200
Equipment 100 000
Furniture 2 000
Trade receivables 4 000
Capital 130 000
Drawings 1 000
Loan 25 000
Trade payables 200
Wages 800
Advertisements 200
Income received 7 000
162 200 162 200
GOLDEN RULE
Asset and expense accounts have debit (Dr) balances brought down (b/d) and are entered
on the debit side of the trial balance.
GOLDEN RULE
Equity (capital), liability and income accounts have credit (Cr) balances brought down (b/d)
and are entered on the credit side of the trial balance.
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COMMENTS
.The trial balance balances.
.Note that an account with a debit balance (brought down) is shown on the debit side of
the trial balance and an account with a credit balance (brought down) on the credit
side.
.If we compare the totals of the trial balance with the totals of the columns of the BAE
(see paragraph 4.6), we note the following:
.Capital in the BAE is R129 000. In the trial balance capital, R130 000 (Cr), and
drawings, R1 000 (Dr), are shown separately. This also gives a net total of
R129 000.
.Income less expenditure = R6 000. If the expenses in the trial balance, namely
wages and advertisements with debit balances of R800 and R200 respectively, are
subtracted from the income, namely fees with a credit of R7 000, the net amount is
R(7 000 71 000) = R6 000 credit, which corresponds to the income in the
BAE.
4.15 Preparing financial statements
In this module we deal with the statement of financial position, statement of profit or loss and
other comprehensive income and statement of changes in equity as well as some of the notes.
The statement of cash flows will be dealt with in FAC1601.
As mentioned previously, the trial balance serves as a basis for preparing a statement of profit
or loss and other comprehensive income, statement of changes in equity, and statement of
financial position. The trial balance represents the information in the ledger. The statement of
profit or loss and other comprehensive income shows the entity’s financial result and the
statement of financial position shows its financial position.
Study paragraphs 4.6 and 4.7 of the prescribed book.
4.15.1 The statement of profit or loss and other comprehensive income
We now use the information from the trial balance in paragraph 4.14 above to prepare a
statement of profit or loss and other comprehensive income for Fix-’n-Mat.
FIX-’N-MAT
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
MONTH ENDED 28 FEBRUARY 20.1
Note R
Revenue 7 000
Distribution, administrative and other expenses (1 000)
Wages 800
Advertisements 200
Profit for the period 6 000
Other comprehensive income for the period
Total comprehensive income for the period 6 000
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COMMENTS
.Note the title. A statement of profit or loss and other comprehensive income is
prepared for a period ended, not on a certain date.
.The profit for the period as determined in the statement of profit or loss and other
comprehensive income corresponds to the income/expenditure column in the BAE.
.The income and expenditure accounts are called nominal accounts.
GOLDEN RULE
Revenue (comprising income accounts) less expenses result in a profit or loss.
4.15.2 The statement of changes in equity
This statement shows all the changes in equity which have occurred during the financial period.
The purpose of the statement of changes in equity is to reconcile the equity at the beginning of
the financial period with the equity at the end of the financial period. The balance of the equity
at the end of the financial period is then shown in the statement of financial position. Equity will
be discussed in more detail later in this study guide.
FIX-’N-MAT
STATEMENT OF CHANGES IN EQUITY FOR THE MONTH ENDED 28 FEBRUARY 20.1
Capital
R
Balance at 1 February 20.1 130 000
Total comprehensive income for the period 6 000
Drawings (1 000)
Balance at 28 February 20.1 135 000
GOLDEN RULE
The profit increases equity and a loss decreases equity.
COMMENTS
.Note that the statement of changes in equity is prepared for a period ended and not
on a specific date.
.The equity at the end of the month corresponds to the net total in the BAE in paragraph
4.6.
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GOLDEN RULE
The balance at the end of the period on the statement of changes in equity must be the
same as the ‘‘capital’’ reflected in the statement of financial position.
4.15.3 The statement of financial position
Before we prepare a statement of financial position, please refer to paragraph 2.5 and also to
the statement of financial position for Fix-’n-Mat which we compiled in paragraph 4.7.
We will now show the statement of financial position of Fix-’n-Mat in narrative form and in
compliance with IFRS.
FIX-’N-MAT
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1
ASSETS Note R
Non-current assets 102 000
Property, plant and equipment 3 102 000
Current assets 58 200
Trade and other receivables 4 000
Cash and cash equivalents (bank) 54 200
Total assets 160 200
EQUITY AND LIABILITIES
Total equity 135 000
Capital 135 000
Total liabilities 25 200
Non-current liabilities 25 000
Long-term borrowings 25 000
Current liabilities 200
Trade and other payables 200
Total equity and liabilities 160 200
COMMENTS
.See paragraph 4.15.4, Notes, for the calculation of property, plant and equipment.
.The total assets of R160 200 corresponds to the total as shown in the BAE in
paragraph 4.6.
.The total equity and liabilities of R160 200 corresponds to the total as shown in the
BAE in paragraph 4.6.
.Words and figures between brackets is for explaining purposes only and do not form
part of any financial statement.
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GOLDEN RULES
.ASSETS are, at this stage, grouped into non-current and current assets.
.Non-current assets do not change often and are used in ordinary business, production
or to render services.
.Current assets change after every operating transaction, thus very often.
.EQUITY (the interest of the owner(s) in the entity) comprise, at this stage, of capital only.
.LIABILITIES comprise, at this stage, non-current and current liabilities
.Non-current liabilities are to be paid after 12 months and do not change often. Current
liabilities are short term, change often and must be repaid within 12 months.
4.15.4 Notes
Additional information on items appearing in the financial statements is given in the notes to the
financial statements.
These explanatory notes are shown after the statement of cash flows. We do not deal with the
statement of cash flows in this module and will therefore show the notes after the statement of
profit or loss and other comprehensive income.
Note number 1 is used to reveal the accounting policies of the business. Now let us prepare the
notes of Fix-’n-Mat.
FIX ’N MAT
NOTES FOR THE MONTH ENDED 28 FEBRUARY 20.1
1. Accounting policy:
The financial statements have been prepared on the historical cost basis and comply with
International Financial Reporting Standards.
2. Revenue represents fees earned for services rendered to clients.
3. Property, plant and equipment Equipment Furniture Total
R R R
Carrying amount: Beginning of period
Cost — —
Accumulated depreciation
Additions 100 000 2 000 102 000
Depreciation — —
Carrying amount: End of period 100 000 2 000 102 000
Cost 100 000 2 000 102 000
Accumulated depreciation
No depreciation was written off during this financial period.
4.16 Summary
We began by explaining the financial position (statement of financial position) and financial
performance (statement of profit or loss and other comprehensive income) and then went back
to how we enter into a transaction to set the accounting process in motion.
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4.17 Revision exercises and solutions
4.17.1 Revision exercise 1
(1) Name the three groups of accounts in the general ledger.
(2) What is the difference between the total debits and the total credits of an account called?
(3) How do we test the arithmetical accuracy of transactions in the general ledger?
Solution: Revision exercise 1
(1) .Assets
.Liabilities
.Equity, which includes:
.capital
.drawings
.income
.expenditure
(2) Balance
(3) By preparing a trial balance
4.17.2 Revision exercise 2
List each of the following ledger accounts under one of the categories in the table below.
‘‘Furniture’’ is inserted as an example.
ASSETS EQUITY LIABILITIES
Non-
Non-current Current Expendi- current Current
assets assets Capital Income ture liabilities liabilities
Furniture
Ledger accounts to be classified:
(a) Land and buildings
(b) Bond
(c) Petty cash
(d) Postage
(e) Interest income
(f) Vehicles
(g) Salaries
(h) Trade receivables
(i) Trade payables
(j) Bank overdraft
(k) Income received
(l) Electricity deposit
(m) Drawings
(n) Subscriptions (e.g. Membership fees)
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Solution: Revision exercise 2
ASSETS EQUITY LIABILITIES
Non- Non-
current Current current Current
assets assets Capital Income Expenditure liabilities liabilities
(a) Land and
buildings
(b) Bond
(c) Petty cash
(d) Postage
(e) Interest
income
(f) Vehicles
(g) Salaries
(h) Trade
receivables
(i) Trade
payables
(j) Bank
overdraft
(k) Income
received
(l) Electricity
deposit
(m) Drawings
(n) Subscriptions
4.17.3 Revision exercise 3
The following transactions during February 20.1 relate to G Goodman, a dentist:
Date Transactions Amount
20.1 R
Feb 1 G Goodman deposited as opening capital 50 000
Feb 2 G Goodman transferred personal equipment to his firm 6 000
Feb 4 Paid rental for February by cheque 8 000
Feb 6 Bought furniture on credit from Badman 12 000
Feb 8 Rendered services on credit to R Rudman 30 000
Feb 12 G Goodman drew a cheque for private use 1 000
Feb 16 Issued a cheque to Badman in part payment of their account 5 000
Feb 20 Rendered services for cash to C Coleman 7 000
Feb 27 Received payment from R Rudman on his account 1 300
Feb 28 Paid the following by cheque:
ii(i) Salaries 10 000
i(ii) Wages 2 000
(iii) Telephone 500
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Required:
Record the above transactions using a table as illustrated in the following example:
Feb 28 G Goodman paid the water and electricity account by cheque — R600.
Date General ledger A = E + L
20.1 Account Account Dr Cr Dr Cr Dr Cr
Feb debited credited
R R R R R R
28 Water and Bank
electricity 600 600
Solution: Revision exercise 3
G GOODMAN
Date General ledger A = E + L
20.1 Account Account
Feb debited credited Dr Cr Dr Cr Dr Cr
R R R R R R
1 Bank Capital 50 000 50 000
2 Equipment Capital 6 000 6 000
4 Rent Bank
expenses 8 000 8 000
6 Furniture B Badman 12 000 12 000
8 R Rudman Income
received 30 000 30 000
12 Drawings Bank 1 000 1 000
16 B Badman Bank 5 000 5 000
20 Bank Income
received 7 000 7 000
27 Bank R Rudman 1 300 1 300
28 Salaries Bank 10 000 10 000
Wages Bank 2 000 2 000
Telephone Bank
expenses 500 500
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4.17.4 Revision exercise 4
The following transactions during October 20.1 relate to Witblits Electricians:
Date Transactions Amount
20.1 R
Oct 1 W Blits, the owner, deposited as opening capital 10 000
Obtained loan from SA Bank 6 000
Oct 3 Bought equipment on credit from Sparks Dealers 1 000
Oct 9 Issued a cheque for an advertisement in a local news-
paper 200
Oct 12 Paid the telephone account by cheque 75
Oct 13 Received a cheque from H House for services rendered 500
Oct 17 Drew a cheque for private use 2 000
Oct 24 As an additional capital contribution W Blits transfered
his motor vehicle to the business 9 000
Oct 27 Paid salaries by cheque 2 000
Oct 30 Issued a cheque to SA Bank as a repayment on the loan 1 500
Required:
Prepare the following in the accounting records of Witblits Electricians:
(1) The appropriate ledger accounts which reflect the above transactions, properly
balanced/closed on 31 October 20.1.
NB: Indicate the correct contra ledger account.
(2) The trial balance on 31 October 20.1.
Solution: Revision exercise 4
WITBLITS ELECTRICIANS
(1) GENERAL LEDGER
Dr Capital: W Blits Cr
20.1 R
Oct 1 Bank 10 000
Oct 24 Vehicles 9 000
19 000
Dr Drawings: W Blits Cr
20.1 R
Oct 17 Bank 2 000
Dr Equipment (at cost) Cr
20.1 R
Oct 3 Sparks
Dealers 1 000
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Dr Vehicles (at cost) Cr
20.1 R
Oct 24 Capital:
W Blits 9 000
Dr Bank Cr
20.1 R 20.1 R
Oct 1 Capital 10 000 Oct 9 Advertisements 200
Long-term Oct 12 Telephone expenses 75
loan 6 000 Oct 17 Drawings:
13 Income received 500 W Blits 2 000
Oct 27 Salaries 2 000
Oct 30 Long-term loan 1 500
Oct 31 Balance c/d 10 725
16 500 16 500
20.1
Nov 1 Balance b/d 10 725
Dr Long-term borrowing (SA Bank) Cr
20.1 R 20.1 R
Oct 30 Bank 1 500 Oct 1 Bank 6 000
31 Balance c/d 4 500
6 000 6 000
20.1
Nov 1 Balance b/d 4 500
Dr Sparks Dealers Cr
20.1 R
Oct 3 Equipment 1 000
Dr Advertisements Cr
20.1 R
Oct 9 Bank 200
Dr Income received Cr
20.1 R
Oct 13 Bank 500
Dr Salaries Cr
20.1 R
Oct 27 Bank 2 000
Dr Telephone expenses Cr
20.1 R
Oct 12 Bank 75
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WITBLITS ELECTRICIANS
(2) TRIAL BALANCE AS AT 31 OCTOBER 20.1
Dr Cr
R R
Capital — W Blits 19 000
Drawings — W Blits 2 000
Equipment (at cost) 1 000
Vehicles (at cost) 9 000
Bank 10 725
Long-term loan (SA Bank) 4 500
Sparks Dealers 1 000
Income received 500
Advertisements 200
Salaries 2 000
Telephone expenses 75
25 000 25 000
4.17.5 Revision exercise 5
The following transactions during March 20.1 relate to P Victor, an attorney:
Date Transactions Amount
20.1 R
Mar 3 P Victor opened his firm of attorneys and deposited as
opening capital 12 000
Mar 34 Paid rental for March 1 000
Mar 35 Bought a photocopier from Foto-Kop on credit 8 000
Paid Foto-Kop by cheque 2 000
Mar 15 Rendered services on credit to U Wright 3 000
Mar 18 Received a cheque from U Wright 1 800
Mar 21 Bought stationery from AA Dealers on credit 3 000
Mar 23 Deposited cash received for services rendered to U Wrong 1 200
Mar 25 Paid on account to AA Dealers 1 500
Mar 30 Paid salaries by cheque 400
Mar 31 P Victor drew a cheque for private use 1 000
Required:
(1) Record the above transactions using a table as illustrated in the following example:
20.1
March 3 Paid telephone account by cheque — R1 000.
ASSETS = EQUITY + LIABILITIES
Trade Equip- Income/ Trade
Date Bank receiv- ment Capital Expendi- payables
ables ture
20.1 R R R R R R
March 3 71 000 71 000
Totals 71 000 71 000
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{
{
(2) Prepare the statement of changes in equity of P Victor for the month ended 31 March
20.1.
(3) Prepare P Victor’s statement of financial position as at 31 March 20.1 in narrative form.
(4) Show the accounting policy and the property, plant and equipment notes.
Solution: Revision exercise 5
P VICTOR
(1) TRANSACTION ANALYSIS
ASSETS = EQUITY + LIA-
BILITIES
Trade Income/
receiv- Equip- Expendi- Trade
Date Bank ables ment Capital ture payables
20.1 R R R R R R
Mar 3 + 12 000 + 12 000
Mar 471 000 71 000
Mar 5 + 8 000 + 8 000
72 000 72 000
Mar 15 + 3 000 + 3 000
Mar 18 + 1 800 71 800
Mar 21 73 000 + 3 000
Mar 23 + 1 200 + 1 200
Mar 25 71 500 71 500
Mar 30 7400 7400
Mar 31 71 000 71 000
+ 9 100 + 1 200 + 8 000 =+ 11 000 7200 ++ 7 500
R18 300 R18 300
P VICTOR
(2) STATEMENT OF CHANGES IN EQUITY FOR THE MONTH ENDED 31 MARCH 20.1
Capital
R
Capital contribution from owner 12 000)
Total comprehensive loss for the period (200)
Drawings (1 000)
Balance at 31 March 20.1 10 800)
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P VICTOR
(3) STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20.1
ASSETS Note R
Non-current assets 8 000
Property, plant and equipment 2 8 000
Current assets 10 300
Trade and other receivables 1 200
Cash and cash equivalents (bank) 9 100
Total assets 18 300
EQUITY AND LIABILITIES
Total equity 10 800
Capital 10 800
Current liabilities 7 500
Trade and other payables 7 500
Total equity and liabilities 18 300
P VICTOR
(4) NOTES FOR THE MONTH ENDED 31 MARCH 20.1
1. Accounting policy:
The financial statements have been prepared on the historical cost basis and comply with
International Financial Reporting Standards.
2. Property, plant and equipment Equipment Total
R R
Carrying amount: Beginning of period
Cost — —
Accumulated depreciation
Additions 8 000 8 000
Depreciation — —
Carrying amount: End of period 8 000 8 000
Cost 8 000 8 000
Accumulated depreciation
No depreciation was written off during the month.
SELF-ASSESSMENT
Now that you have studied this study unit, can you prepare the following:
.ledger accounts?
.a trial balance?
.a basic statement of profit or loss and other comprehensive income?
.a statement of changes in equity?
.a basic statement of financial position?
.certain notes to the financial statements?
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TOPIC B
COLLECTING AND PROCESSING THE
ACCOUNTING DATA OF
ENTITIES
Learning outcome
The learner should be able to collect, process, adjust (where necessary) and record
financial information in order to complete the statement of profit or loss and other
comprehensive income (thereby calculating the gross and net profits) and statement of
changes in equity for the financial period and the statement of financial position at the end
of the financial period, of a sole proprietor.
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CONTENTS
Study unit Page
5 PROCESSING ACCOUNTING DATA 59
6 ADJUSTMENTS 98
7 THE CLOSING-OFF PROCEDURE, DETERMINING PROFIT
OF AN ENTITY AND PREPARING FINANCIAL STATEMENTS 116
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STUDY UNIT
5
Processing accounting data
Learning outcome
Students should be able to prepare all the journals, posting to ledger accounts and to
prepare a trial balance.
Contents Page
Key concepts 60
5.1 Introduction 60
5.2 The accounting cycle 60
5.3 Books of first entry: journals 61
5.4 Types of journals 61
5.5 Cash journals 61
5.5.1 Cash receipts journal 61
5.5.2 Cash payments journal 62
5.6 Credit journals and the general journal 67
5.6.1 Introduction 67
5.6.2 Inventory systems 68
5.6.3 Purchases journal and purchases returns journal 68
5.6.4 Sales journal and sales returns journal 70
5.6.5 General journal 72
5.7 The trial balance 73
5.8 Revision exercise and solution 73
5.9 Settlement discount 81
5.9.1 Settlement discount granted 81
5.9.2 Settlement discount received 81
5.10 Value added tax (VAT) 82
5.10.1 Background 82
5.10.2 Tax period 82
5.10.3 Accounting bases 83
5.11 Revision exercise and solution 88
Self-assessment 97
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!
!
!
!
!
!
!
KEY CONCEPTS
.Source documents .General ledger
.Accounting cycle .Trade receivables ledger
.Cash receipts journal .Trade payables ledger
.Cash payments journal .Comprehensive taxation
.Purchases journal .Vendor
.Purchases returns journal .Taxable supplies
.Sales journal .Exempted supplies
.Sales returns journal .Settlement discount
.General journal .Value added tax (VAT)
.Output VAT .Input VAT
5.1 Introduction
In the previous study units you learnt how to analyse transactions and to determine their effect
on the basic accounting equation. We then recorded all the transactions in the accounts in the
general ledger and we explained the principle of the double-entry system and emphasised how
important it is. This created a framework in which to study the processing of accounting data in
greater detail and this is what we are going to look at next.
Study paragraph 5.1 of the prescribed book.
5.2 The accounting cycle
Accounting data are processed within a definite framework which is known as the accounting
cycle.
The following diagram shows the accounting cycle:
Transactions
taking place
Completion of
source documents
Recording of transactions
in journals
Posting to ledgers
Reporting in
financial statements
Analysis and interpretation
of financial statements
Decision making by
the management
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5.3 Books of first entry: journals
Because of the large number of transactions that take place in an entity, it is not practical to
record each transaction directly in the ledger. This makes the ledger very bulky and
unmanageable and in a manual system it means that only one person can write up the books.
This led to the use of subsidiary journals or books of first entry in which transactions of the
same type are grouped together and analysed before being recorded in summarised form in
the ledger. A journal is thus a link between source documents and the ledger. No transaction
may be recorded in the ledger before it has been recorded in a journal.
Study paragraph 5.2 of the prescribed book.
5.4 Types of journals
There are various types of journals or books of first entry but for the time being we will be
concentrating on the following:
.the cash receipts journal and the cash payments journal in which all cash transactions
are recorded
.the purchases journal and the purchases returns journal in which all credit purchases
and returns of credit purchases are recorded
.the sales journal and the sales returns journal in which all credit sales and returns of
credit sales are recorded
.the general journal in which transactions are recorded which are not recorded in one of the
other journals, for example the correction of errors and the writing off of credit losses (bad debts)
5.5 Cash journals
5.5.1 Cash receipts journal
All moneys received which is deposited in the entity’s bank account is recorded in the cash
receipts journal. At the end of the month only one amount, which represents the entire month’s
cash receipts, is debited to the bank account. The other column totals represent the contra
accounts and are credited to such accounts. The amounts in the sundry accounts column are
credited individually to the relevant accounts.
Study paragraph 5.3.1 of the prescribed book.
Let us now go back to the information we had for Fix-’n-Mat in study unit 4. Fix-’n-Mat’s cash
receipts journal and ledger accounts would look as follows:
FIX-’N-MAT
CASH RECEIPTS JOURNAL — FEBRUARY 20.1 CRJ1
Analysis Sundry accounts
Document Day Details of Bank Current
number receipts income Amount Fol Details
R R R
Rec 1 1 T Tom 130 000 130 000 130 000 Capital
2 2 ABC Bank 25 000 25 000 25 000 Loan:
ABC Bank
3 13 S Silver 1 000 1 000 1 000
4 28 C Canon 2 000 2 000 2 000 C Canon
158 000 1 000 157 000
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Dr Bank Cr Dr Capital Cr
20.1 R 20.1 R
Feb 28 Receipts 158 000 Feb 1 Bank 130 000
Dr Fees earned Cr Dr Loan: ABC Bank Cr
20.1 R 20.1 R
Feb 18 .... .... Feb 2 Bank 25 000
28 Bank 1 000
Dr C Canon Cr
20.1 20.1 R
Feb 18 .... .... Feb 28 Bank 2 000
COMMENTS
.Source documents for entries in the cash receipts journal are the cash register roll,
duplicate receipts, duplicate cash invoices and duplicate deposit slips.
.The cash receipts for the month are recorded and analysed in date order.
.Each amount received during the day is not banked immediately. Receipts are first
recorded in the analysis of receipts column and the amount which is banked for that
day is recorded in the bank column.
.Check the addition in the columns by cross-casting. In other words, when the totals of
the analysis columns are added, they must equal the total in the bank column.
.Entries in the sundry accounts column are posted individually to the general ledger.
.Only the totals of the other columns are posted.
.The cash receipts journal is a book of first entry. The double-entry system has to be
applied in the general ledger.
.The amounts are not recorded individually again in the bank account in the general
ledger. Note that the credit entries in the accounts add up to R158 000, which
corresponds to the debit entry in the bank account.
.The number and headings of columns in the journal will depend on the frequency of
occurrence of transactions and can differ from one entity to the other.
5.5.2 Cash payments journal
All cash payments, that is payments by cheque, are recorded in the cash payments journal. At
the end of the month only one amount, which represents the entire month’s cash payments, is
credited to the bank account. The other column totals represent the contra accounts and are
debited to such accounts. The amounts in the sundry accounts column are debited individually
to the relevant accounts.
Study paragraph 5.3.2 of the prescribed book.
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Fix-’n-Mat’s cash payments journal and ledger accounts would look as follows:
FIX-’N-MAT
CASH PAYMENTS JOURNAL — FEBRUARY 20.1 CPJ1
Cheque Day Details Bank Wages Sundry accounts
number Amount Fol Details
R R R
1 6 XY Furnishers 100 000 100 000 Equipment
2 11 Joc Limited 2 000 2 000 Joc Limited
3 12 Cash 1 000 1 000 Drawings
4 16 Cash 800 800
103 800 800 103 000
Dr Bank Cr Dr Equipment Cr
20.1 20.1 R 20.1 R
Feb 28 Feb 28 Payments 103 800 Feb 6 Bank 100 000
Dr Wages Cr Dr Joc Limited Cr
20.1 R 20.1 R 20.1
Feb 28 Bank 800 Feb 11 Bank 2 000 Feb 10 ... ...
Dr Drawings Cr
20.1 R
Feb 12 Bank 1 000
The complete bank account will now take the following form:
Dr Bank Cr
20.1 R 20.1 R
Feb 28 Receipts CRJ1 158 000 Feb 28 Payments CPJ1 103 800
Balance c/d 54 200
158 000 158 000
20.1
Mar 1 Balance b/d 54 200
Note that this balance is the same as the bank balance we calculated using the BAE in
paragraph 4.6 and the bank account in paragraph 4.13 of study unit 4.
COMMENTS
.Source documents for entries in the cash payments journal are cheque counterfoils
and debit notes, or the bank statement issued by the bank.
.Entries are recorded and analysed in the cash payments journal in the same order as
the cheque numbers.
.The amount which is written on the cheque is the amount which is recorded in the
bank column.
.Check whether the adding of the columns is correct by cross-casting. In other words,
when the totals of the analysis columns are added, they must equal the total of the
bank column.
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.Entries in the sundry accounts column are posted individually to the general ledger.
.Only the totals of the other columns are posted.
.The amounts are not recorded individually again in the bank account in the general
ledger.
.The cash payments journal is a book of first entry. The double-entry system has to be
applied in the general ledger.
.More analysis columns can be included as is required by the organisation.
Exercise 5.1
Ms Beauty Baloyi opens a hairdressing salon, Beauty’s Hair, on 1 June 20.3 and enters into the
following transactions during June:
20.3
Jun 1 Deposited R10 000 in the business’s bank account
Paid the month’s rental by cheque to Huurtru, R1 000.
Paid the water and electricity deposit, R500.
Jun 2 Bought R2 500 worth of equipment and R845 worth of consumable inventory from
Head Suppliers and paid by cheque, R3 345.
Jun 5 Fees received for services rendered, R350.
Jun 7 Drew a cheque and paid the assistant’s wages, R200.
Jun 10 Cash banked for services rendered, R556.
Jun 14 Drew a cheque for R500 to pay the week’s wages, R200, the remainder being for Ms
Baloyi’s own use.
Jun 15 Cash register roll total for services rendered, R642.
Jun 17 Bought stationery from Office Suppliers, R80 and paid by cheque.
Jun 19 Fees received for services rendered, R438.
Jun 21 Paid the week’s wages, R200.
Jun 22 Bought shampoo and other requirements from Head Suppliers and paid by cheque,
R550.
Jun 24 Cash register roll total for services rendered, R387.
Jun 25 Issued a cheque to Telkom to pay the telephone account, R260, which included
installation costs of R180.
Jun 28 Cashed a cheque for R1 500. R1 300 was for the owner’s own use and R200 was for
wages.
Jun 30 Cash banked for services rendered, R875.
Required:
(1) Prepare the cash receipts journal for Beauty’s Hair for June 20.3.
(2) Prepare the cash payments journal for Beauty’s Hair for June 20.3.
(3) Show the postings from these journals to the general ledger accounts.
(4) Prepare the trial balance as at 30 June 20.3.
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Solution: Exercise 5.1
BEAUTY’S HAIR
(1) CASH RECEIPTS JOURNAL — JUNE 20.3 CRJ1
Document Day Details Analysis Bank Current Sundry accounts
number
of receipts
income Amount Fol Details
Rec 1 1 B Baloyi 10 000 10 000 10 000 B4 Capital
CRR 1 5 Service fee 350 350 350
CRR 2 10 Service fee 556 556 556
CRR 3 15 Service fee 642 642 642
CRR 4 19 Service fee 438 438 438
CRR 5 24 Service fee 387 387 387
CRR 6 30 Service fee 875 875 875
13 248 3 248 10 000
B3 N1
(CRR = Cash register roll)
BEAUTY’S HAIR
(2) CASH PAYMENTS JOURNAL — JUNE 20.3 CPJ1
Consum- Sundry accounts
Cheque Day Details Bank able inven-
number tory Wages Amount Fol Details
1 1 Huurtru Rental
1 000 1 000 N2 expenses
2 City Water and
Treasurer electricity
500 500 B2 deposit
3 2 Head
Suppliers 3 345 845 2 500 B1 Equipment
4 7 Cash 200 200
5 14 Cash 500 200 300 B5 Drawings
6 17 Office
Suppliers 80 80 N3 Stationery
7 21 Cash 200 200
8 22 Head
Suppliers 550 550
9 25 Telkom Telephone
260 260 N4 expenses
10 28 Cash 1 500 200 1 300 B5 Drawings
8 135 1 395 800 5 940
B3 N5 N6
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BEAUTY’S HAIR
(3) GENERAL LEDGER
Dr Equipment B1 Cr
20.3 R
Jun 2 Bank CPJ1 2 500
Dr Water and electricity deposit B2 Cr
20.3 R
Jun 1 Bank CPJ1 500
Dr Bank B3 Cr
20.3 R 20.3 R
Jun 30 Receipts CRJ1 13 248 Jun 30 Payments CPJ1 8 135
Balance c/d 5 113
13 248 13 248
20.3
Jul 1 Balance b/d 5 113
Dr Capital B4 Cr
20.3 R
Jun 1 Bank CRJ1 10 000
Dr Drawings B5 Cr
20.3 R
Jun 14 Bank CPJ1 300
28 Bank CPJ1 1 300
1 600
Dr Current income N1 Cr
20.3 R
Jun 30 Bank CRJ1 3 248
Dr Rental expenses N2 Cr
20.3 R
Jun 1 Bank CPJ1 1 000
Dr Stationery N3 Cr
20.3 R
Jun 17 Bank CPJ1 80
Dr Telephone expenses N4 Cr
20.3 R
Jun 25 Bank CPJ1 260
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Dr Consumable inventory N5 Cr
20.3 R
Jun 30 Bank CPJ1 1 395
Dr Wages N6 Cr
20.3 R
Jun 30 Bank CPJ1 800
BEAUTY’S HAIR
(4) TRIAL BALANCE AS AT 30 JUNE 20.3
Fol Debit Credit
R R
Equipment B1 2 500
Water and electricity deposit B2 500
Bank B3 5 113
Capital B4 10 000
Drawings B5 1 600
Current income N1 3 248
Rental expenses N2 1 000
Stationery N3 80
Telephone expenses N4 260
Consumable inventory N5 1 395
Wages N6 800
13 248 13 248
COMMENTS
.The B numbers indicate the statement of financial position accounts and the N
numbers, the nominal accounts. Nominal accounts are income and expenditure
accounts while statement of financial position accounts are capital, asset and liability
accounts.
.In the folio column in the ledger, the cash receipts or cash payments journal is given as
a reference, but in the details column the names of the contra ledger accounts are
entered.
.The summarising effect of the subsidiary journals can be clearly seen in the ledger.
Note the entries in the bank account and the current income account.
5.6 Credit journals and the general journal
5.6.1 Introduction
In many business entities goods are bought and sold on credit. In the process, accounts have
to be opened for debtors and creditors. If all these accounts are included in the general ledger,
the same sort of problem arises that we have already mentioned — the ledger becomes too
bulky and unmanageable and in a manual system only one person can write up the books. For
this reason a trade receivables ledger and a trade payables ledger are opened in which the
individual debtors’ and creditors’ accounts are kept. A single account is then held in the general
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ledger for debtors, namely a trade receivables control account, and one for creditors,
namely a trade payabless control account. This means that the entire accounting system is
adapted to make provision for the control accounts. In the cash receipts journal and the cash
payments journal provision is made for additional columns for trade receivables control and
trade payables control.
You can read more about the trade receivables control and the trade payables control accounts
in study units to follow,
Study paragraph 5.3.3 of the prescribed book.
5.6.2 Inventory systems
We distinguish between the periodic inventory system and the perpetual inventory system,
which will be dealt with in detail in study unit 7. At this stage all you need to know is that
inventory in trade (merchandise) which is purchased has to be debited to a purchases account
if a periodic system is being used. Provision must therefore be made for a purchases column
in the subsidiary journal. If a perpetual inventory system is used, inventory in trade
(merchandise) is debited to the inventory account and an inventory column is required
instead of a purchases column in the subsidiary journals.
5.6.3 Purchases journal and purchases returns journal
Merchandise purchased on credit is recorded in the purchases journal. At the end of the month
only the total credit purchases for the month is debited to the purchases account and credited
to the trade payables control account. If some of the goods are returned, they are recorded in
the purchases returns journal.
NB: For the purpose of this module, only merchandise purchased on credit is recorded in
the purchases journal. All other credit purchases are recorded in the general journal.
Trade discount is often allowed by a wholesaler to a retailer. The discount percentage that is
agreed upon, is calculated and deducted on the cash or credit invoice. The net amount on the
invoice is recorded as the amount of purchases in the accounting records of the purchaser.
Thus, the trade discount amount is never recorded in the accounting records of the purchaser.
To encourage a debtor to pay his/her account within a certain period, a cash discount option is
given to the debtor. If the account is settled within the stipulated period, the discount will be
recorded in the settlement discount granted account in the sellers’ accounting records and the
settlement discount received account in the buyers’ accounting records. The full amount of the
invoice must be paid if the account is not settled within the stipulated period.
Study paragraphs 9.3 and 13.6 of the prescribed book.
A purchases journal and purchases returns journal have the following formats:
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ABC DEALERS
PURCHASES JOURNAL — MAY 20.3 PJ5
Invoice No Day Details Fol Purchases Trade
payables
R R
1534 3 Grand Wholesalers CL2 1 258 1 258
1535 7 XY Company CL3 983 983
1536 11 AA Limited CL1 2 324 2 324
1537 14 XY Company CL3 437 437
1538 21 XY Company CL3 1 212 1 212
1539 25 Grand Wholesalers CL2 538 538
1540 30 AA Limited CL1 215 215
6 967 6 967
ABC DEALERS
PURCHASES RETURNS JOURNAL — MAY 20.3 PRJ5
Credit note
No
Day Details Fol Purchases
returns
Trade
payables
R R
C115 10 Grand Wholesalers CL2 158 158
C116 27 XY Company CL3 114 114
272 272
GENERAL LEDGER TRADE PAYABLES LEDGER
Dr Purchases Cr
20.3 R Date Details Fol Debit Credit Balance
May 31 Creditors 6 967 20.3 R R R
May
Dr Trade payables control Cr AA Limited CL1
20.3 R 20.3 R 11 Inv 1536 PJ5 2 324 2 324
May 31 Purchases May 31 Purchases 6 967 30 Inv 1540 PJ5 2215 2 539
returns 272
Dr Purchases returns Cr Grand Wholesalers CL2
20.3 R 3 Inv 1534 PJ5 1 258 1 258
May 31 Creditors 272 10 Credit note
C 115 PRJ5 158 1 100
25 Inv 1539 PJ5 538 1 638
XY Company CL3
7 Inv 1535 PJ5 983 983
14 Inv 1537 PJ5 437 1 420
21 Inv 1538 PJ5 1 212 2 632
27 Credit note
C 116 PRJ5 114 2 518
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COMMENTS
.The source documents for entries in the purchases journal are original invoices.
Because these invoices come from different businesses, they are renumbered
consecutively.
.The source documents for entries in the purchases returns journal are the original
credit notes received from the creditors and they must be renumbered consecutively.
.Entries are recorded and analysed in date order in the purchases journal and
purchases returns journal.
.The creditor’s name and the amount for which purchases or returns were made must
be clearly shown.
.Only the totals of the columns are posted to the general ledger.
.The amounts in the purchases and the creditors columns are the same in the
purchases journal because we are still ignoring VAT. The same applies for purchases
returns.
.The creditors’ accounts are individually credited in the trade payables ledger with
purchases and debited with returns. A three-column ledger is preferable to the
traditional T-account format because the balance can be calculated after each
transaction.
.The total of all the balances of the individual creditor’s accounts must correspond with
the balance of the trade payables control account.
.The purchases journal and purchases returns journal are books of first entry. The
double-entry procedure has to be applied in the general ledger.
5.6.4 Sales journal and sales returns journal
Merchandise sold on credit is recorded in the sales journal. At the end of the month only the total
credit sales for the month are credited to the sales account and debited to the trade receivables
control account. If the debtors return some of the goods, they are recorded in the sales returns
journal.
NB: For the purposes of this module, only merchandise sold on credit is recorded in the
sales journal. All other credit sales are recorded in the general journal.
Study paragraphs 5.3.3.3 and 5.3.3.4 of the prescribed book.
A sales journal and sales returns journal have the following formats:
ABC DEALERS
SALES JOURNAL — MAY 20.3 SJ3
Invoice
No Day Details Fol Sales Debtors
R R
2018 2 M Moloi DL4 268 268
2019 5 A Abdul DL1 315 315
2020 12 G Green DL3 424 424
2021 14 E Els DL2 176 176
2022 17 G Green DL3 587 587
2023 21 M Moloi DL4 643 643
2024 29 E Els DL2 269 269
2025 30 A Abdul DL1 103 103
2 785 2 785
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ABC DEALERS
SALES RETURNS JOURNAL — MAY 20.3 SRJ3
Credit
Note No Day Details Fol Sales
returns
Trade
receiv-
ables
R R
D223 8 M Moloi DL4 175 175
D224 19 G Green DL3 114 114
D225 21 E Els DL2 192 192
11281 11281
GENERAL LEDGER
Dr Sales Cr
TRADE RECEIVABLES LEDGER
20.3 R Date Details Fol Debit Credit Balance
May 31 Trade 20.3 R R R
receiv- May
ables 2 785
Dr Trade receivables control Cr A Abdul DL1
20.3 R 20.3 R 5 Inv 2019 315 315
May 31 Sales 2 785 May 31 Sales 30 Inv 2025 103 418
returns 281
Dr Sales returns Cr E Els DL2
20.3 R 14 Inv 2021 176 176
May 31 Trade 21 Credit
receiv-
able 281
Note no
D225 92 84
29 Inv 2024 269 353
G Green DL3
12 Inv 2020 424 424
17 Inv 2022 587 1 011
19 Credit Note
no D224 114 897
M Moloi DL4
2 Inv 2018 268 268
8 Credit
Note no
D223 75 193
21 Inv 2023 643 836
COMMENTS
.The source documents for entries in the sales journal are the duplicates of sales
invoices.
.The source documents for entries in the sales returns journal are the duplicates of
credit notes issued to the debtors.
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.The debtor’s name and the amount of the transaction should be clearly indicated.
.Entries are recorded and analysed in date order in the sales journal and sales returns
journal.
.Only the totals of the columns are posted to the general ledger.
.The amounts in the sales and the debtors columns are the same in the sales journal
and sales returns journal, because we are still ignoring VAT. The effect of VAT will be
explained later.
.The debtors’ accounts are debited individually in the trade receivables ledger with
sales, and credited with sales returns.
.The total of all the balances of the individual debtor’s accounts must correspond with
the balance of the trade receivables control account.
.The sales journal and sales returns journal are books of first entry; it is, in other words,
a summary of sales and returns. The double-entry system has to be applied in the
general ledger.
5.6.5 General journal
All transactions which cannot be entered in one of the journals which we have discussed are
entered in the general journal. Examples are credit losses (bad debts) which are written off,
interest on debtors’ accounts, errors which are corrected and year-end adjustments (which will
be discussed in a later study unit).
Study paragraph 5.3.3.5 of the prescribed book.
NB: Purchases and sales of goods other than merchandise are recorded in the general
journal for the purposes of this module.
A general journal takes the following form:
ABC DEALERS
GENERAL JOURNAL — MAY 20.3 J3
Date Particulars Fol Debit Credit
R R
5 Vehicles 43 000
ABC Bank 43 000
Delivery vehicle bought on credit per invoice
F147 from ORA Motors. The delivery vehicle was
financed by obtaining a loan from ABC Bank at
an interest rate of 9% per annum
16 Packaging material 430
Stationery 430
Packaging material per invoice Z214 incorrectly
debited to stationery account
18 Credit losses (Bad debts) 84
F Field 84
F Field’s balance written off as irrecoverable
COMMENTS
.The account which is entered first is the account which has to be debited in the general
ledger.
.The narration is very important since it gives the reason for the entry and must also
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refer to source documents.
.The general journal is a book of first entry. The double-entry system has to be applied
in the general ledger.
.Theoretically all transactions can be recorded in the general journal.
5.7 The trial balance
For each transaction, the debit entry must equal the credit entry. The total of all the debit
balances should, therefore, correspond to the total of all the credit balances. A list of balances
is prepared periodically to determine whether any errors have been made. This list of balances
is called a trial balance.
Study paragraph 4.5 of the prescribed book again.
5.8 Revision exercise and solution
On 1 March 20.5 A Apple opened a supermarket under the tradename AA Supermarket. He
decided to use the periodic inventory system and entered into the following transactions during
March 20.5:
20.5
March 1 A Apple deposited R50 000 in the entity’s current bank account as a capital
contribution.
Paid rental by cheque to JHB Letting Agents, R2 000.
Bought shop equipment from EQUIP on credit, R10 000 and paid R1 000 as a
deposit.
Issued a cheque to City Treasurer to pay the water and electricity deposit, R1 000.
2 Purchased merchandise on credit from TR Wholesalers, R23 541.
Purchased packaging material from S Suppliers and paid by cheque, R468.
3 Drew a cash cheque for cash float, R500.
4 Cash sales on opening day, R18 674.
5 Purchased merchandise on credit from the following wholesalers:
BB Dealers R7 832
DBN Distributors R6 965
6 Sublet a storeroom to G Gold and received his cheque for R250.
Cash sales per cash register roll, R12 455.
10 Drew a cheque to pay wages, R1 200.
12 Issued invoices to the following people for goods sold:
B Blue R478
S Silver R693.
13 Purchased merchandise from Z Zulu and paid by cheque, R5 378.
14 Purchased a computer from HI Q, R5 260. Issued a cheque for R1 478, which
included a deposit of R1 000 and R478 for paper and computer supplies.
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20.5
March 15 Sold on credit to the following people:
G Green R324.
R Red R299.
16 Cash sales, R8 790.
17 Drew a cash cheque for the following:
Wages R1 500.
Owner’s own use R1 000.
19 Received a cheque from B Blue, R200.
20 Purchased merchandise from TR Wholesalers and paid by cheque, R2 675.
Merchandise sold for cash, R12 570.
21 Goods sold on credit:
B Blue R362.
R Red R178.
23 S Silver paid R100 on his account.
Cash sales, R10 238.
24 Paid R550 to The Newsmaker for placing advertisements.
Drew cash to pay wages, R1 500.
25 Purchased stationery on credit from HI Q, R267.
Issued a receipt to R Red for R299 in part payment of his account.
27 Issued cheques to the following people in part settlement of their accounts:
TR Wholesalers R20 000
BB Dealers R 6 000
DBN Distributors R 5 000
HI Q R 1 000
29 Credit sales to S Silver, R262. He paid R200 on his account.
Cash sales, R16 742.
30 Issued cheques for the following:
L Lemon, the manager’s salary, R2 500
EQUIP on account, R1 000
JHB Letting Agents for rental for April, R2 000
31 Issued a cheque to Telkom to pay the telephone account, R595
Cash sales, R15 284
31 Issued receipts to the following debtors for money received on their accounts:
G Green R324
B Blue R640
31 Cashed a cheque for R3 000, to pay wages of R1 500, and the balance was for the
owner’s own use.
Required:
Prepare the following:
(1) The subsidiary journals of AA Supermarket for March 20.5
(2) The general, trade receivables and trade payables ledgers of AA Supermarket for
March 20.5
(3) The trial balance of AA Supermarket as at 31 March 20.5
Ignore VAT.
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Solution: Revision exercise
AA SUPERMARKET
(1) SUBSIDIARY JOURNALS
(a) CASH RECEIPTS JOURNAL — MARCH 20.5 CRJ1
Analysis Trade
Document Day Details Fol of Bank Sales receiv- Sundry accounts
number receipts ables
control Amount Fol Details
R R R R R
Rec 1 1 A Apple 50 000 50 000 50 000 B7 Capital
CRR 1 4 Sales 18 674 18 674 18 674
Rec 2 6 G Gold 250 250 N2 Rental income
CRR 2 Sales 12 455 12 705 12 455
CRR 3 16 Sales 8 790 8 790 8 790
Rec 3 19 B Blue DL1 200 200 1200
CRR 4 20 Sales 12 570 12 570 12 570
Rec 4 23 S Silver DL2 100 1100
CRR 5 Sales 10 238 10 338 10 238
Rec 5 25 R Red DL4 299 299 1299
Rec 6 29 S Silver DL2 200 1200
CRR 6 Sales 16 742 16 942 16 742
CRR 7 31 Sales 15 284 15 284
Rec 7 G Green DL3 324 1324
Rec 8 B Blue DL1 640 16 248 1640
146 766 94 753 1 763 50 250
B5 N1 B3
(b) CASH PAYMENTS JOURNAL — MARCH 20.5 CPJ1
Cheque Day Details Fol Bank Trade pay- Purchases Wages Sundry accounts
number ables control
Amount Fol Details
R R R R R
001 1 JHB Letting Agents 2 000 2 000 N8 Rental expenses
002 EQUIP CL4 1 000 1 000
003 City Treasurer 1 000 1 000 B2 Water and electricity
deposit
004 2 S Suppliers 468 468 N5 Packaging material
005 3 Cash 500 500 B4 Cash float
006 10 Cash 1 200 1 200
007 13 Z Zulu 5 378 5 378
008 14 HI Q CL5 1 478 1 000 478 N4 Stationery
009 17 Cash 2 500 1 500 1 000 B8 Drawings
010 20 TR Wholesalers 2 675 2 675
011 24 The Newsmaker 550 550 N6 Advertisements
012 Cash 1 500 1 500
013 27 TR Wholesalers CL1 20 000 20 000
014 BB Dealers CL2 6 000 6 000
015 DBN Distributors CL3 5 000 5 000
016 HI Q CL5 1 000 1 000
017 30 L Lemon 2 500 2 500 N7 Salaries
018 EQUIP CL4 1 000 1 000
019 JHB Letting Agents 2 000 2 000 N8 Rental expenses
020 31 Telkom 595 595 N9 Telephone expenses
021 Cash 3 000 1 500 1 500 B8 Drawings
61 344 35 000 8 053 5 700 12 591
B5 B6 N3 N10
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(c) PURCHASES JOURNAL — MARCH 20.5 PJ1
Invoice Trade
no Day Details Fol Purchases payables
A0001 2 TR Wholesalers CL1 23 541 23 541
A0002 5 BB Dealers CL2 7 832 7 832
A0003 DBN Distributors CL3 6 965 6 965
38 338 38 338
N3 B6
(d) SALES JOURNAL — MARCH 20.5 SJ1
Invoice Trade
No Day Details Fol Sales receivables
F001 12 B Blue DL1 478 478
F002 S Silver DL2 693 693
F003 15 G Green DL3 324 324
F004 R Red DL4 299 299
F005 21 B Blue DL1 362 362
F006 R Red DL4 178 178
F007 29 S Silver DL2 262 262
2 596 2 596
N1 B3
(e) GENERAL JOURNAL — MARCH 20.5 J1
Date Details Fol Debit Credit
R R
1 Equipment B1 10 000
EQUIP/Trade payables control B6 10 000
Shop equipment bought on credit per invoice
Z001
14 Equipment B1 5 260
HI Q/Trade payables control B6 5 260
Computer bought on credit per invoice Z002
25 Stationery N4 267
HI Q/Trade payables control B6 267
Stationery bought on credit per invoice Z003
AA SUPERMARKET
(2) LEDGERS
(a) GENERAL LEDGER
Dr Equipment (at cost) B1 Cr
20.5 R
Mar 1 Trade payables
control J1 10 000
14 Trade payables
control J1 5 260
15 260
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Dr Water and electricity deposit B2 Cr
20.5 R
Mar 1 Bank CPJ1 1 000
Dr Trade receivables B3 Cr
20.5 R 20.5 R
Mar 31 Sales SJ1 2 596 Mar 31 Bank CRJ1 1 763
Balance c/d 833
2 596 2 596
20.5
Apr 1 Balance b/d 833
Dr Cash float B4 Cr
20.5 R
Mar 3 Bank CPJ1 500
Dr Bank B5 Cr
20.5 R 20.5 R
Mar 31 Receipts CRJ1 146 766 Mar 31 Payments CPJ1 61 344
Balance c/d 85 422
146 766 146 766
20.5
Apr 1 Balance b/d 85 422
Dr Trade payables B6 Cr
20.5 R 20.5 R
Mar 31 Bank CPJ1 35 000 Mar 1 Equipment J1 10 000
Balance c/d 18 865 14 Equipment J1 5 260
25 Stationery J1 267
31 Purchases PJ1 38 338
53 865 53 865
20.5
Apr 1 Balance b/d 18 865
Dr Capital B7 Cr
20.5 R
Mar 1 Bank CRJ1 50 000
Dr Drawings B8 Cr
20.5 R
Mar 17 Bank CPJ1 1 000
31 Bank CPJ1 1 500
2 500
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Dr Sales N1 Cr
20.5 R
Mar 31 Trade receivables SJ1 2 596
Bank CRJ1 94 753
97 349
Dr Rental income N2 Cr
20.5 R
Mar 6 Bank CRJ1 250
Dr Purchases N3 Cr
20.5 R
Mar 31 Trade payables PJ1 38 338
Bank CPJ1 8 053
46 391
Dr Stationery N4 Cr
20.5 R
Mar 14 Bank CPJ1 478
25 Trade payables
control J1 267
745
Dr Packaging material N5 Cr
20.5 R
Mar 2 Bank CPJ1 468
Dr Advertisements N6 Cr
20.5 R
Mar 24 Bank CPJ1 550
Dr Salaries N7 Cr
20.5 R
Mar 30 Bank CPJ1 2 500
Dr Rental expenses N8 Cr
20.5 R
Mar 1 Bank CPJ1 2 000
30 Bank CPJ1 2 000
4 000
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Dr Telephone expenses N9 Cr
20.5 R
Mar 31 Bank CPJ1 595
Dr Wages N10 Cr
20.5 R
Mar 31 Bank CPJ1 5 700
(b) TRADE RECEIVABLES LEDGER
B Blue DL1
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 12 Invoice F001 SJ1 478 478
Mar 19 Receipt No 3 CRJ1 200 278
Mar 21 Invoice F005 SJ1 362 640
Mar 31 Receipt No 8 CRJ1 640
S Silver DL2
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 12 Invoice F002 SJ1 693 693
Mar 23 Receipt No 4 CRJ1 100 593
Mar 29 Invoice F007 SJ1 262 855
Receipt No 6 CRJ1 200 655
G Green DL3
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 15 Invoice F003 SJ1 324 324
Mar 31 Receipt No 7 CRJ1 324
R Red DL4
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 15 Invoice F004 SJ1 299 299
Mar 21 Invoice F006 SJ1 178 477
Mar 25 Receipt No 5 CRJ1 299 178
Debtors list R
S Silver 655
R Red 178
833 Corresponds to the balance of account B3.
79
FAC1502/1
GOLDEN RULE
The total of all the balances of the individual debtor acconts in die subsidiary trade
receivables ledger MUST equal the balance of the trade receivables control account in the
general ledger.
(c) TRADE PAYABLES LEDGER
TR Wholesalers CL 1
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 2 Invoice A0001 PJ1 23 541 23 541
27 Cheque 013 CPJ1 20 000 3 541
BB Dealers CL 2
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 5 Invoice A0002 PJ1 7 832 7 832
27 Cheque 014 CPJ1 6 000 1 832
DBN Distributors CL 3
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 5 Invoice A0003 PJ1 6 965 6 965
27 Cheque 015 CPJ1 5 000 1 965
EQUIP CL 4
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 1 Invoice Z001 J1 10 000 10 000
Cheque 002 CPJ1 1 000 9 000
30 Cheque 018 CPJ1 1 000 8 000
HI Q CL 5
Date Details Fol Debit Credit Balance
20.5 R R R
Mar 14 Invoice Z002 J1 5 260 5 260
Cheque 008 CPJ1 1 000 4 260
25 Invoice Z003 J1 267 4 527
27 Cheque 016 CPJ1 1 000 3 527
Creditors list R
TR Wholesalers 3 541
BB Dealers 1 832
DBN Distributors 1 965
EQUIP 8 000
HI Q 3 527
18 865 Corresponds to the balance of account B6
80
FAC1502/1
GOLDEN RULE
The total of the individual creditor accounts in the subsidiary trade payables ledger MUST
equal the balance of the trade payables control account in the general ledger.
AA SUPERMARKET
(3) TRIAL BALANCE AS AT 31 MARCH 20.5
Fol Debit Credit
R R
Equipment (at cost) B 1 15 260
Water and electricity deposit B 2 1 000
Trade receivables control B 3 833
Cash float B 4 500
Bank B 5 85 422
Trade payables control B 6 18 865
Capital B 7 50 000
Drawings B 8 2 500
Sales N 1 97 349
Rent income N 2 250
Purchases N 3 46 391
Stationery N 4 745
Packaging material N 5 468
Advertisements N 6 550
Salaries N 7 2 500
Rental expenses N 8 4 000
Telephone expenses N 9 595
Wages N10 5 700
166 464 166 464
5.9 Settlement discount
5.9.1 Settlement discount granted
Discount is often offered to debtors in order to encourage quick settlement of their debts within
the stated credit term. The credit term will be shown on the credit invoice.
Study paragraph 9.3 of the prescribed book.
5.9.2 Settlement discount received
Discount is often received from creditors in order to encourage quick settlement of our
outstanding account.
Study paragraph 13.6 of the prescribed book.
81
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5.10 Value-Added Tax (VAT)
5.10.1 Background
Study paragraphs 5.4 and 5.5 of the prescribed book.
VAT is levied at every point in the chain of production and distribution. Value-Added Tax is
based on a tax credit system which allows every producer or distributor along the chain to
recover the Value-Added Tax which was previously paid by the business. The tax borne by
each producer or distributor, through whose hands the goods or services have passed, before
reaching the end user, is in effect the tax on the value added by the business.
The tax that must eventually (every two months) be paid to the South African Revenue Service
(SARS) is the tax on the supply of goods (sales) and/or services rendered by the entity
(OUTPUT VAT) less the tax paid by the entity on the goods (purchases) and/or services
supplied to the entity (INPUT VAT).
GOLDEN RULES
.OUTPUT VAT is the tax levied (charged) by the entity on sales of goods or services
rendered by the business.
.INPUT VAT is the tax paid (or payable) on goods delivered and/or services rendered to
the entity, including imports. Deductions for input tax will only be allowed if a proper tax
invoice is received and kept.
.OUTPUT VAT minus INPUT VAT = amount payable/refundable, i.e. the amount payable
to the South African Revenue Services (SARS) or the amount that can be claimed from
SARS.
Value-Added Tax (VAT) can only be charged by persons who, in terms of the Act, are registered
as VAT vendors. Registration is compulsory if a person carries on an entity and the total value
of his supplies for a 12 month period exceeds or is likely to exceed a stipulated (in the Act)
amount.
An entity may also register voluntarily if its sales or service rendered are less than the
stipulated amount.
The stipulated amount excludes tax, exempted supplies and abnormal receipts.
If an entity is not registered, no output tax may be charged and no deduction for input tax can
be claimed.
The onus is on the entity to register where necessary and this must be done within 21 days of
becoming liable to register.
5.10.2 Tax period
A tax period is allocated to each entity. The return submitted by the entity must cover the period
allocated.
Some entities registered for VAT (vendors) must submit their returns every two months for
those two months. Some entities must complete and submit their returns for unequal months,
i.e. January, March, May, etc., others for equal months, i.e. February, April, etc.
82
FAC1502/1
5.10.3 Accounting bases
There are only two bases allowed for the calculation of the VAT liability, namely:
.the invoice basis
.the payments basis
Under the invoice basis tax is accounted for on
.the issue of an invoice or
.the receipt of payment, whichever comes first
Under the payments basis tax is accounted for when payments are made (purchases) and
payments are received (sales).
Certain requirements have to be met before a vendor may use the payments basis.
Exercise 5.2
To grasp the principles of VAT, work through the following exercise thoroughly. VAT at 14% is
applicable.
The following information relates to Rundu Dealers, who is registered as a VAT vendor and
who use the periodic inventory system: (The VAT period of the business ends on unequal
months.)
(a) TRIAL BALANCE AS AT 28 FEBRUARY 20.4
Debit Credit
R R
Capital 177 150
Land and buildings 144 200
Equipment 29 700
Inventory — 1 November 20.3 19 200
Bank 4 467
W Wolf 1 583
L Lion 770
T Tiger 2 310
VAT input 2 715
VAT output 2 925
Sales 86 400
Purchases 45 650
Distribution, administration and other expenses 20 500
268 785 268 785
83
FAC1502/1
(b) TRANSACTIONS FOR MARCH 20.4
March 1 Cash sales, R15 504.
5 Paid the account of T Tiger by cheque after deducting R114 discount.
7 Received a cheque from W Wolf for R1 469 in full settlement of his account.
Received a cheque from L Lion for R713 and allowed R57 discount.
12 Received an account from Stationers Ltd for the printing of documents, R684.
13 Credit sales:
L Lion R2 280
W Wolf R1 140
14 Sold an old computer to O Old for R285 and received his cheque for the amount
due.
Cash sales, R6 840.
21 Issued a credit note to L Lion for an overcharge on the invoice of the 13th, R57.
23 Paid C Cheetah by cheque for carriage on goods purchased, R1 140.
28 Received a credit invoice from T Tiger for goods purchased, R14 535.
29 Issued cheques for salaries and wages, R5 746 and for purchases from B Bam
R7 980.
30 Issued a debit note to T Tiger for goods returned to him, R798.
Required:
(1) Record the above transactions in the following subsidiary journals, properly totalled,
of Rundu Dealers for March 20.4:
(a) Cash receipts journal (analysis columns for bank, sales, VAT output, trade
receivables, VAT input (Dr), settlement discount granted and sundries)
(b) Cash payments journal (analysis columns for bank, purchases, trade payables,
settlement discount received, VAT input, VAT output (Cr) and sundries)
(c) Sales journal (analysis columns for VAT output, sales and trade receivables)
(d) Purchases journal (analysis columns for VAT input, purchases and trade
payables)
(e) Sales returns journal (analysis columns for VAT output, sales returns and trade
receivables)
(f) Purchases returns journal (analysis columns for VAT input, purchases returns and
trade payables)
(g) General journal
(2) Post the entries recorded above to the VAT input and VAT output accounts. Close off
these accounts to the VAT control account. Balance the VAT control account at
31 March 20.4, the end of the business’ VAT period.
84
FAC1502/1
Solution Exercise 5.2
RUNDU DEALERS
(1) SUBSIDIARY JOURNALS
(a) CASH RECEIPTS JOURNAL — MARCH 20.4 CRJ2
Date Details Fol Bank Sales Trade
receiv-
ables
VAT input VAT
output
Settlement
discount
granted
Sundry accounts
Dr Dr Amount Fol Details
R R R R R R R
1 Sales 15 504 13 600 1 904
7 W Wolf 1 469 1 583 (14*) # (100)
L Lion 713 770 (7) # (50)
14 O Old 285 35 250 Equipment
Sales 6 840 6 000 840
24 811 19 600 2 353 (21)
L15
2 779
L16
(150) 250
* Discount includes 14% VAT therefore
R114
1614
114 = R14
# VAT input is debited. See # under comments on p. 88
(b) CASH PAYMENTS JOURNAL — MARCH 20.4 CPJ2
Date Details Fol Bank Purchases Trade
payables
VAT
input
VAT
output
Settlement
discount
received
Sundry accounts
Cr Amount Fol Details
R R R R R R R
5 T Tiger 2 196 2 310 (14*) (100)
23 C Cheetah 1 140 140 1 000 Carriage
on purchases
29 Cash 5 746 5 746 Salaries and
wages
B Bam 7 980 7 000 980
17 062 7 000 2 310 1 120 (14) (100) 6 746
L15 L15
* Discount includes 14% VAT therefore
R114
1614
114 = R14
85
FAC1502/1
(c) SALES JOURNAL — MARCH 20.4 SJ2
Trade
Date Details Fol VAT output Sales receivables
R R R
13 L Lion 280 2 000 2 280
W Wolf 140 1 000 1 140
420 3 000 3 420
L16
(d) PURCHASES JOURNAL — MARCH 20.4 PJ2
Trade
Date Details Fol VAT input Purchases payables
R R R
28 T Tiger 1 785 12 750 14 535
1 785 12 750 14 535
L15
(e) SALES RETURNS JOURNAL — MARCH 20.4 SRJ2
Sales Trade
Date Details Fol VAT output returns receivables
R R R
21 L Lion 7 50 57
7 50 57
L16
(f) PURCHASES RETURNS JOURNAL — MARCH 20.4 PRJ2
Purchases Trade
Date Details Fol VAT input returns payables
R R R
30 T Tiger 98 700 798
98 700 798
L15
86
FAC1502/1
(g) GENERAL JOURNAL — MARCH 20.4 J2
Date Detail Fol Debit Credit
R R
12 Printing 600
VAT input L15 84
Stationers Ltd/Trade payables control 684
Account received for printing
31 VAT control L17 5 627
VAT input L15 5 627
Transfer of VAT input to the
VAT control account
VAT output L16 6 131
VAT control L17 6 131
Transfer of VAT output to the
VAT control account
NB: The last two journal entries can only be done after the VAT input account and the VAT
output account in the general ledger have been completed. It is in fact the ‘‘balances’’ of
these two accounts that are transferred to the VAT control account.
RUNDU DEALERS
(2) General ledger
Dr VAT input L15 Cr
20.4 R 20.4 R
Mar 1 Balance b/d 2 715 Mar 31 Trade payables control PRJ2 98
31 Bank CPJ2 1 120 VAT control J2 5 627
Trade receivables
control CRJ2 21
Trade payables control PJ2 1 785
Trade payables control J2 84
5 725 5 725
Dr VAT output L16 Cr
20.4 R 20.4 R
Mar 31 Trade receivables
control SRJ2 7 Mar 1 Balance b/d 2 925
VAT control J2 6 131 31 Bank CRJ2 2 779
Trade receivables control SJ2 420
Trade payables control CPJ2 14
6 138 6 138
Dr VAT control L17 Cr
20.4 R 20.4 R
Mar 31 VAT input J2 5 627 Mar 31 VAT output J2 6 131
Balance c/d 504
6 131 6 131
20.4
Apr 1 Balance b/d 504*
* A cheque must be issued to the South African Revenue Service for this amount before
25 April 20.4
87
FAC1502/1
COMMENTS
.Calculation of VAT on all amounts which include 14% VAT is:
%or R
Amount without VAT = 100 1,00
VAT = 14 0,14
;Amount VAT inclusive = 114 1,14
To calculate an amount if VAT was included
14
114 x Amount given
Example: Amount received on 1 March 20.4 = R15 504 (including VAT). (See cash
receipts journal.)
VAT = 14
114 6R15 504 = R1 904
SALES = 100
114 6R15 504 = R13 600
or
SALES = R15 504 7R1,14 = R13 600.
.VAT on cash sales is credited to the VAT output account because Rundu Dealers
received VAT for payment to the South African Revenue Service.
.VAT on credit sales is credited to the VAT output account.
.VAT on cash purchases is debited to the VAT input account.
.VAT on credit purchases is debited to the VAT input account.
.VAT on sales returns is debited to the VAT output account. (To cancel the VAT output
portion of the sales returned.)
.VAT on purchases returns is credited to the VAT input account. (To cancel the VAT
input portion of the purchases returned.)
.# VAT on settlement discount granted to debtors is debited to the VAT input account (to
reduce the amount owed to the South African Revenue Service).
.VAT on settlement discount received from creditors is credited to the VAT output
account (to increase the amount owed to the South African Revenue Service).
.The balances of the VAT input and VAT output accounts are transferred to the VAT
control account to determine what amount must be paid to or to be claimed from the
South African Revenue Service.
.When the difference between the debit and credit sides of the VAT control is a:
.credit,the difference is payable to the South African Revenue Service (current
liability)
.debit,the difference is refundable by the South African Revenue Service (current
asset)
NB: VAT is charged on services, for example telephone account, water and electricity
account and repairs.
5.11 Revision exercise and solution
The following information relates to Sunshine Glass Traders, who is registered as a VAT
vendor. The periodic inventory system and control accounts are in use: (The VAT period of the
business ends on equal months.)
88
FAC1502/1
SUNSHINE GLASS TRADERS
(a) TRIAL BALANCE AS AT 31 JANUARY 20.4
Fol Debit Credit
R R
Land and buildings (at cost) B1 60 000
Furniture (at cost) B2 5 320
Inventory: Trading B3 6 536
Trade receivables control B4 2 431
Bank B5 2 554
Trade payables control B6 6 075
Capital B7 75 000
Drawings B8 3 884
VAT input B9 4 337
VAT output B10 4 527
Sales N1 13 569
Purchases N2 9 855
Rent income N3 800
Packaging material N4 964
Telephone expenses N5 483
Water and electricity N6 1 247
Settlement discount granted N7 170
Settlement discount received N8 210
Wages N9 2 150
Stationery N10 250
100 181 100 181
(b) Transactions, 14% VAT inclusive, for February 20.4:
R
Feb 1 The owner, S Shine, increased his capital contribution 15 000
Paid the City Council for water and electricity 3 078
Feb 3 Purchased merchandise from Glasco Ltd and paid by cheque 8 778
Purchased merchandise on credit from Ferguson Limited 9 120
Sold trading inventory on credit to J Jason 13 680
4 Purchased a desk on credit from City Furnitures 3 534
6 Purchased receipt books and pens from Pen and Pencil
and paid by cheque 228
Drew a cheque for the week’s wages 954
8 Paid Glasco Ltd on account 3 992
Received discount 228
10 Cash sales of merchandise 3 876
12 Issued a credit note to J Jason for an overcharge on the 3rd 114
Drew a cheque for the week’s wages 940
15 Cash sales 2 394
Received a cheque from J Jason 5 988
Settlement discount granted to him 342
89
FAC1502/1
Feb 18 Sold goods on credit to F Brown 4 560
Cash purchases of trading inventory 2 736
Purchased glassware on credit from Glasco Ltd 5 700
20 Returned damaged goods to Glasco Ltd 570
21 Drew a cheque for wages 989
Received damaged goods returned by F Brown and issued a
credit note 228
25 Cash sales 6 156
Received a payment from F Brown 2 552
Discount allowed to him 228
26 Drew a cheque for wages 945
Issued a cheque to Telkom to pay the telephone account 570
Received an account from Printo Limited for the printing of
documents 798
27 Purchased inventory on credit from Glasco Ltd 3 420
Paid Ferguson Limited by cheque and received 5 490
R285 discount
28 Paid the owner’s house instalment by cheque to HP Bank 2 500
Received a cheque from Z Zittace for rental 912
Required:
(1) Record the above transactions in the following subsidiary journals of Sunshine Glass
Traders for February 20.4:
(a) Cash receipts journal (analysis columns for bank, sales, VAT output, trade
receivables, settlement discount granted, VAT input (Dr) and sundries)
(b) Cash payments journal (analysis columns for bank, purchases, trade payables,
settlement discount received, wages, VAT input, VAT output (Cr) and sundries)
(c) Sales journal (analysis columns for trade receivables, VAT output and sales)
(d) Purchases journal (analysis columns for trade payables, VAT input and
purchases)
(e) Sales returns journal (analysis columns for trade receivables, VAT output and
sales returns)
(f) Purchases returns journal (analysis columns for trade payables, VAT input and
purchases returns)
(g) General journal
(2) Post the entries recorded in the subsidiary journals to the relevant accounts in the
general ledger of Sunshine Glass Traders. (All the accounts must be properly
balanced/totalled at 28 February 20.4.) Close the VAT input and VAT output accounts
and transfer the balances to the VAT control account.
NB: (a) Remember to enter the balances at 31 January 20.4 in the applicable ledger
accounts.
NB: (b) The first word(s) of each entry must indicate the contra ledger account.
(3) Prepare the trial balance of Sunshine Glass Traders as at 28 February 20.4.
90
FAC1502/1
SOLUTION: Revision exercise
SUNSHINE GLASS TRADERS
(1) SUBSIDIARY JOURNALS
(a) CASH RECEIPTS JOURNAL – FEBRUARY 20.4 CRJ2
Date Details Fol Bank Sales Trade
receivables
Settlement
discount
granted
VAT input VAT
output
Sundry accounts
Dr Dr Amount Fol Details
R R R R R R R
1 S Shine 15 000 15 000 B7 Capital
10 Cash 3 876 3 400 476
15 Cash 2 394 2 100 294
J Jason 5 988 6 330 (300) (42)
25 Cash 6 156 5 400 756
F Brown 2 552 2 780 (200) (28)
28 Z Zittace 912 112 800 N3 Rental
income
36 878 10 900 9 110 (500) (70) 1 638 15 800
B5 N1 B4 N7 B9 B10
(b) CASH PAYMENTS JOURNAL — FEBRUARY 20.4 CPJ2
Date Details Fol Bank Purchases Trade
payables
Wages Settlement
discount
received
VAT VAT
input output Sundry accounts
Cr Amount Fol Details
R R R R R R R
1 City Council 3 078 378 2 700 N6 Water and
electricity
3 Glasco Ltd 8 778 7 700 1 078
6 Pen and Pencil 228 28 200 N10 Stationery
Cash 954 954
8 Glasco Ltd 3 992 4 220 (200) (28)
12 Cash 940 940
18 Cash 2 736 2 400 336
21 Cash 989 989
26 Cash 945 945
Telkom 570 70 500 N5 Telephone
expenses
27 Ferguson Ltd 5 490 5 775 (250) (35)
28 HP Bank 2 500 2 500 B8 Drawings
31 200 10 100 9 995 3 828 (450) 1 890 (63) 5 900
B5 N2 B6 N9 N8 B9 B8
(c) SALES JOURNAL — FEBRUARY 20.4 SJ2
Date Details Fol Trade VAT output Sales
receivables
R R R
3 J Jason 13 680 1 680 12 000
18 F Brown 4 560 560 4 000
18 240 2 240 16 000
B4 B10 N1
91
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(d) PURCHASES JOURNAL — FEBRUARY 20.4 PJ2
Trade
Date Details Fol payables VAT input Purchases
R R R
3 Ferguson Limited 9 120 1 120 8 000
18 Glasco Ltd 5 700 700 5 000
27 Glasco Ltd 3 420 420 3 000
18 240 2 240 16 000
B6 B9 N2
(e) SALES RETURNS JOURNAL — FEBRUARY 20.4 SRJ2
Trade Sales
Date Details Fol receivables VAT output returns
R R R
12 J Jason 114 14 100
21 F Brown 228 28 200
342 42 300
B4 B9 N11
(f) PURCHASES RETURNS JOURNAL — FEBRUARY 20.4 PRJ2
Trade Purchases
Date Details Fol payables VAT input returns
R R R
20 Glasco Ltd 570 70 500
570 70 500
B6 B9 N12
(g) GENERAL JOURNAL — FEBRUARY 20.4 J2
Date Details Fol Debit Credit
R R
4 Furniture B2 3 100
VAT input B 434
City Furnitures/Trade payables control B6 3 534
Desk purchased on credit
26 Printing N13 700
VAT input B9 98
Printo Limited/Trade payables control B6 798
Printing of documents on credit
28 VAT output B10 8 426
VAT control B11 8 426
Transfer of VAT output to the
VAT control account
VAT control B11 8 999
VAT input B9 8 999
Transfer of VAT input to the
VAT control account
92
FAC1502/1
(2) GENERAL LEDGER
Dr Land and buildings (at cost) B1 Cr
20.4 R
Feb 1 Balance b/d 60 000
Dr Furniture (at cost) B2 Cr
20.4 R
Feb 1 Balance b/d 5 320
4 City Furnitures J2 3 100
8 420
Dr Inventory: Trading B3 Cr
20.4 R
Feb 1 Balance b/d 6 536
Dr Trade receivables control B4 Cr
20.4 R 20.4 R
Feb 1 Balance b/d 2 431 Feb 28
Bank and discount
CRJ2 9 110
28 Sales SJ2 18 240 Sales returns SRJ2 342
Balance c/d 11 219
20 671 20 671
20.4
Mar 1 Balance b/d 11 219
Dr Bank B5 Cr
20.4 R 20.4 R
Feb 1 Balance b/d 2 554 Feb 28 Total payments CPJ2 31 200
28 Total receipts CRJ2 36 878 Balance c/d 8 232
39 432 39 432
20.4
Mar 1 Balance b/d 8 232
Dr Trade payables control B6 Cr
20.4 R 20.4 R
Feb 28
Bank and discount
CPJ2 9 995 Feb 1 Balance b/d 6 075
Purchases returns
PRJ2 570 Feb 4 Furniture J2 3 534
Balance c/d 18 082 Feb 26 Printing J2 798
Feb 28 Purchases PJ2 18 240
28 647 28 647
20.4
Mar 1 Balance b/d 18 082
Dr Capital B7 Cr
R 20.4 R
Feb 1 Balance b/d 75 000
Bank CRJ2 15 000
90 000
93
FAC1502/1
Dr Drawings B8 Cr
20.4 R
Feb 1 Balance b/d 3 884
28 Bank CPJ2 2 500
6 384
Dr VAT input B9 Cr
20.4 R 20.4 R
Feb 1 Balance b/d 4 337 Feb 28 Trade payables control PRJ2 70
4 Trade payables VAT control J2 8 999
control J2 434
26 Trade payables
control J2 98
28 Bank CPJ2 1 890
Trade receivables
control CRJ2 70
Trade payables
control PJ2 2 240
9 069 9 069
Dr VAT output B10 Cr
20.4 R 20.4 R
Feb 28 Trade receivables Feb 1 Balance b/d 4 527
control SRJ2 42 28 Trade receivables
VAT control J2 8 426 control SJ2 2 240
Bank CRJ2 1 638
Trade payables control CPJ2 63
8 468 8 468
Dr VAT control B11 Cr
20.4 R 20.4 R
Feb 28 VAT input J2 8 999 Feb 28 VAT output J2 8 426
Balance c/d 573
8 999 8 999
20.4
Mar 1 Balance b/d 573
Dr Sales N1 Cr
20.4 R
Feb 1 Balance b/d 13 569
28 Bank CRJ2 10 900
Trade receivables
control SJ2 16 000
40 469
Dr Purchases N2 Cr
20.4 R
Feb 1 Balance b/d 9 855
28 Bank CPJ2 10 100
Trade payables
control PJ2 16 000
35 955
94
FAC1502/1
Dr Rental income N3 Cr
20.4 R
Feb 1 Balance b/d 800
28 Bank CRJ2 800
1 600
Dr Packaging material N4 Cr
20.4 R
Feb 1 Balance b/d 964
Dr Telephone expenses N5 Cr
20.4 R
Feb 1 Balance b/d 483
26 Bank CPJ2 500
983
Dr Water and electricity N6 Cr
20.4 R
Feb 1 Balance b/d 1 247
Bank CPJ2 2 700
3 947
Dr Settlement discount granted N7 Cr
20.4 R
Feb 1 Balance b/d 170
28 Trade receivables
control CRJ2 500
670
Dr Settlement discount received N8 Cr
20.4 R
Feb 1 Balance b/d 210
28 Trade payables
control CPJ2 450
660
Dr Wages N9 Cr
20.4 R
Feb 1 Balance b/d 2 150
28 Bank CPJ2 3 828
5 978
95
FAC1502/1
Dr Stationery N10 Cr
20.4 R
Feb 1 Balance b/d 250
6 Bank CPJ2 200
450
Dr Sales returns N11 Cr
20.4 R
Feb 28 Trade receivables
control SRJ2 300
Dr Purchases returns N12 Cr
20.4 R
Feb 28 Trade payables
control PRJ2 500
Dr Printing N13 Cr
20.4 R
Feb 26 Printo Limited J2 700
(3) TRIAL BALANCE AS AT 28 FEBRUARY 20.4
Fol Debit Credit
R R
Land and buildings at cost B1 60 000
Furniture at cost B2 8 420
Inventory: Trading B3 6 536
Trade receivables control B4 11 219
Bank B5 8 232
Trade payables control B6 18 082
Capital B7 90 000
Drawings B8 6 384
VAT control B11 573
Sales N1 40 469
Purchases N2 35 955
Rental income N3 1 600
Packaging material N4 964
Telephone expenses N5 983
Water and electricity N6 3 947
Settlement discount granted N7 670
Settlement discount received N8 660
Wages N9 5 978
Stationery N10 450
Sales returns N11 300
Purchases returns N12 500
Printing N13 700
151 311 151 311
96
FAC1502/1
COMMENTS
.After the journal entries have been posted to the VAT input account and the VAT output
account in the general ledger, the ‘‘balances’’ on these accounts must be transferred to
the VAT control account. This means that the general journal entries on 28 February
20.4 can only be done after the ‘‘balances’’ on these accounts have been calculated.
.The VAT control account has a debit balance, which is refundable by the South African
Revenue Service.
.VAT is not included in the amount credited to sales as this is not an income for the
business but must be paid over to the South African Revenue Service.
.The debtors owe the VAT-inclusive amount to the business.
.The same reasoning applies to creditors and purchases.
SELF-ASSESSMENT
Having studied this study unit, can you:
.prepare the following books, taking Value-Added Tax into account?
.cash receipts journal
.cash payments journal
.purchases journal
.purchases returns journal
.sales journal
.sales returns journal
.general journal
.post to the following ledgers?
.general ledger
.Trade receivables ledger
.Trade payables ledger
.prepare a trial balance?
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STUDY UNIT
6
Adjustments
Learning outcome
Students should be able to do year-end adjustments to balances in the books of an entity.
Contents Page
Key concepts 99
6.1 Introduction 99
6.2 Short-term adjustments 99
6.2.1 Prepaid expenses 100
6.2.2 Accrued expenses 101
6.2.3 Consumable inventory adjustments 103
6.2.4 Income received in advance 104
6.2.5 Accrued income 105
6.2.6 Credit losses (bad debts) 107
6.2.7 Allowance for settlement discount 108
6.3 Long-term adjustments 108
6.4 Preparation of the trial balance 110
6.4.1 Pre-adjustment trial balance 110
6.4.2 Post-adjustment trial balance 110
6.4.3 Post-closing trial balance 110
6.5 Revision exercise and solution 110
Self-assessment 115
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KEY CONCEPTS
.Adjustment
.Closing
.Prepaid expenses
.Accrued expenses
.Consumable inventory adjustments
.Income received in advance
.Credit losses (Bad debts)
.Settlement discount
.Depreciation
.Accumulated depreciation
.Asset contra account
.Carrying amount
.Pre-adjustment trial balance
.Post-adjustment trial balance
.Post-closing trial balance
6.1 Introduction
An entity usually does business on a permanent basis without any interruptions. We also know that
its owners and managers need regular information on its financial results and financial position. The
life of an entity is therefore divided into equal periods (financial periods), usually of 12 months, and
the profit or loss is determined for that period.
Thus far it was assumed that all transactions recorded were in respect of the specific financial
period. The closing off of accounts and the determination of the profit, were recorded under this
assumption. This does not always happen and the accounts (and eventually statements) have
sometimes to be adjusted to ‘‘correct’’ the balances in accounts before the final accounts and
financial statements can be prepared.
For more accurate financial statements at the end of a financial period, additional entries, which
do not originate from source documents, may therefore be necessary.
Study paragraphs 6.1 to 6.4 of the prescribed book.
The three steps relating to adjustments mentioned in paragraph 6.3 (and further on) can be
extended to five steps:
Step 1: Identify the accounts that must be adjusted.
Step 2: Determine how the accounts would be affected and what the balances of these
accounts should be.
Step 3: Calculate the amount(s) involved in the adjustment.
Step 4: Record the necessary adjustments in the general journal and past the entries to the
ledger(s)
Step 5: Ensure that the new balances of the accounts are now correct.
6.2 Short-term adjustments
Short-term adjustments have to do with the apportionment of income and expenditure to
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consecutive periods within a year. This is income which is received in one period but which is
earned in an earlier or a later period. The same applies to expenses which are incurred in
another period.
6.2.1 Prepaid expenses
Study paragraph 6.3.5.2 in the prescribed book.
A prepaid expense is an expense which has been paid during the current financial period,
where all or part of the expense relates to a future financial period. For example, insurance
expenses are usually payable in advance. When the financial year of a business entity ends, it
is therefore possible that a portion of the insurance expense relates to the next financial period.
An adjustment is therefore necessary to match only that portion of the expense which relates to
the current financial period against the income for that period.
On 2 January 20.1 Xa-Xa Dealers paid a new annual insurance premium of R2 400. Its
financial year ends on 28 February 20.1. Using this information we can work out that the actual
amount it spent on insurance up to and including 28 February was only R400, which is R2 400
712 = R200 per month for two months, namely January and February. The R2 000 which
was paid in advance represents an asset at that point. The apportionment of the amount
between asset and expenditure elements will be as follows: R400 is an expenditure item in
respect of insurance for the current financial year. This amount must appear in the profit and
loss account and the statement of profit or loss and other comprehensive income. The R2 000
is a prepaid expense and therefore represents an amount that will be used in future. It must
appear on the statement of financial position of 28 February 20.1 and is therefore a short-term
(current) asset.
GOLDEN RULE
One entry or ‘‘leg’’ of the adjustment journal always affects a nominal account and thereby
the trading account or profit or loss account. The other entry or ‘‘leg’’ of the journal always
affects a statement of financial position account.
Accounting entries
The debit balance in the expense account for insurance has to be reduced by R2 000. To
reduce an expense account, a credit entry has to be made. The balance of the insurance
account will then reflect the actual expense, namely R400, and this amount can be written off
against the profit or loss account. The prepaid amount of R2 000 is a temporary asset on the
date of the statement of financial position and it is debited in the prepaid expense account and
shown on the statement of financial position under current assets.
JOURNAL ENTRIES
ADJUSTMENT ENTRY: 28 FEBRUARY 20.1 J1
Prepaid expenses GL55 2 000
Insurance GL40 2 000
Adjustment of insurance account
100
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CLOSING TRANSFER: 28 FEBRUARY 20.1 J2
Profit or loss GL60 400
Insurance GL40 400
Transfer of insurance to profit or loss account
GENERAL LEDGER
Dr Insurance 40 Cr
20.1 R 20.1 R
Jan 2 Bank CPJ 2 400 Feb 28 Prepaid expenses J1 2 000
Profit or loss J2 400
2 400 2 400
Dr Prepaid expenses 55 Cr
20.1 R
Feb 28 Insurance J1 2 000
Dr Profit or loss (extract) 60 Cr
20.1 R
Feb 28 Insurance J2 400
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1
(extract)
R
Current assets xxxx
Prepayments 2 000
6.2.2 Accrued expenses
An accrued expense is an expense which relates to the current financial period, but which is
still unpaid at the end of that period.
On 28 February 20.1, the end of its financial year, Xa-Xa Dealers’ water and electricity account
shows expenses of R2 880. On closer examination Xa-Xa’s accountant establishes that the
February water and electricity account of R360 has not been taken into account. With this
information the actual expenditure on water and electricity for the year can be determined,
namely R2 880 + R360 = R3 240. The apportionment of the item between actual expenditure
and amount owing (liability) will be as follows: R3 240 was the actual expenditure (to be
reflected in the profit or loss account and statement of profit or loss and other comprehensive
income) and R360 is still owed (to be reflected in the statement of financial position) and must
be paid at a future date.
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Accounting entries
The debit balance on the water and electricity expense account has to be increased by R360.
To increase an expense account, a debit entry has to be made. The balance on the water
and electricity account will now reflect the actual expenditure, namely R3 240. This amount can
be written off against the profit and loss account. The outstanding amount of R360 is a liability
on the date of the statement of financial position and it is credited in the accrued expense
account and is shown on the statement of financial position under current liabilities.
JOURNAL ENTRIES J5
ADJUSTMENT ENTRY — 28 FEBRUARY 20.1
Water and electricity GL41 360
Accrued expenses GL56 360
Adjustment of water and electricity account
CLOSING TRANSFER — 28 FEBRUARY 20.1 J6
Profit or loss GL60 3 240
Water and electricity GL41 3 240
Closing of water and electricity account to profit or
loss account
GENERAL LEDGER
Dr Water and electricity 41 Cr
20.1 R 20.1 R
Feb 28 Balance b/d 2 880 Feb 28 Profit or loss J6 3 240
Accrued expenses J5 360
3 240 3 240
Dr Accrued expenses 56 Cr
20.1 R
Feb 28 Water and
electricity J5 360
Dr Profit or loss (extract) 60 Cr
20.1 R
Feb 28 Water and
electricity J6 3 240
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (extract)
R
Current liabilities xxxx
Trade and other payables xxxx
Accrued expenses 360
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6.2.3 Consumable inventory adjustments
Study paragraph 6.3.2 of the prescribed book.
On 28 February 20.1, the end of its financial year, Xa-Xa Dealers’ stationery account shows
that stationery to the value of R500 was purchased during the year. At a physical count it is
determined that R150’s worth of stationery is still on hand. With this information the actual
expenditure on stationery can be calculated, namely R500 7R150 = R350. The apportionment
of the item between actual expenditure (profit and loss account and statement of profit or loss
and other comprehensive income) and the asset element (statement of financial position) will
be as follows: R350 represents expenditure on stationery while R150 represents the value of
the stationery that will be used in the future.
Accounting entries
The debit balance in the stationery expense account has to be reduced by R150. To reduce an
expense account acredit entry has to be made. The balance on the stationery account will
now show the actual expenditure, namely R350. This amount can now be written off against
the profit or loss account. The stationery on hand, worth R150, is an asset on the date of the
statement of financial position and is debited in the stationery on hand account and is shown in
the statement of financial position under current assets.
JOURNAL ENTRIES
ADJUSTMENT JOURNAL — 28 FEBRUARY 20.1 J3
Inventory: Stationery GL57 150
Stationery GL42 150
Adjustment of stationery account
CLOSING TRANSFER — 28 FEBRUARY 20.1 J4
Profit or loss GL60 350
Stationery GL42 350
Closing of stationery account
GENERAL LEDGER
Dr Stationery 42 Cr
20.1 R 20.1 R
Feb 28 Balance b/d 500 Feb 28 Inventory:
Stationery J3 150
Profit or loss J4 350
500 500
Dr Inventory: Stationery 57 Cr
20.1 R
Feb 28 Stationery J3 150
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Dr Profit or loss (extract) 60 Cr
20.1 R
Feb 28 Stationery J4 350
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (extract)
R
Current assets xxxx
Inventories xxxx
Stationery 150
6.2.4 Income received in advance
Study paragraph 6.3.4.2 in the prescribed book.
Income received in advance is income which has been received during the current financial
period but relates to a future financial period. Only the portion relating to the current financial
period must be recorded as income, and an adjustment is necessary for the portion received in
advance.
On 28 February 20.1, the end of its financial year, Xa-Xa Dealers’ rental income account shows
that R10 400 was received. Xa-Xa Dealers rent out a part of their building for R800 a month. On
closer investigation it is established that the rental for March 20.1 has already been received.
With this information the actual income received in rental for the year can be determined, that is
R10 400 7R800 = R9 600 (= R800 612).
The apportionment of the item between actual income and the liability (amount owing)
component will be as follows: R9 600 is the actual income and R800 is due to the lessee
because it was paid in advance. Differently stated, the income has not yet been earned.
Accounting entries
The credit balance in the rental income account has to be reduced by R800. To reduce an
income account adebit entry has to be made. The balance on the rental income account will
now show the actual income, namely R9 600. This amount can now be written off against the
profit or loss account. The amount received in advance is a liability on the date of the
statement of financial position and is credited in the income received in advance account and
shown in the statement of financial position under current liabilities.
JOURNAL ENTRIES
ADJUSTMENT JOURNAL — 28 FEBRUARY 20.1 J9
Rental income GL44 800
Income received in advance GL59 800
Adjustment of rental income account
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CLOSING TRANSFER — 28 FEBRUARY 20.1 J10
Rental income GL44 9 600
Profit or loss GL60 9 600
Closing of rental income to profit or loss account
GENERAL LEDGER
Dr Rental income 44 Cr
20.1 R 20.1 R
Feb 28 Income received Feb 28 Balance b/d 10 400
in advance J9 800
Profit or loss J10 9 600
10 400 10 400
Dr Income received in advance 59 Cr
20.1 R
Feb 28 Rental income J9 800
Dr Profit or loss (extract) 60 Cr
20.1 R
Feb 28 Rental income J10 9 600
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (extract)
R
Current liabilities xxxx
Income received in advance 800
6.2.5 Accrued income
Study paragraph 6.3.4.1 in the prescribed book.
Accrued income is income which relates to the current financial period but which has not yet
been received.
On 28 February 20.1, the end of its financial year, Xa-Xa Dealers’ commission income account
shows an income of R2 200. On closer examination it is established that an amount of R200
earned in commission has not yet been received.
With this information the actual income in commission can be determined. It is
R2 200 + R200 = R2 400. The apportionment of the item between actual earnings in
commission and the associated asset (the commission which has not yet been received)
will be as follows: R2 400 which has actually been earned and R200 which is still to be
received.
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Accounting entries
The credit balance in the commission income account has to be increased by R200. To
increase an income account another credit entry has to be made. The balance on the
commission income account will now reflect the actual income, namely R2 400. This amount
can now be written off against the profit or loss account. The outstanding amount of R200 is an
asset on the day of the statement of financial position and is shown under current assets in the
statement of financial position.
JOURNAL ENTRIES
ADJUSTMENT JOURNAL — 28 FEBRUARY 20.1 J11
Accrued income GL61 200
Commission income GL45 200
Adjustment of commission income account
CLOSING TRANSFER — 28 FEBRUARY 20.1 J12
Commission income GL45 2 400
Profit or loss GL60 2 400
Closing of commission income to profit or loss
account
GENERAL LEDGER
Dr Commission income 45 Cr
20.1 R 20.1 R
Feb 28 Profit or loss J12 2 400 Feb 28 Balance b/d 2 200
Accrued income J11 200
2 400 2 400
Dr Accrued income 61 Cr
20.1 R
Feb 28 Commission
income J11 200
Dr Profit or loss (extract) 60 Cr
20.1 R
Feb 28 Commission
income J12 2 400
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (extract)
R
Current assets xxx
Trade and other receivables xxx
Accrued income 200
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6.2.6 Credit losses (Bad debts)
Study paragraph 6.3.3 in the prescribed book.
On 25 January 20.1 Xa-Xa Dealers receive a notification that a debtor, A Boeka, is insolvent.
On closer investigation it is established that the debtor still owes R230.
With this information an adjustment must be made in A Boeka’s account. The outstanding
amount of R230 must be removed from his account and shown as an expense or loss.
The assets will therefore decrease and an expense or loss component, namely credit losses,
will come into being.
Accounting entries
The debit balance of R230 on A Boeka’s account has to be written off, since he is insolvent and
cannot pay. To reduce an asset account, acredit entry has to be made. A Boeka’s account in
the trade receivables ledger will be credited and will now show no balance. The trade
receivables’ control account in the general ledger must also be credited and the credit losses
account debited. The debt which cannot be paid is an expense/loss and is written off against
the profit and loss account at the end of the financial year.
JOURNAL ENTRIES
GENERAL JOURNAL — 25 JANUARY 20.1 J13
Credit losses (Bad debts) GL62 230
A Boeka/Trade receivables control DL2/GL6 230
Write off debtor’s account as irrecoverable
CLOSING TRANSFER — 28 FEBRUARY 20.1 J14
Profit or loss GL60 230
Credit losses GL62 230
Closing of credit losses to profit or loss account
GENERAL LEDGER
Dr Credit losses (Bad debts) 62 Cr
20.1 R 20.1 R
Jan 25 Trade receivables Feb 28 Profit or loss J14 230
control(A Boeka) J13 230
Dr Profit or loss (extract) 60 Cr
20.1 R
Feb 28 Credit losses J14 230
Dr Trade receivables control 6 Cr
20.0 20.1 R
Mar 1 Balance b/d xxxx Jan 25 Credit losses J13 230
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TRADE RECEIVABLES LEDGER
Dr A Boeka 2 Cr
20.1 R 20.1 R
Jan 25 Balance b/d 230 Jan 25 Credit losses J13 230
In study unit 9 the writing off of credit losses is explained in detail. The above solution is done
according to method 2 as explained in paragraph 9.4.5.
6.2.7 Allowance for settlement discount
Study paragraph 9.3 of the prescribed book.
6.3 Long-term adjustments (depreciation)
Study paragraph 6.3.1 in the prescribed book.
Business entities buy tangible assets (property, plant and equipment) which are not for resale,
but are used in the operation of the business. As these assets are used, they decrease in
value. This decline in value is charged against the profits of the business and is spread
(apportioned) over the expected useful life of the asset.
The apportionment of the cost of the asset usually takes the form of depreciation entries.
Xa-Xa Dealers bought machinery to the value of R80 000 during the year. On 28 February
20.1, the end of its financial year, an amount of R12 000 has to be written off as depreciation.
With this information an adjustment can be made in the books. An expense, namely
depreciation of R12 000, is created. Instead of crediting the machinery account, a special
account known as accumulated depreciation: machinery account is credited. The account
is known as an asset contra account.
Accounting entries
Depreciation is an expense to the entity and the depreciation account will therefore be debited
with R12 000. The expense will then be written off against the profit and loss account. The
apportionment of the depreciation is credited in the asset contra account, namely
accumulated depreciation: machinery. The accumulated depreciation is subtracted from the
cost price of the machinery to determine the carrying amount of the machinery. The carrying
amount is shown under non-current assets in the statement of financial position and is part of
property, plant and equipment.
JOURNAL ENTRIES
ADJUSTMENT JOURNAL — 28 FEBRUARY 20.1 J15
Depreciation GL46 12 000
Accumulated depreciation: machinery GL63 12 000
Adjustment to make provision for depreciation
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CLOSING TRANSFER — 28 FEBRUARY 20.1 J16
Profit or loss GL60 12 000
Depreciation GL46 12 000
Closing of depreciation to the profit or loss
account
GENERAL LEDGER
Dr Depreciation 46 Cr
20.1 R 20.1 R
Feb 28 Accumulated Feb 28 Profit or loss J16 12 000
depreciation:
machinery J15 12 000
Dr Accumulated depreciation: machinery 63 Cr
20.1 R
Feb 28 Depreciation J15 12 000
Dr Profit or loss (extract) 60 Cr
20.1 R
Feb 28 Depreciation J16 12 000
XA-XA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.1 (extract)
ASSETS Note R
Non-current assets
Property, plant and equipment 3 68 000
XA-XA DEALERS
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.1
Property, plant and equipment Machinery Total
Carrying amount: Beginning of year
Cost — —
Accumulated depreciation
Additions 80 000 80 000
Disposals — —
Depreciation (12 000) (12 000)
Carrying amount: End of year 68 000 68 000
Cost 80 000 80 000
Accumulated depreciation (12 000) (12 000)
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6.4 Preparation of the trial balance
It is important to be able to identify at what stage in the accounting process a trial balance is
prepared.
A trial balance is prepared as many times as it is required, but at least every month. At the end
of the financial year, as many as three trial balances are prepared.
6.4.1 Pre-adjustment trial balance
This is the trial balance which is compiled to test the correctness of the entries after the posting
from the subsidiary journals to the general ledger (the same as the usual monthly trial balance). Its
purpose is to test whether the requirements of the double-entry system have been met because if
the trial balance does not balance at this stage, the statement of financial position will not balance
either.
6.4.2 Post-adjustment trial balance
Study paragraph 6.4 in the prescribed book.
This is the trial balance which is compiled after all the journalised adjustments have been
posted to the general ledger.
6.4.3 Post-closing trial balance
This is the trial balance which is compiled after the closing journal entries have been posted to
the ledger. In this trial balance all the nominal accounts are closed and the profit or loss as well
as drawings are transferred to the capital account. All that remains in the trial balance at this
stage are the assets, liabilities and equity accounts. These are the accounts which appear as
items in the statement of financial position.
6.5 Revision exercise and solution
The following information relates to A Abbo:
Balances at 30 June 20.2 (extract)
Debit Credit
R R
Rental income 6 600
Stationery 350
Water and electricity 1 800
Commission income 5 600
Credit losses 280
Accumulated depreciation: machinery 30 000
Trade receivables control 11 150
Machinery at cost 200 000
ADDITIONAL INFORMATION:
(a) Only 11 months’ rental was received.
(b) Stationery on hand on 30 June 20.2 amounted to R50.
(c) R600 commission was received in advance.
(d) An additional amount of R150 must be written off as irrecoverable.
(e) Provision must be made for depreciation of R30 000 on machinery.
(f) June 20.2’s water and electricity account of R160 has not yet been paid.
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Required:
(1) Open the above accounts in the general ledger.
(2) Record the adjustments and post to the general ledger accounts.
(3) Record the closing journals and show the partial profit or loss account in the ledger.
(4) Show the necessary items in the partial statement of financial position.
(5) Show the property, plant and equipment note.
Solution: Revision exercise
NB: Only one set of accounts is used. The journal entries after the accounts must also be
posted to the same set of accounts.
A ABBO
(1) GENERAL LEDGER
Dr Rental income 1 Cr
20.2 R 20.2 R
Jun 30 Profit or loss J2 7 200 June 30 Balance b/d 6 600
Accrued
income J1 600
7 200 7 200
Dr Stationery 2 Cr
20.2 R 20.2 R
Jun 30 Balance b/d 350 Jun 30 Inventory:
Stationery J1 50
Profit or loss J2 300
350 350
Dr Water and electricity 3 Cr
20.2 R 20.2 R
Jun 30 Balance b/d 1 800 Jun 30 Profit or loss J2 1 960
Accrued
expenditure J1 160
1 960 1 960
Dr Commission income 4 Cr
20.2 R 20.2 R
Jun 30 Income received Jun 30 Balance b/d 5 600
in advance J1 600
Profit or loss J2 5 000
5 600 5 600
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Dr Credit losses (Bad debts) 5 Cr
20.2 R 20.2 R
Jun 30 Balance b/d 280 Jun 30 Profit or loss J2 430
Trade receivables
control J1 150
430 430
Dr Accumulated depreciation: machinery 6 Cr
20.2 R
Jun 30 Balance b/d 30 000
Depreciation J1 30 000
60 000
Dr Trade receivables control 7 Cr
20.2 R 20.2 R
Jun 30 Balance b/d 11 150 Jun 30 Credit losses
(Bad debts) J1 150
Balance c/d 11 000
11 150 11 150
20.2
Jul 1 Balance b/d 11 000
Dr Machinery (at cost) 8 Cr
20.2 R
Jun 30 Balance b/d 200 000
Dr Accrued income 9 Cr
20.2 R
Jun 30 Rental income J1 30 600
Dr Inventory: Stationery 10 Cr
20.2 R
Jun 30 Stationery J1 53 050
Dr Accrued expenditure 11 Cr
20.2 R
Jun 30 Water and
electricity J1 30 160
Dr Income received in advance 12 Cr
20.2 R
Jun 30 Commission
income J1 30 600
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Dr Depreciation 13 Cr
20.2 R 20.2 R
Jun 30 Accumulated June 30 Profit or
depreciation J1 30 000 loss J2 30 000
Dr Profit or loss (extract) 14 Cr
20.2 R 20.2 R
Jun 30 Stationery J2 30300 Jun 30 Rent income J2 07 200
Water and Commission
electricity J2 31 960 income J2 35 000
Credit losses J2 30 430
Depreciation J2 30 000
A ABBO
(2) GENERAL JOURNAL
ADJUSTMENT ENTRIES: 30 JUNE 20.2 J1
R R
Accrued income GL9 600
Rental income GL1 600
To adjust the above
Inventory: Stationery GL10 50
Stationery GL2 50
To adjust the above
Commission income GL4 600
Income received in advance GL12 600
To adjust the above
Credit losses GL5 150
Trade receivabels control GL7 150
To adjust the above
Depreciation GL13 30 000
Accumulated depreciation: machinery GL6 30 000
To make provision for depreciation
Water and electricity GL3 160
Accrued expenditure GL11 160
To adjust the above
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A ABBO
(3) Closing transfers J2
R R
Rental income GL1 7 200
Commission income GL4 5 000
Profit or loss GL14 12 200
Closing off of accounts against the
profit or loss account
Profit or loss GL14 32 690
Stationery GL2 300
Water and electricity GL3 1 960
Credit losses GL5 430
Depreciation GL13 30 000
Closing off of accounts against the
profit or loss account
A ABBO
(4) STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.2 (extract)
ASSETS Note R
Non-current assets 140 000
Property, plant and equipment 1 140 000
Current assets X XXX
Inventories 50
Trade and other receivables R(11 000 + 600) 11 600
EQUITY AND LIABILITIES
Current liabilities XXX
Trade and other payables 160
Income received in advance 600
A ABBO
(5) NOTES FOR THE YEAR ENDED 30 JUNE 20.2
Property, plant and equipment Machinery Total
R R
Carrying amount:
Beginning of the period 170 000 170 000
Cost 200 000 200 000
Accumulated depreciation (30 000) (30 000)
Depreciation (30 000) (30 000)
Carrying amount:
End of the period 140 000 140 000
Cost 200 000 200 000
Accumulated depreciation (60 000) (60 000)
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SELF-ASSESSMENT
Now that you have studied this study unit can you:
.list the accounts and items which have to be adjusted?
.record the adjustments in respect of the following?
.short-term adjustments such as
prepaid expenses
accrued expenses
consumable inventory adjustments
income received in advance
accrued income
Credit losses (Bad debts)
.long-term adjustments such as depreciation
.calculate the amounts in question?
.record the necessary entries in the books?
.prepare a pre-adjustment, a post-adjustment and a post-closing trial balance?
.show the effect of adjustments in the statement of profit or loss and other
comprehensive income and statement of financial position?
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STUDY UNIT
7
The closing-off procedure, determining profit of
an entity and preparing financial statements
Learning outcome
Students should be able to complete the closing-off procedure, determine the profit or loss
of an entity and prepare more advanced financial statements.
Contents
Study unit Page
Key concepts 117
7.1 Introduction 118
7.2 Financial performance of a service entity 118
7.3 Components of the financial performance of an entity 118
7.3.1 Gross profit 118
7.3.2 Profit for the year/period 118
7.3.3 Cost price of sales 119
7.4 Inventory systems 119
7.4.1 The perpetual (continuous) inventory system 119
7.4.2 The periodic inventory system 123
7.4.3 Additional purchase costs 127
7.4.4 Drawings and donations of inventory 128
7.5 Closing-off of nominal accounts 128
7.5.1 Trading account 130
7.5.2 Profit or loss account 135
7.6 Preparation of financial statements 138
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7.6.1 The statement of profit or loss and other comprehensive income
(financial performance) 138
7.6.2 The statement of changes in equity 139
7.6.3 The statement of financial position 140
7.6.4 Notes 141
7.7 Gross profit percentage 141
7.8 Integrated example 142
7.9 Revision exercises and solutions 153
7.9.1 Revision exercise 1 153
7.9.2 Revision exercise 2 154
7.9.3 Revision exercise 3 156
7.9.4 Revision exercise 4 156
7.9.5 Revision exercise 5 157
7.9.6 Revision exercise 6 159
7.9.7 Revision exercise 7 162
7.9.8 Revision exercise 8 163
Self-assessment 166
KEY CONCEPTS
.Financial period
.Nominal accounts
.Cost of sales
.Gross profit
.Profit for the year/period
.Inventory (merchandise, trading goods)
.Perpetual inventory system
.Periodic inventory system
.Closing entries
.Trading account, profit or loss account
.Statement of profit or loss and other comprehensive income, statement of changes in
equity, statement of financial position and notes.
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7.1 Introduction
This study unit will give you the background knowledge which you require to prepare the
financial statements of a service entity and a trading concern.
With the accounting entries we have dealt with so far, you already know how to determine:
.the owner’s capital
.the entity’s assets (including trading inventory and cash)
.the entity’s liabilities
.income and expenditure accounts (nominal accounts), which include the following in the
case of a trading concern:
.merchandise sales
.merchandise purchases
.all other expenditure
.other income
Since the preparing of financial statements goes hand in hand with the closing off procedure
every financial year, we will explain the closing entries which have to be made annually. All the
nominal accounts (income and expenditure) are closed off and they provide the details
for compiling the statement of profit or loss and other comprehensive income.
The accounts which remain in the trial balance after closing, namely the assets, liabilities and
capital accounts, form the basis of the information which is included in the statement of
financial position.
Study paragraph 7.1 of the prescribed book.
7.2 Financial performance of a service entity
Study paragraph 7.2 of the prescribed book.
7.3 Components of the financial performance of an entity
As you already know, the most important question is, ‘‘How has the business fared financially?’’
Has it made a profit or a loss? The calculations are made for a specific financial period, usually
a year. We now turn our attention to the following aspects:
7.3.1 Gross profit
This is the difference between sales and the ‘‘cost price of sales’’. The relevant accounts are
closed off to the trading account.
7.3.2 Profit for the year/period
This is the amount which remains from the gross profit after all expenditure necessary to
manage the business has been subtracted and other income has been added. These income
and expenditure accounts are closed off and transferred to the profit or loss account.
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7.3.3 Cost price of sales
Before determining the cost price of sales, we need to look at inventory. The merchandise
inventory which an entity buys during a financial period is not necessarily all sold during that
period. The inventory still in the entity at the beginning of the accounting period is known as the
opening inventory and that at the end of the period as the closing inventory.
Study paragraph 7.3.1 of the prescribed book.
7.4 Inventory systems (trading inventory)
Depending on the nature of the entity, the type of merchandise sold and the level of computerisation
in the entity, an entity can either use a perpetual (continuous) inventory system or a periodic
inventory system. Thusfar we have worked with the periodic inventory system.
With a perpetual inventory system the entity will keep a continuous track of inventory levels for
the different inventory items it sells. This method is ideally suited to an entity that sells items
that can be easily identified, measured and a value attached to them. The use of scanners and
bar codes enables many entities to apply this method of inventory recording.
Study paragraph 7.3.2 of the prescribed book.
7.4.1 The perpetual (continuous) inventory system
Under the perpetual inventory system, the purchase of inventory is recorded directly into the
inventory account at cost price. At the time of sale, the cost price of the goods sold is
transferred from the inventory account to the cost of sales account.
The accounting entries under such a system can be summarised as follows (VAT is ignored in
these examples):
Purchase of inventory for cash:
Dr Inventory (because the asset inventory increases.)
Cr Bank (because the asset bank decreases when money is paid out.)
The transaction is recorded in the cash payments journal at cost price.
Purchase of inventory on credit:
Dr Inventory (see above.)
Cr Trade payables (because a liability is created or increased.)
and
Cr Trade payables control
The transaction is recorded in the purchases journal at cost price.
Sale of merchandise for cash:
Dr Bank (an asset increases with money received) (selling price)
Cr Sales (an income which increases equity) (selling price)
Dr Cost of sales (an expense that decreases equity) (cost price)
Cr Inventory (an asset decreases) (cost price)
The transaction is recorded in the cash receipts journal.
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It is important to note that the difference between the cost of sales and the selling price is the
gross profit which is the amount by which the equity increases.
Merchandise sold on credit:
Dr Debtor (an asset is created or increased) (selling price)
and
Dr Debtors control
Cr Sales (see above) (selling price)
Dr Cost of sales (see above) (cost price)
Cr Inventory (see above) (cost price)
The transaction is recorded in the sales journal.
When merchandise is returned by a debtor:
Dr Sales returns (this has the opposite effect of sales on equity – it decreases equity)
(selling price)
Cr Debtor (the asset decreases because the debtor owes the
business less) (selling price)
and
Cr Debtors control
Cr Cost of sales (this has the opposite effect on equity to the effect when
merchandise was sold) (cost price)
Dr Inventory (the asset increases by the amount of the merchandise returned)
(cost price)
The transaction is recorded in the sales returns journal.
Merchandise returned, previously sold for cash:
If the business has a policy of not repaying cash, a credit note will be issued to the client that
can be exchanged for other merchandise.
If the business is willing to refund the cash:
Dr Sales returns (see above) (selling price)
Cr Bank (the asset bank will decrease to cancel the previous increase)
(selling price)
The transaction is recorded in the cash payments journal.
To reinstate the merchandise as part of inventory:
Dr Inventory (the asset inventory increases) (cost price)
Cr Cost of sales (see above) (cost price)
The transaction is recorded in the general journal
When merchandise is returned to a creditor:
Dr Creditor (because the liability decreases) (cost price)
and
Dr Creditors control
Cr Inventory (an asset is decreased – there is less inventory because of the
goods returned) (cost price)
The transaction is recorded in the purchases returns journal.
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From the above discussion it is clear that the cost price of merchandise sold is recorded at the
same time as the sale of the merchandise. This procedure enables the entity to determine the
gross profit on each sale and to keep a continuous record of the Rand value of the inventory
that has not yet been sold.
However, it remains necessary to do a physical inventory count at least once a year, usually at
the end of the financial year. Theoretically the result of the inventory count should yield the
same result as the balance on the inventory account. This seldom happens. Some of the main
reasons why there is a difference are the theft of inventory, breakages, leakages, and
evaporation. This loss of inventory will, of course, not be recorded in the inventory account and
will only be detected when a physical count of inventory is done.
GOLDEN RULES
.Perpetual inventory system: Cost of sales is determined with every sales transaction:
Debit: Cost of sales, Credit: Inventory with the cost value of the sales.
.Perpetual inventory system: No purchases or purchases returns accounts are kept (see
paragraph 7.4.2)
.Perpetual inventory system: A physical inventory count will only disclose shortages (or
surpluses) in inventory.
Exercise 7.1
The following exercise illustrates the perpetual inventory system:
R
Inventory on 1 January 20.1 10 000
Transactions for year up to 31 December 20.1
Credit purchases 50 000
Cash purchases 40 000
Credit sales (mark-up on cost price is 25%) 75 000
Cash sales (mark-up on cost price is 25%) 25 000
Solution Exercise 7.1
Accounting entries which have to be made
(1) In the perpetual inventory system inventory is an asset. Inventory on hand and inventory
which is purchased are therefore debited in the asset account, inventory, at cost price
and the contra account such as creditors or bank is credited.
(2) When goods (merchandise) are sold, the sales account (income) is credited with the
selling price and the contra account such as debtors or bank is debited.
(3) Goods (merchandise) are taken out of the inventory (asset) account at cost price
(inventory account is credited) and debited to the cost of sales (expense) account.
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LEDGER ENTRIES
GENERAL LEDGER
Dr Inventory Cr
20.1 R 20.1 R
Jan 1 Balance b/d 10 000 Dec 31 Cost of sales 60 000
Dec 31 Trade payables Cost of sales 20 000
control 50 000 Balance c/d 20 000
Bank 40 000
100 000 100 000
20.2
Jan 1 Balance b/d 20 000
Dr Sales Cr
20.1 R 20.1 R
Dec 31 Trading Dec 31 Trade receivables
account 100 000 control 75 000
Bank 25 000
100 000 100 000
Dr Cost of sales Cr
20.1 R 20.1 R
Dec 31 Inventory 60 000 Dec 31 Trading account 80 000
Inventory 20 000
80 000 80 000
Dr Trading account Cr
20.1 R 20.1 R
Dec 31 Cost of sales 80 000 Dec 31 Sales 100 000
Profit or
loss
(Gross profit*) 20 000
100 000 100 000
* The gross profit is the difference between sales and cost of sales. The gross profit is
transferred to the profit or loss account. Where cost of sales is more than sales, the result is a
gross loss.
COMMENTS
.When determining the cost of sales, it is important to establish whether the mark-up
was made on the cost price or the selling price since the price that applies is taken
to be 100 (100%).
Suppose the mark-up of 25% is on the cost price as in the above exercise.
Thus:
%
Cost price = 100
Mark-up = 25
Selling price = 125
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The cost price in Rand will obviously be less than the selling price.
Therefore:
Multiply by the smaller figure (100) and divide by the larger figure (125).
To calculate the cost of sales of R75 000
100
125 x75 000
1
Cost price = R60 000
If the mark-up of 25% is on the selling price:
%
Selling price = 100
Mark-up = 25
Cost price = 75
The cost price will again be less than the selling price.
Thus: 75
100 x75 000
1
Cost price = R56 250
.The gross profit, which is also called the trading profit, is determined in the
trading account.
.The details which are required to calculate the gross profit or loss are
transferred to the trading account by means of the general journal:
.The sales account is debited and the trading account is credited (sales are
closed).
.The cost of sales account is credited (the account is closed) and the trading
account is debited. The balance on the trading account represents the gross
profit or loss.
.The closing balance of the inventory account (asset) represents the closing
inventory.
7.4.2 The periodic inventory system
Under the periodic inventory system, the purchase of inventory is not recorded in the
inventory account. A separate account, known as the purchases account, is used to record
these purchases. It follows that if inventory is returned, for one reason or another, to the seller,
the return of inventory cannot be recorded in the inventory account but must be recorded in a
separate account known as the purchases returns account.
As a result of the above procedure it should be clear that under a periodic inventory system, the
cost of sales is not determined at the time of the recording of the sale. The cost of sales can
thus only be determined at the end of the financial period after a physical inventory count has
been done.
The cost price of inventory sold during an accounting period will thus be determined as follows:
Cost price of inventory at the beginning of the financial year (closing inventory of
previous year)
Add: Cost price of inventory purchased during the financial year. (This is the total
amount spent on purchases)
Less: Cost price of inventory at the end of the financial year, determined by a physical
inventory count. (This is the unsold inventory)
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The accounting entries associated with a periodic inventory system can be summarised as
follows (VAT is ignored in the examples):
Purchase of inventory for cash:
Dr Purchases (under the periodic inventory system, purchases are regarded as an
expense that reduces equity)
Cr Bank (the asset bank decreases when money is paid out)
The transaction is recorded in the cash payments journal at cost price.
Purchase of inventory on credit:
Dr Purchases (see above)
Cr Trade payables (creditors is a liability account which is created or increased)
and
Cr Trade payables control
The transaction is recorded in the purchases journal at cost price.
Sale of merchandise for cash:
Dr Bank (the asset increases with the money received)
Cr Sales (an income account which increases equity)
The transaction is recorded in the cash receipts journal at selling price.
Sale of merchandise on credit:
Dr Trade receivables (an asset which is created or increased)
and
Dr Trade receivables control
Cr Sales (see above)
The transaction is recorded in the sales journal at selling price.
When merchandise is returned by a debtor:
Dr Sales returns (equity decreases)
Cr Trade receivables (the asset decreases)
and
Cr Trade receivables control
The transaction is recorded in the sales returns journal at selling price.
Merchandise returned, previously sold for cash:
The policy of the business would determine whether a credit note will be issued (refer to the
perpetual inventory system) or whether the cash will be refunded to the client.
The entry for a cash refund will be as follows:
Dr Sales returns (the equity decreases)
Cr Bank (the asset bank will decrease to cancel the previous increase)
The transaction is recorded in the cash payments journal.
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When inventory is returned to a creditor:
Dr Trade payables (the liability decreases)
and
Dr Trade payables control
Cr Purchase returns (the actual purchase is reduced)
The transaction is recorded in the purchases returns journal at cost price.
Physical inventory count at the end of the financial year:
Dr Inventory (an asset account which is created with the inventory on hand at the
end of the financial year)
Cr Trading account (a nominal account which is used to determine the gross profit and
which increases equity if a gross profit is made)
The transaction is recorded in the general journal.
From the above summary it is clear that, under a periodic inventory system, there is no cost of
sales account but a purchases account and that the column headings of subsidiary journals will
have to be adapted to accommodate this inventory system. Some of the accounts kept in the
general ledger will also have to be changed when the periodic inventory system is in use.
It is very important, in assignments and in the examination, to make sure that you know which
inventory system a business uses as this will determine how the subsidiary journals and the
general ledger will be laid out.
GOLDEN RULES
.Periodic inventory system: Purchases and purchases returns accounts are kept. These
accounts are closed off (made NIL), at the end of the financial period, to the Trading
account.
.Periodic inventory system: NO cost of sales account is kept. Cost of sales is determined
via entries in the Trading account.
.Periodic inventory system: A physical inventory count is essential.
Exercise 7.2
We use the information from the previous exercise except that in this system (periodic system)
the closing inventory on 31 December 20.1 is determined first; it is R20 000.
Solution Exercise 7.2
Accounting entries which have to be made
(1) The opening balance on the inventory account (asset) is held in the books throughout the
financial period, which is usually a year, without any other entries.
(2) Inventory purchased is recorded (debited) at cost price in the purchases account
(expenditure) and the contra account, for instance creditors or bank, is credited. The
purchases account is closed off at the end of the financial year, to the trading account by
means of a general journal entry (debit trading account and credit purchases account).
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(3) When goods are sold, the sales account (income) is credited with the selling price and the
contra account, say bank or debtors, is debited.
(4) A physical inventory count is undertaken to determine the closing inventory (usually at cost
price — R20 000 in the exercise). To record this figure, the inventory account is debited
and the trading account is credited. At this point, you should have a look at the trading
account in the ledger. In this system a cost of sales account is not kept.
(5) As the opening inventory is either sold or included in the closing inventory, it must be
‘‘transferred’’. The inventory account is therefore credited and the trading account debited.
This means that the opening inventory is added to purchases. Closing inventory is
deducted (the trading account is credited) and the cost of sales is thus calculated.
COMMENTS
.Determining cost of sales and gross profit R
Opening inventory at cost price 10 000
Plus: Purchases at cost price 90 000
Inventory available for sale at cost price 100 000
Less: Closing inventory at cost price 20 000
Cost of sales 80 000
Gross profit 20 000*
Sales 100 000
* Balancing figure
.When determining the gross profit, the required details are transferred to the trading
account:
.The inventory account is credited and the trading account is debited with the
opening inventory (transfer of opening inventory).
.The purchases account is credited and the trading account is debited (purchases
account is closed).
.The sales account is debited and the trading account is credited (sales account is
closed).
The closing inventory is given (see accounting entry 4 above) and has already been
entered in the inventory account and the trading account.
GENERAL LEDGER
Dr Inventory Cr
20.1 R 20.1 R
Jan 1 Balance b/d 10 000 Dec 31 Trading account 10 000
20.1
Dec 31 Trading account 20 000
Dr Purchases Cr
20.1 R 20.1 R
Dec 31 Creditors control 50 000 Dec 31 Trading account 90 000
Bank 40 000
90 000 90 000
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Dr Sales Cr
20.1 R 20.1 R
Dec 31 Trading account 100 000 Dec 31 Trade receivables
control 75 000
Bank 25 000
100 000 100 000
Dr Trading account Cr
20.1 R 20.1 R
Dec 31 Inventory (opening) 10 000 Dec 31 Sales 100 000
Purchases 90 000 Inventory (closing) 20 000
Profit or loss
(gross profit)* 20 000
120 000 120 000
* Balancing figure
COMMENTS
.The gross profit calculated is the same for both systems (see * above and in the
previous example).
.The main differences between the two systems are:
(1) In the perpetual inventory system, purchases are recorded at cost price in the
inventory account (asset) and a cost of sales account is kept during the financial
period.
(2) In the periodic inventory system, purchases are recorded in the purchases
account (expenditure) and the cost of sales is calculated, by implication, in the
trading account.
7.4.3 Additional purchase costs
Study paragraph 7.3.2.2 of the prescribed book.
Carriage on purchases and railage are examples of expenses that an entity may have to pay in
order to transport the inventory which has been purchased to the premises of the entity.
Custom and excise duties may also have to be incurred when inventory is imported.
When the perpetual (continuous) inventory system is used, carriage on purchases, and the like,
is debited directly to the inventory account, since the cost of sales must be brought into account
with each sales transaction and carriage constitutes an integral part of the cost per unit.
When the periodic inventory system is used, all purchases of inventory during a financial year
are debited to the purchases account. Consequently this account will show the total of all
purchases at the end of the financial year. Carriage on purchases (paid for in cash, as well as
on credit) by an entity which uses this inventory system, will be debited to the carriage on
purchases account. This account will show the total amount spent for transporting inventory to
the premises of the entity. When the cost of sales is calculated at the end of the financial year,
carriage on purchases must also be taken into account. Custom and excise duties will be
treated in a similar manner.
The following illustration will demonstrate how accounts under the different inventory systems
will be affected when additional purchase costs are incurred:
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Transaction Perpetual inventory
system
Periodic inventory
system
Payment of delivery costs
on inventory purchased
Dr Inventory
Cr Bank
or
Cr Trade payables (and
trade receivables control)
if on credit
Dr Carriage on purchases
Cr Bank
or
Cr Trade payables (and
trade receivables control)
if on credit
Use the following information from the books of Gogo Dealers to calculate the cost of sales:
R
Inventory (1 January 20.1) 95 000
Purchases 260 000
Carriage on purchases 3 600
A physical inventory count on 31 December 20.1 indicated that inventory on hand amounted to
R80 000.
Solution:
R
Inventory (1 January 20.1) 95 000
Add: Purchases 260 000
Add: Carriage on purchases 3 600
358 600
Less: Inventory (31 December 20.1) 80 000
Cost of sales 278 600
7.4.4 Drawings and donations of inventory
Drawings and donations of inventory are recorded by means of the general journal at cost price.
Please study the following table carefully:
Transaction Perpetual inventory
system
Periodic inventory system
Inventory taken by owner
for personal use
Dr Drawings
Cr Inventory
Dr Drawings
Cr Purchases
Donation of inventory Dr Donations
Cr Inventory
Dr Donations
Cr Purchases
Drawings and donations are not exempted from VAT. The VAT is, however, calculated on the
cost price and must be credited to the VAT output account.
7.5 Closing-off of nominal accounts
Study paragraph 7.3 of the prescribed book again.
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We have worked through the accounting cycle up to the trial balance. This means that we have
tested the arithmetic of our accounts while bearing in mind the shortcomings of a trial balance.
As mentioned previously, the main purpose of an entity is to make a profit. To determine the
financial result of an entity, the nominal accounts are closed by means of closing journals and
transferred to the trading account (a nominal account) in the case of trading entities and/or
to the profit or loss account.
The gross profit, as determined, is debited to the trading account and credited to the profit or loss
account (a nominal account). All the other nominal accounts with credit balances such as rental
income and discount received, are debited (closed off) and the profit or loss account is credited.
Similarly, all expense accounts with debit balances such as telephone expenses, rental
expenses and salaries, are credited (closed off) and the profit or loss account is debited.
The difference between the debit and credit sides of the profit or loss account results in the
profit or loss which is, in turn, transferred to the capital account. The profit or loss account is
therefore, also closed off.
Remember that the trading account and the profit or loss account form part of the
accounting system.
By using the information in the following trial balance, the closing off of the nominal accounts at
the end of the accounting period, will be explained.
TOEKELA DEALERS
PRE-CLOSING TRIAL BALANCE AS AT 31 January 20.1
Fol Dr Cr
R R
Capital B 1 103 400
Drawings B 2 3 000
Bank B 3 4 250
Inventory – 1 February 20.0 B 4 5 000
Vehicles (at cost) B 5 91 000
Equipment (at cost) B 6 19 500
Trade receivables control B 7 10 100
Trade payables control B 8 14 700
Sales N 1 77 500
Sales returns N 2 1 500
Purchases N 3 52 500
Purchases returns N 4 2 500
Rent income N 5 600
Stationery N 6 150
Wages N 7 10 550
Water and electricity N 8 950
Credit losses (Bad debts) N 9 300
Settlement discount granted N10 150
Settlement discount received N11 250
198 950 198 950
Because of the presence of a purchases account, we know that the periodic inventory system
is in use.
On 31 January 20.1 a physical inventory count was done and the value of the inventory was
found to be R8 000 according to the inventory list. Remember that this amount still has to be
recorded in the books.
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GOLDEN RULES
All nominal accounts (i.e. income or revenue and expense acounts) MUST be closed off
(made NIL) at the end of the financial period to either the Trading account or the Profit or
Loss account.
Only entities that trade i.e. buy and sell merchandise, will have a Trading account.
7.5.1 Trading account
As mentioned previously, the gross profit is calculated in the trading account. The details
required to do this calculation are:
.opening inventory at cost price
.purchases at cost price
.closing inventory at cost price
.sales at selling price
.cost price of goods sold
In accounting terms the calculation would take the following form:
Opening inventory + purchases (all at cost price) 7closing inventory (at cost price) = cost
price of goods sold.
Gross profit = sales 7cost price of goods sold.
Using the details from a previous exercise, we have the following:
R10 000 + R90 000 7R20 000 = R80 000 (cost price of sales)
Gross profit = R100 000 7R80 000
= R20 000
The cost price of goods sold is influenced by all the expenses incurred up to the point where
the goods are offered for sale. It includes costs such as carriage on purchases, customs duty,
dock dues and freight. Such costs increase the cost prices of goods sold and therefore reduce
the gross profit.
Closing inventory
In practice it seldom happens that an entity sells all the available inventory, that is opening
inventory and purchases, and that there is no closing inventory. If this does happen, the closing
inventory is simply left out of the calculation. The closing inventory is actually counted, a list is
made and it is valued at cost price or market price, whichever is the lower. It is then recorded in
the books by means of a general journal entry. Since the closing inventory is an asset, the
inventory account is debited.
The necessary details such as opening inventory, purchases and sales, are transferred from
the nominal ledger accounts to the trading account by means of closing transfers in the general
journal.
The gross profit is obtained when the ‘‘balance’’ on the trading account is determined. The
journal entries for the closing transfers are given after the following ledger accounts.
TOEKELA DEALERS
GENERAL LEDGER
Dr Capital B1 Cr
20.1 R
Jan 31 Balance b/d 103 400
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Dr Drawings B2 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 3 000 Jan 31 Capital J3 3 000
Dr Bank B3 Cr
20.1 R
Jan 31 Balance b/d 4 250
Dr Inventory B4 Cr
20.0 R 20.1 R
Feb 1 Balance b/d 5 000 Jan 31 Trading account J1 5 000
20.1
Jan 31 Trading account J1 8 000
Dr Vehicles (at cost) B5 Cr
20.1 R
Jan 31 Balance b/d 91 000
Dr Equipment (at cost) B6 Cr
20.1 R
Jan 31 Balance b/d 19 500
Dr Trade receivables control B7 Cr
20.1 R
Jan 31 Balance b/d 10 100
Dr Trade payables control B8 Cr
20.1 R
Jan 31 Balance b/d 14 700
Dr Sales N1 Cr
20.1 R 20.1 R
Jan 31 Sales returns J 1 500 Jan 31 Balance b/d 77 500
Settlement
discount granted J 150
Trading account J 75 850
77 500 77 500
Dr Sales returns N2 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 1 500 Jan 31 Sales J1 1 500
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Dr Purchases N3 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 52 500 Jan 31 Purchases returns J 2 500
Settlement
discount received J 250
Trading account J 49 750
52 500 52 500
Dr Purchases returns N4 Cr
20.1 R 20.1 R
Jan 31 Purchases J1 2 500 Jan 31 Balance b/d 2 500
Dr Rent income N5 Cr
20.1 R 20.1 R
Jan 31 Profit or loss J2 600 Jan 31 Balance b/d 600
Dr Stationery N6 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 150 Jan 31 Profit or loss J2 150
Dr Wages N7 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 10 550 Jan 31 Profit or loss J2 10 550
Dr Water and electricity N8 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 950 Jan 31 Profit or loss J2 950
Dr Credit losses (Bad debts) N9 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 300 Jan 31 Profit or loss J2 300
Dr Settlement discount granted N10 Cr
20.1 R 20.1 R
Jan 31 Balance b/d 150 Jan 31 Sales J2 150
150 150
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Dr Settlement discount received N11 Cr
20.1 R 20.1 R
Jan 31 Purchases J 250 Jan 31 Balance b/d 250
250 250
Dr Trading account N12 Cr
20.1 R 20.1 R
Jan 31 Inventory (opening) J 5 000 Jan 31 Sales J 75 850
Purchases J 49 750 Inventory
Profit or loss (closing) J 8 000
(Gross profit) J 29 100
83 850 83 850
COMMENTS
CLOSING TRANSFERS OF SETTLEMENT DISCOUNT:
(1) Settlement discount granted transferred to sales:
To transfer settlement discount granted to the sales account the sales account is debited
and the settlement discount granted account is credited (thus the account is closed)
20.1 R R
Jan 31 Sales 150
Settlement discount granted 150
Closing transfer of settlement discount granted
(2) Settlement discount received transferred to purchases:
To transfer settlement discount received to the purchases account the settlement discount
received account is debited (thus the account is closed) and the purchases account is
credited.
20.1 R R
Jan 31 Settlement discount received 250
Purchases 250
Closing transfer of settlement discount received
CLOSING TRANSFERS TO THE TRADING ACCOUNT:
(1) To transfer the opening inventory to the trading account, the inventory account is
credited (account is closed) and the trading account is debited by means of a closing
transfer in the general journal
20.1 R R
Jan 31 Trading account N12 5 000
Inventory B4 5 000
Closing transfer of opening inventory
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(2) To transfer purchases to the trading account, the purchases account is credited
(account is closed) and the trading account is debited.
20.1 R R
Jan 31 Trading account N12 49 750
Inventory N3 49 750
Closing transfer of purchases account
(3) To transfer sales returns to the trading account, sales returns is credited (account is
closed) and the trading account is debited.
J1
20.1 R R
Jan 31 Sales N12 1 500
Sales returns N2 1 500
Closing transfer of sales returns
(4) To transfer sales to the trading account, sales are debited (account is closed) and the
trading account is credited.
20.1 R R
Jan 31 Sales N1 75 850
Trading account N12 75 850
Closing transfer of sales account
(5) To transfer purchases returns to the trading account, purchases returns are debited
(account is closed) and the trading account is credited. J1
20.1 R R
Jan 31 Purchase returns N4 2 500
Purchases N12 2 500
Closing transfer of purchases returns
(6) To record the closing inventory, which is an asset, in the books, the inventory account
is debited and the trading account is credited. J1
20.1 R R
Jan 31 Inventory B4 8 000
Trading account N12 8 000
To record the closing inventory in the books
(7) The trading account is now balanced. The result (balance) is the gross profit, namely
R29 100, which is transferred by means of a closing transfer to the profit or loss
account, where the profit is determined.
20.1 R R
Jan 31 Trading account N12 29 100
Profit or loss N13 29 100
Closing transfer of gross profit to profit or
loss account
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(8) Instead of all the separate closing transfers, a combined entry can be made with the
same effect.
General journal J1
20.1 R R
Jan 31 Sales N 1 75 850
Inventory (closing) B 4 8 000
Inventory (opening) B 4 5 000
Purchases N 3 49 750
Trading account N12 29 100*
Closing off and transfer of above
accounts to trading account
* Balancing figure between debits and credits
The amount of R29 100 is NOT credited in itself to the trading account. Each entry is shown
separately in the trading account (being contra entries). This will in effect credit the trading
account with the R29 100.
GOLDEN RULE
The trading account, being also a nominal account, is closed off to the profit or loss
account. (See the schematic representation.)
7.5.2 Profit or loss account
As mentioned previously, the profit is calculated in the profit or loss account.
The details required to do this calculation are:
.the gross profit
.all business expenditure
.all business income
Dr Profit or loss N13 Cr
20.1 R 20.1 R
Jan 31 Stationery J 150 Jan 31 Trading account J 29 100
Wages J 10 550 (Gross profit)
Water and Rent income J 600
electricity J 950
Credit losses J 300
Capital (Total com-
prehensive income
for the year) J 17 750
29 700 29 700
COMMENTS
Closing journal entries
(1) The gross profit has already been transferred.
(2) To transfer the expenditure accounts to the profit and loss account, the expenditure
accounts such as stationery, wages, and water and electricity are credited (accounts
are closed) and the profit and loss account is debited with each account individually.
This is done so that the expenditure on each item can readily be identified.
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FAC1502/1
CLOSING TRANSFERS OF EXPENDITURE J2
20.1 R R
Jan 31 Profit or loss N13 150
Stationery N6 150
Closing transfer
Profit or loss N13 10 550
Wages N7 10 550
Closing transfer
Profit or loss N13 950
Water and electricity N8 950
Closing transfer
Profit or loss N13 300
Credit losses (Bad debts) N9 300
Closing transfer
(3) To transfer the income accounts to the profit or loss account, the income accounts
such as rental income and commission received are debited (accounts are closed)
and the profit or loss account is credited.
CLOSING TRANSFERS OF INCOME J2
20.1 R R
Jan 31 Rental income N5 600
Profit or loss N13 600
Closing transfer
(4) Instead of all the individual closing transfers, a combined entry can be made, for
instance:
GENERAL JOURNAL J2
20.1 R R
Jan 31 Rental income N5 600
Profit or loss N13 11 350*
Stationery N6 150
Wages N7 10 550
Water and electricity N8 950
Credit losses (Bad debts) N9 300
Closing off the above accounts against
the profit and loss account
* Balancing figure between debits and credits. Remember that the amounts in the
nominal accounts are shown separately in the profit or loss account, which means that
the amount of R11 350 is not posted in itself to the account.
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FAC1502/1
(5) The profit or loss is the result (‘‘balance’’) of the profit or loss account.
(6) To transfer the profit due to the owner to the capital account, the profit or loss
account is debited (account is closed) and the capital account is credited (equity
increases).
GOLDEN RULE
The profit or loss account, also being a nominal account, is closed off to the capital
account. The profit or loss must be disclosed in the statement of changes in equity. (See
the schematic representation.)
CLOSING TRANSFER OF PROFIT FOR THE YEAR/PERIOD J3
20.1 R R
Jan 31 Profit or loss N13 17 750
Capital B1 17 750
To transfer profit to capital
(7) If the entity suffers a loss, the profit or loss account is credited and the capital account
is debited (equity decreases).
(8) At the same time the owner owes the amount in the drawings account to the entity. To
bring this debt into account, the drawings account is closed against the capital
account by crediting drawings and debiting the capital account (equity decreases).
GENERAL JOURNAL J3
20.1 R R
Jan 31 Capital B1 3 000
Drawings B2 3 000
To close drawings
(9) The complete capital account will then look like this:
Dr Capital B1 Cr
20.1 R 20.1 R
Jan 31 Drawings J3 3 000 Jan 31 Balance b/d 103 400
Balance c/d 118 150 Profit or loss J3 17 750
121 150 121 150
20.1
Feb 1 Balance b/d 118 150
(10) Post-closing trial balance
At this stage a post-closing trial balance can be prepared. This trial balance contains
the balances of all those accounts the balances of which are to be carried forward to
the following financial period. These balances are used to prepare the statement of
financial position.
In the above example this trial balance is as follows (note that there are NO nominal
account balances, or a balance for the Drawings account, any more, as they have
been closed off):
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FAC1502/1
POST-CLOSING TRIAL BALANCE AS AT 31 JANUARY 20.1
Fol Dr Cr
R R
Capital B1 118 150
Bank B3 4 250
Inventory B4 8 000
Vehicles (at cost) B5 91 000
Equipment (at cost) B6 19 500
Trade receivables control B7 10 100
Trade payables control B8 14 700
132 850 132 850
GOLDEN RULE
The post closing trial balance contains only balances of statement of financial position
accounts — no nominal accounts.
7.6 Preparation of financial statements
The financial statements of an entity do not form part of the ledger accounts of the entity, but
are prepared from the information in the accounts and the balances of such accounts. The
statements are prepared separately from the accounting records.
Study paragraph 7.3.4 of the prescribed book.
7.6.1 The statement of profit or loss and other comprehensive income
(financial performance)
The information in the trading and profit or loss accounts is communicated to interested
parties by means of the statement of profit or loss and other comprehensive income.
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FAC1502/1
TOEKELA DEALERS
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 JANUARY 20.1
Notes R
Revenue 2 75 850)
Cost of sales (46 750)
Opening inventory 5 000)
Net purchases 49 750)
54 750)
Closing inventory (8 000)
Gross profit 29 100)
Other income: 600)
Rental income 600)
29 700
Distribution, administrative and other expenses (11 950)
Stationery 150)
Wages 10 550)
Water and electricity 950)
Credit losses (Bad debts) 300)
Profit for the year 17 750)
Other comprehensive income for the year
Total comprehensive income for the year 17 750)
GOLDEN RULE
The statement of profit or loss and other comprehensive income is prepared from
information in the trading account and profit or loss account. (See schematic
representation.)
7.6.2 The statement of changes in equity
The statement of changes in equity was discussed in paragraph 4.15.2. Please study this
paragraph again. This statement is prepared from the information in the capital account.
TOEKELA DEALERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 JANUARY 20.1
Capital
R
Balance at 1 February 20.0 103 400
Total comprehensive income for the year 17 750
Drawings (3 000)
Balance at 31 January 20.1 118 150
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FAC1502/1
GOLDEN RULE
The statement of changes in equity is prepared from the information in the capital account.
(See schematic representation.)
7.6.3 The statement of financial position
The statement of financial position is compiled from those accounts which are not closed in the
process of determining the profit/loss of the entity. These accounts are either assets, liabilities
or equity accounts (the balances of these accounts appearing in the post-closing trial balance).
All the nominal accounts (expenditure and income) are closed. In the statement of financial
position a summary is made of all the entity’s assets and liabilities based on the accounting
equation, A = E + L.
A statement of financial position shows the entity’s financial position on a specific date,
whereas the profit or loss account or statement of profit or loss and other comprehensive
income shows the financial result over a financial period. The change in equity from one
financial period to the following financial period is reflected in the statement of changes in equity.
TOEKELA DEALERS
STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY 20.1
ASSETS Note R
Non-current assets 110 500
Property, plant and equipment 3 110 500
Current assets 22 350
Inventories 8 000
Trade and other receivables 10 100
Cash and cash equivalents 4 250
Total assets 132 850
EQUITY AND LIABILITIES
Total equity 118 150
Capital 118 150
Current liabilities 14 700
Trade and other payables 14 700
Total equity and liabilities 132 850
COMMENTS
.When the totals of the different assets are calculated and added together, the result is
equal to:
.the equity, plus
.the totals of the different liabilities which are calculated and added together (In the
example there is only one short-term liability, namely creditors.)
.Remember that the balances in the statement of financial position are the opening
balances of the ledger accounts for the next financial period.
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FAC1502/1
.There are usually more items under trade and other receivables and trade and other
payables than merely debtors and creditors. These items will be listed under trade and
other receivables and trade and other payables and will be added up to give the total
for trade and other receivables and trade and other payables.
GOLDEN RULE
The statement of financial position is prepared from the balances in the post-closing trial
balance after the note on property, plant and equipment has been prepared.
7.6.4 Notes
1 Accounting policy: The annual financial statements have been prepared on the historical
cost basis and comply with International Financial Reporting Standards.
2 Income represents net sales to third parties.
3Property, plant and Equipment Vehicles Total
equipment
R R R
Carrying amount:
Beginning of year 19 500 91 000 110 500
Cost 19 500 91 000 110 500
Accumulated
depreciation (—) (—) (—)
Depreciation (—) (—) (—)
Carrying amount:
End of year 19 500 91 000 110 500
Cost 19 500 91 000 110 500
Accumulated
depreciation (—) (—) (—)
No depreciation was written off during the financial year.
GOLDEN RULE
The note on ‘‘property, plant and equipment’’ reflects all changes in all non-current assets
and the associated accumulated depreciation accounts.
GOLDEN RULE
The total of the ‘‘carrying amount: end of year’’ must be the same as the amount disclosed
as ‘‘property, plant and equipment’’ under ‘‘non-current assets’’ in the statement of financial
position.
7.7 Gross profit percentage
An entity calculates its gross profit separately because it gives an indication of its performance
in its major activity, namely selling goods at a profit, apart from all the other activities in which it
engages to support this primary activity.
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FAC1502/1
Study paragraphs 7.3.3 and 7.4 of the prescribed book.
COMMENT
The gross profit is normally expressed as a percentage of either the selling price or the
cost price of goods sold.
Gross profit 100 =29 000 6100
Selling price 61 76 000 1
= 38,2%
Gross profit 100 =29 000 6100
Cost of sales 61 47 000 1
= 61,7%
Entities usually have a price policy which sets a certain gross profit percentage as an objective.
The selling price is determined by adding this profit percentage to the cost price of
merchandise. At the end of the period management can compare the actual result (gross profit
percentage) with the theoretical percentage (ie the profit-taking policy), or the result can be
compared with the results of other years, or with those of other entities in the industry.
7.8 Integrated example
The following information pertains to Hot-Rod Dealers:
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HOT-ROD DEALERS
(1) PRE-ADJUSTMENT TRIAL BALANCE AS AT 31 DECEMBER 20.4
Fol Debit Credit
R R
Capital GL 1 250 000
Drawings GL 2 4 400
Land and buildings (at cost) GL 3 180 000
Vehicles (at cost) GL 4 120 000
Furniture (at cost) GL 5 15 000
Inventory: Trading — 1 Jan 20.4 GL 6 4 000
Trade receivables control GL 7 40 140
Bank GL 8 5 900
Accumulated depreciation: vehicles GL 9 26 000
Accumulated depreciation: furniture GL10 3 000
Trade payables control GL11 50 750
Sales GL12 253 615
Sales returns GL13 615
Carriage on sales GL14 670
Commission income GL15 480
Rental income GL16 2 860
Purchases GL17 170 550
Purchases returns GL18 550
Carriage on purchases GL19 400
Credit losses (Bad debts) GL20 230
Insurance GL21 2 750
Packaging material GL22 800
Salaries GL23 38 500
Water and electricity GL24 3 300
587 255 587 255
(2) ADDITIONAL INFORMATION:
(a) Inventory on 31 December 20.4 R
Trading inventory 6 500
Packaging material 175
(b) Debtor S Sorry is insolvent; his debt of R140 has to be written off as irrecoverable.
(c) An employee is on leave and his January 20.5 salary of R1 500 has been paid to him in
advance.
(d) Delivery fees of R100 on purchases have not been paid yet.
(e) An insurance premium of R250 per month has been paid until the end of March 20.5.
(f) Rent income has been paid until the end of January 20.5.
(g) R880 commission was earned on 28 December 20.4; the amount is still outstanding.
(h) Provision must be made for depreciation as follows:
Vehicles R15 750
Furniture R 1 275
Required:
(1) Open the accounts of Hot-Rod Dealers in the general ledger with the given balances.
(2) Record the adjustments in the general journal and post to the ledger accounts.
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(3) Record the closing journal entries. Post to the ledger and show the trading account
and profit or loss account for the year ended 31 December 20.4.
(4) Prepare a post-closing trial balance as at 31 December 20.4.
(5) Prepare the statement of profit or loss and other comprehensive income of Hot-Rod
Dealers for the year ended 31 December 20.4.
(6) Prepare the statement of changes in equity for the year ended 31 December 20.4.
(7) Prepare the statement of financial position of Hot-Rod Dealers as at 31 December 20.4.
(8) Prepare the following notes:
(a) Accounting policy
(b) Property, plant and equipment.
Solution: Integrated example
Please note: Only one set of general ledger accounts is used. The journal entries after the
accounts, must be posted to the same set of accounts.
HOT-ROD DEALERS
(1) GENERAL LEDGER (POSTINGS INCLUDED)
Dr Capital 1 Cr
20.4 R 20.4 R
Dec 31 Drawings J2 4 400 Dec 31 Balance b/d 250 000
Balance c/d 273 610 Profit or loss J2 28 010
278 010 20.5 278 010
Jan 1 Balance b/d 273 610
Dr Drawings 2 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 4 400 Dec 31 Capital J2 4 400
Dr Land and buildings (at cost) 3 Cr
20.4 R
Dec 31 Balance b/d 180 000
Dr Vehicles (at cost) 4 Cr
20.4 R
Dec 31 Balance b/d 120 000
Dr Furniture (at cost) 5 Cr
20.4 R
Dec 31 Balance b/d 15 000
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Dr Inventory: Trading 6 Cr
20.4 R 20.4 R
Jan 1 Balance b/d 4 000 Dec 31 Trading
Dec 31 Trading account J2 6 500 account J2 4 000
Balance c/d 6 500
20.5 10 500 10 500
Jan 1 Balance b/d 6 500
Dr Trade receivables control 7 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 40 140 Dec 31 Credit losses
(Bad debts) J1 140
Balance c/d 40 000
20.5 40 140 40 140
Jan 1 Balance b/d 40 000
Dr Bank 8 Cr
20.4 R
Dec 31 Balance b/d 5 900
Dr Accumulated depreciation: vehicles 9 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 26 000
Depreciation J1 15 750
41 750
Dr Accumulated depreciation: furniture 10 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 3 000
Depreciation J1 1 275
4 275
Dr Trade payables control 11 Cr
20.4 R
Dec 31 Balance b/d 50 750
Dr Sales 12 Cr
20.4 R 20.4 R
Dec 31 Sales returns J2 615 Dec 31 Balance b/d 253 615
Trading account J2 253 000
253 615 253 615
Dr Sales returns 13 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 615 Dec 31 Sales J2 615
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Dr Carriage on sales 14 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 670 Dec 31 Profit or loss J2 670
Dr Commission income 15 Cr
20.4 R 20.4 R
Dec 31 Profit or loss J2 1 360 Dec 31 Balance b/d 480
Accrued
income J1 880
1 360 1 360
Dr Rental income 16 Cr
20.4 R 20.4 R
Dec 31 Income received Dec 31 Balance b/d 2 860
in advance J1 220
Profit or loss J2 2 640
2 860 2 860
Dr Purchases 17 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 170 550 Dec 31 Purchases returns J2 550
Trading account J2 170 000
170 550 170 550
Dr Purchases returns 18 Cr
20.4 R 20.4 R
Dec 31 Purchases J2 550 Dec 31 Balance b/d 550
Dr Carriage on purchases 19 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 400 Dec 31 Trading account J2 500
Accrued expenses
J1 100
500 500
Dr Credit losses (Bad debts) 20 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 230 Dec 31 Profit or loss J2 370
Trade receivables J1 140
370 370
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Dr Insurance 21 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 2 750 Dec 31 Prepaid
expenses J1 750
Profit or loss J2 2 000
2 750 2 750
Dr Packaging material 22 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 800 Dec 31 Inventory:
Packaging
material J1 175
Profit or loss J2 625
800 800
Dr Salaries 23 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 38 500 Dec 31 Prepaid
expenses J1 1 500
Profit or loss J2 37 000
38 500 38 500
Dr Water and electricity 24 Cr
20.4 R 20.4 R
Dec 31 Balance b/d 3 300 Dec 31 Profit or loss J2 3 300
Dr Prepaid expenses 25 Cr
20.4 R
Dec 31 Salaries J1 1 500
Insurance J1 750
2 250
Dr Accrued income 26 Cr
20.4 R
Dec 31 Commission
income J1 880
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Dr Income received in advance 27 Cr
20.4 R
Dec 31 Rent income J1 220
Dr Accrued expenses 28 Cr
20.4 R
Dec 31 Carriage on
purchases J1 100
Dr Inventory: Packaging material 29 Cr
20.4 R
Dec 31 Packaging
material J1 175
Dr Depreciation 30 Cr
20.4 R 20.4 R
Dec 31 Accumulated Dec 31 Profit or loss J2 17 025
depreciation:
vehicles J1 15 750
Accumulated
depreciation:
furniture J1 1 275
17 025 17 025
HOT-ROD DEALERS
GENERAL JOURNAL
(2) ADJUSTMENT ENTRIES — 31 DECEMBER 20.4 J1
R R
Inventory: Packaging material GL29 175
Packaging material GL22 175
Packaging material on hand at 31 December 20.4
Credit losses (Bad debts) GL20 140
Trade receivables control GL 7 140
Write S Sorry’s debt off as irrecoverable
Prepaid expenses GL25 1 500
Salaries GL23 1 500
Salaries prepaid
Carriage on purchases GL19 100
Accrued expenses GL28 100
Carriage on purchases still payable
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R R
Prepaid expenses GL25 750
Insurance GL21 750
Insurance prepaid for 3 months
Rental income GL16 220
Income received in advance GL27 220
Rent received in advance for January 20.5
Accrued income GL26 880
Commission income GL15 880
Commission earned not yet received
Depreciation GL30 17 025
Accumulated depreciation: vehicles GL 9 15 750
Accumulated depreciation: furniture GL10 1 275
Provision for depreciation
HOT-ROD DEALERS
GENERAL JOURNAL
(3) CLOSING ENTRIES — 31 DECEMBER 20.4 J2
R R
Purchases returns GL18 550
Purchases GL17 550
Closing transfer of purchases returns
Sales GL12 615
Sales returns GL13 615
Closing transfer of sales returns
Inventory: Trading (closing) GL 6 6 500
Sales GL12 253 000
Trading account GL31 259 500
Closing off and transfer of accounts to trading
account
Trading account GL31 174 500
Inventory: Trading (opening) GL 6 4 000
Purchases GL17 170 000
Carriage on purchases GL19 500
Closing off and transfer of accounts to trading
account
Trading account GL31 85 000
Profit or loss GL32 85 000
Transfer of gross profit
Commission income GL15 1 360
Rental income GL16 2 640
Profit or loss GL32 4 000
Closing off of accounts against profit or
loss account
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R R
Profit or loss GL32 60 990
Salaries GL23 37 000
Water and electricity GL24 3 300
Carriage on sales GL14 670
Insurance GL21 2 000
Packaging material GL22 625
Credit losses GL20 370
Depreciation GL30 17 025
Closing off of accounts against profit or
loss account
Profit or loss GL32 28 010
Capital GL 1 28 010
Transfer of profit to capital
Capital GL 1 4 400
Drawings GL 2 4 400
Close off drawings against capital
HOT-ROD DEALERS
GENERAL LEDGER
Dr Trading account 31 Cr
20.4 R 20.4 R
Dec 31 Inventory: Dec 31 Sales J2 253 000
Trading (opening) J2 4 000 Inventory:
Purchases J2 170 000 Trading
Carriage on (closing) J2 6 500
purchases J2 500
Profit or loss
(gross profit) J2 85 000
259 500 259 500
Dr Profit or loss 32 Cr
20.4 R 20.4 R
Dec 31 Salaries J2 37 000 Dec 31 Trading account
Water and electricity
J2 3 300 (gross profit) J2 85 000
Carriage on sales
J2 670 Commission
Insurance J2 2 000 income J2 1 360
Packaging material
J2 625 Rental income J2 2 640
Credit losses
(Bad debts) J2 370
Depreciation J2 17 025
Capital
(Total com-
prehensive income
for the year)
J2 28 010
89 000 89 000
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HOT-ROD DEALERS
(4) POST-CLOSING TRIAL BALANCE AS AT 31 DECEMBER 20.4
Fol Debit Credit
R R
Capital GL 1 273 610
Land and buildings (at cost) GL 3 180 000
Vehicles (at cost) GL 4 120 000
Furniture (at cost) GL 5 15 000
Inventory: Trading GL 6 6 500
Packaging material GL29 175
Trade receivables control GL 7 40 000
Bank GL 8 5 900
Accumulated depreciation: vehicles GL 9 41 750
Accumulated depreciation: furniture GL10 4 275
Trade payables control GL11 50 750
Prepaid expenses GL25 2 250
Accrued income GL26 880
Income received in advance GL27 220
Accrued expenses GL28 100
370 705 370 705
HOT-ROD DEALERS
(5) STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20.4
R
Revenue 253 000
Cost of sales (168 000)
Inventory (1 January 20.4) 4 000
Net purchases 170 000
Carriage on purchases 500
174 500
Inventory (31 December 20.4) (6 500)
Gross profit 85 000
Other income 4 000
Rental income 2 640
Commission income 1 360
89 000
Distribution, administrative and other expenses (60 990)
Salaries 37 000
Water and electricity 3 300
Carriage on sales 670
Insurance 2 000
Packaging material 625
Credit losses (Bad debts) 370
Depreciation (R15 750 + R1 275) 17 025
Profit for the year 28 010
Other comprehensive income for the year
Total comprehensive income for the year 28 010
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COMMENTS
.Revenue are sales less sales returns R (253 615 7615) = R253 000.
.Net purchases are purchases less purchases returns R (170 550 7550) = R170 000.
HOT-ROD DEALERS
(6) STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 DECEMBER 20.4
Capital
R
Balance at 1 January 20.4 250 000)
Total comprehensive income for the year 28 010)
Drawings (4 400)
Balance at 31 December 20.4 *273 610)
* Capital account
HOT-ROD DEALERS
(7) STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.4
ASSETS Note R
Non-current assets 268 975
Property, plant and equipment 2 268 975
Current assets 55 705
Inventories R(6 500 + 175) 6 675
Trade and other receivables R(40 000 + 880)* 40 880
Prepayments 2 250
Cash and cash equivalents 5 900
Total assets 324 680
EQUITY AND LIABILITIES
Total equity 273 610
Capital 273 610
Current liabilities 51 070
Trade and other payables R(50 750 + 100)
#
50 850
Income received in advance 220
Total equity and liabilities 324 680
* Trade receivables R40 000 + Accrued income R880 = R40 880.
# Trade payables R50 750 + Accrued expenses R100 = R50 850.
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HOT-ROD DEALERS
(8) NOTES FOR THE YEAR ENDED 31 DECEMBER 20.4
1 Accounting policy:
1.1 The annual financial statements have been prepared on the historical cost basis and
comply with International Financial Reporting Standards appropriate to the business
of the entiity.
1.2 Property, plant and equipment are shown at cost less accumulated depreciation.
Land and buildings are classified as investment properties and are not depreciated.
2
Property, plant and Land and Vehicles Furniture Total
equipment buildings
R R R R
Carrying amount:
Beginning of year 180 000 94 000 12 000 286 000
Cost 180 000 120 000 15 000 315 000
Accumulated depreciation (—) (26 000) (3 000) (29 000)
Depreciation (—) (15 750) (1 275) (17 025)
Carrying amount:
End of year 180 000 *78 250 *10 725 268 975
Cost 180 000 120 000 15 000 315 000
Accumulated depreciation (—) (41 750) (4 275) (46 025)
* Combination of ASSET account and Accumulated Depreciation on ASSET account
7.9 Revision exercises and solutions
7.9.1 Revision exercise 1
(1)Name the two descriptions of profit and the names of the accounts in which each is
determined.
(2) What details are necessary to determine the cost of sales?
(3) What two inventory systems are used mainly in practice?
(4) Name the main differences between the two inventory systems.
(5) Calculate the cost price of goods which were sold for R150 000 if the profit mark-up was
20% on the cost price.
(6) Calculate the cost price of goods which were sold for R150 000 if the profit mark-up was
20% on the selling price.
(7) What statement reflects the position of an entity’s assets and liabilities?
Solution: Revision exercise 1
(1) Gross profit/Trading account
Profit/Profit or loss account
(2) Opening inventory
Purchases
All other purchase related costs
Closing inventory
(3) Perpetual inventory system
Periodic inventory system
(4) Perpetual inventory system:
(a) Purchases of trading inventory are entered in the inventory account.
(b) Purchase related costs are recorded in the inventory account.
(c) The cost of sales account is updated during the financial period.
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Periodic inventory system:
(a) Purchases of trading inventory are recorded in the purchases account.
(b) Purchase related costs are recorded in accounts for each specific type of cost
(c) The cost price of sales may be determined in the trading account.
(5) %
Cost price 100
Profit mark-up 20
Selling price 120
If the selling price is R120, the cost price is R100
If the selling price is R150 000 the cost price is 100
120 6150 000
= R125 000
(6) %
Selling price 100
Profit mark-up 20
Cost price 80
If the selling price is R100, the cost price is R80
If the selling price is R150 000, the cost price 80
100 6150 000
= R120 000
(7) Statement of financial position
7.9.2 Revision exercise 2
Record each of the transactions listed below under the appropriate column heading in a
business that uses:
(1) a perpetual inventory system
(2) a periodic inventory system
NB: Ignore VAT
Account in general Assets = Equity + Liabilities
ledger to be
No Subsidiary journal debited credited + + +
Transactions:
1 Purchased inventory on credit, R4 000.
2 Paid carriage on purchases by cheque, R400.
3 Purchased inventory and paid by cheque, R8 000.
4 Sold half of the inventory on hand for cash, R10 000.
5 Inventory with a cost price of R1 000 was sold on credit for R2 100.
6 Inventory purchased on credit was returned to the seller, R200.
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Solution: Revision exercise 2
(1) ENTITY USING A PERPETUAL INVENTORY SYSTEM
Account in general Assets = Equity + Liabilities
ledger to be
No Subsidiary journal debited credited + + +
1 Purchases journal Inventory 4 000
Trade
payables
control 4 000
2 Cash payments Inventory 400
journal Bank 400
3 Cash payments Inventory 8 000
journal Bank 8 000
4 Cash receipts Cost of
journal sales 6 200
Inventory 6 200
Bank
10 000
Sales
10 000
5 Sales journal Cost of
sales 1 000
Inventory 1 000
Trade receiv-
ables control 2 100
Sales 2 100
6 Purchases returns Inventory 200
journal Trade pay-
ables control 200
(2) ENTITY USING A PERIODIC INVENTORY SYSTEM
Account in general Assets = Equity + Liabilities
ledger to be
No Subsidiary journal debited credited + + +
1 Purchases journal Purchases Trade pay- 4 000
ables control 4 000
2 Cash payments Carriage on-
journal purchases 400
Bank 400
3 Cash payments Purchases 8 000
journal Bank 8 000
4 Cash receipts Bank
10 000
journal Sales
10 000
5 Sales journal Trade receiv-
ables control 2 100
Sales 2 100
6 Purchases returns Trade pay-
journal ables control 200
Purhcases
returns 200
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7.9.3 Revision exercise 3
Calculate the gross profit of Zetta Traders for the year ended 30 June 20.2. Zetta Traders use
the periodic inventory system.
R
Opening inventory on 1 July 20.1 6 000
Total purchases 100 000
Total sales 140 000
Closing inventory (valued on 30 June 20.2) 10 000
Solution: Revision exercise 3
R
Opening inventory 6 000
Plus: Purchases 100 000
Goods available for sale 106 000
Less: Closing inventory 10 000
Cost of goods sold 96 000
Gross profit = Sales – cost of sales
= R(140 000 – 96 000)
= R44 000