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1.2 Purposes of account ing:1. To quantify items such as sales, expenses and profit2. To present the accounts in a meaningful way so as to measure the success of the business3. To provide information to the owner of the business and to other stakeholders
1.3 • documents
processing of source documents relating to accounting transactions
• initial recording of transactions
recording accounting transactions in subsidiary books (or books of prime entry)
• double-entry accounts system
transfer from subsidiary books into the double-entry book-keeping system of accounts in the ledger
• trial balance
extraction of figures from all the double-entry accounts to check their accuracy
• final accounts
production of a trading and profit and loss account and a balance sheet
Information from the accounting system includes:
• purchases of goods for resale to date • assets owned
• turnover (cash and credit sales) to date • liabilities owed
• overheads and expenses to date • profit during a particular period
• debtors – total amount owed to the business, and individual debtors
• creditors – total amount owed by the business, and individual creditors
1.4 Other stakeholders – any four from
• providers of finance, eg the bank manager if the business wants to borrow from the bank• suppliers, who wish to assess the likelihood of receiving payment from the business
• customers, who wish to ensure that the business has the financial strength to continue selling thegoods and services that they buy
• employees and trade unions, who wish to check on the financial prospects of the business
• the tax authorities, who will wish to see that tax due by the business on profits and for Value AddedTax has been paid
• competitors, who wish to assess the profitability of the business
• potential investors in the business
• the local community and national interest groups, who may be seeking to influence business policy
• government and official bodies, eg Companies House who need to see the final accounts of limitedcompanies
1.5 (a) Business entity – the accounts record and report on the financial transactions of a particularbusiness, and not the owner's personal financial transactions.
(b) Money measurement – the accounting system uses money as the common denominator in recordingand reporting all business transactions; thus the loyalty of a firm's workforce or the quality of a productcannot be recorded because these cannot be reported in money terms.
1.6 • assets – items owned by a business; liabilities – items owed by a business
• debtors – individuals or businesses who owe money in respect of goods or services supplied by thebusiness; creditors – individuals or businesses to whom money is owed by the business
• purchases – goods bought, whether on credit or for cash, which are intended to be resold later; sales– the sale of goods, whether on credit or for cash, in which the business trades
• credit purchases – goods bought, with payment to be made at a later date; cash purchases – goodsbought, with immediate payment made in cash, by cheque, debit card, credit card, or bank transfer
1.7 • asset of bank increases by £8,000capital increases by £8,000asset £8,000 – liability £0 = capital £8,000
• asset of computer increases by £4,000asset of bank decreases by £4,000asset £8,000 – liability £0 = capital £8,000
• asset of bank increases by £3,000liability of loan increases by £3,000asset £11,000 – liability £3,000 = capital £8,000
• asset of van increases by £6,000asset of bank decreases by £6,000asset £11,000 – liability £3,000 = capital £8,000
2.1 Dr Capital Account Cr
20-1 £ 20-1 £1 Feb Bank 7,500
Dr Computer Account Cr
20-1 £ 20-1 £6 Feb Bank 2,000
Dr Rent Paid Account Cr
20-1 £ 20-1 £8 Feb Bank 750
Dr Wages Account Cr
20-1 £ 20-1 £12 Feb Bank 42525 Feb Bank 380
Dr Bank Loan Account Cr
20-1 £ 20-1 £14 Feb Bank 2,500
Dr Commission Income Account Cr
20-1 £ 20-1 £20 Feb Bank 145
Dr Drawings Account Cr
20-1 £ 20-1 £23 Feb Bank 200
1
CHAPTER 1 What is financial accounting?
CHAPTER 2 Double-entry book-keeping: first principles
£ £ £1 Nov Capital 75,000 75,000 Dr3 Nov Photocopier 2,500 72,500 Dr7 Nov Bank loan 70,000 142,500 Dr
10 Nov Office premises 130,000 12,500 Dr12 Nov Rates 3,000 9,500 Dr14 Nov Office fittings 1,500 8,000 Dr20 Nov Wages 250 7,750 Dr23 Nov Cash 100 7,850 Dr25 Nov Office fittings 200 8,050 Dr
28 Nov Commission received 200 8,250 Dr
2.7 Guidance to the trainee to include:
• the use of accounts to record different types of transactions
• the principles of double-entry book-keeping whereby one account is debited and one account iscredited for every business transaction
• the debit entry is made in the account which gains value, or records an asset, or an expense
• the credit entry is made in the account which gives value, or records a liability, or an income item
• examples can be given using bank account where money in is recorded on the debit side, and moneyout is recorded on the credit side
• an explanation of various accounts including
– capital – the amount of money invested in the business by the owner
– fixed assets – items purchased by a business for use on a long-term basis (noting thedistinction between capital expenditure and revenue expenditure)
– expenses – the day-to-day running expenses (revenue expenditure) of the business
– income – amounts of income received by the business
– owner’s drawings – where the owner takes money in cash or by cheque (or sometimes goods)
from the business for personal use– loans – where a business receives a loan, eg from a relative or the bank
3.1 Dr Bank Account Cr
20-2 £ 20-2 £1 Oct Capital 2,500 2 Oct Purchases 2004 Oct Sales 150 6 Oct Purchases 908 Oct Sales 125 14 Oct Purchases 250
12 Oct K Smithson: loan 2,000 22 Oct Delivery van 4,00018 Oct Sales 155 25 Oct Wages 37530 Oct Sales 110
7 Jun Mercia Knitwear Ltd 40023 Jun Designs Ltd 285
Dr Designs Ltd Cr
20-3 £ 20-3 £6 Jun Purchases returns 100 2 Jun Purchases 350
18 Jun Bank 250 23 Jun Purchases 285
Dr Sales Account Cr
20-3 £ 20-3 £4 Jun Bank 2205 Jun Cash 115
10 Jun Wyvern Trade Supplies 35012 Jun Bank 17520 Jun Cash 180
Dr Bank Account Cr
20-3 £ 20-3 £4 Jun Sales 220 18 Jun Designs Ltd 250
12 Jun Sales 17528 Jun Wyvern Trade Supplies 300
Dr Cash Account Cr
20-3 £ 20-3 £
5 Jun Sales 115 26 Jun Rent paid 125
20 Jun Sales 180
Dr Purchases Returns Account Cr
20-3 £ 20-3 £
6 Jun Designs Ltd 100
17 Jun Mercia Knitwear Ltd 80
Dr Mercia Knitwear Ltd Cr
20-3 £ 20-3 £
17 Jun Purchases returns 80 7 Jun Purchases 400
Dr Wyvern Trade Supplies Cr20-3 £ 20-3 £
10 Jun Sales 350 15 Jun Sales returns 50
28 Jun Bank 300
Dr Sales Returns Account Cr
20-3 £ 20-3 £
15 Jun Wyvern Trade Supplies 50
Dr Rent Paid Account Cr
20-3 £ 20-3 £
26 Jun Cash 125
3.7 Transaction Account debited Account credited
(a) purchases bank
(b) bank sales
(c) purchases Teme Traders
(d) L Harris sales
(e) Teme Traders purchases returns
(f) sales returns L Harris
(g) bank D Perkins: loan
(h) cash bank
3.8 Answers to the t rainee:
• Separate accounts for purchases and sales enable the business to know the amount of goods boughtand sold. A combined account for ‘goods’ would not provide this information so readily.
• Purchases and sales accounts follow the principles of book-keeping in that the debit side of purchasesaccount gains value when the business buys goods for resale, while the credit side of sales account
gives value when the business sells goods.• The purchase of a new delivery van for use in the business is the purchase of a fixed asset, which will
be used on a long-term basis. As such the purchase of the van – which is an example of capitalexpenditure – is entered on the debit side of van account.
• Purchases returns (or returns out) is where we return goods to a creditor (supplier). The returnstransaction is recorded the opposite way round to a purchases transaction.
Sales returns (or returns in) is where a debtor (customer) returns goods to us. The transaction isrecorded the opposite way round to a sales transaction.
• Carriage inwards and carriage outwards are kept in separate accounts because they representdifferent transactions. Carriage inwards is where we pay the carriage cost of goods purchased to havethem delivered to us. Carriage outwards is where we pay the carriage charge for goods we have sold,that is we have sold the goods to our customers as ‘delivery free’.
Business transaction completely omitted from the accounting records. For example, cash sale omittedfrom both cash account and sales account.
• Reversal of entries
Debit and credit entries on the wrong side of the two accounts concerned. For example, cash saleentered wrongly as debit sales account, credit cash account.
• Mispost/error of commission
Transaction entered to the wrong person's account. For example, a sale of goods on credit to A THughes has been entered as debit A J Hughes' account, credit sales account.
• Error of principleTransaction entered in the wrong type of account. For example, cost of petrol for vehicles has beenentered as debit motor vehicles account, credit bank account.
• Error of original entry (or transcription)
Amount entered incorrectly in both accounts. For example, sale of £45 entered in both sales accountand the debtor's account as £54.
• Compensating error
Two errors cancel each other out. For example, balance of purchases account calculated wrongly at£10 too much, compensated by the same error in sales account.
6.2 (a) Purchases Day Book
Date Details Invoice Reference Amount
20-2 £
1 Feb Softseat Ltd 961 320
2 Feb PRK Ltd 068 80
15 Feb Quality Furnishings 529 160
19 Feb Softseat Ltd 984 160
28 Feb Total for month 720
Sales Day Book
Date Details Invoice Reference Amount
20-2 £8 Feb High Street Stores 001 440
14 Feb Peter Lounds Ltd 002 120
18 Feb Carpminster College 003 320
25 Feb High Street Stores 004 200
28 Feb Total for month 1,080
CHAPTER 6 Division of the ledger – the use of subsidiary books
Date Details Ref Disc Cash Bank Date Details Ref Disc Cash Bankallwd recd
20-7 £ £ £ 20-7 £ £ £
1 Aug Balances b/d 276 4,928 5 Aug T Hall Ltd 24 541
1 Aug Wild & Sons Ltd 398 8 Aug Wages 254
11 Aug Bank C 500 11 Aug Cash C 50012 Aug A Lewis Ltd 20 1,755 18 Aug F Jarvis 457
21 Aug Harvey & Sons Ltd 261 22 Aug Wages 436
29 Aug Wild & Sons Ltd 15 595 25 Aug J Jones 33 628
29 Aug Bank C 275 27 Aug Salaries 2,043
28 Aug Telephone 276
29 Aug Cash C 275
31 Aug Balances c/d 361 3,217
35 1,051 7,937 57 1,051 7,937
1 Sep Balances b/d 361 3,217
7.4
Dr Cash Book Cr
Date Details Ref Discount Cash Bank Date Details Ref Discount Cash Bankallowed received
20-5 £ £ £ 20-5 £ £ £
1 Mar Balances b/d 106 3,214 2 Mar Rent 10674 250
3 Mar Sales* 100 950 5 Mar Cleaning expenses 35
8 Mar Sales 1,680 9 Mar Purchases 10675 1,200
11 Mar Bank C 150 11 Mar Cash 10676 C 150
13 Mar Sales 1,800 16 Mar Postages 50
22 Mar Bank C 150 18 Mar Telephone 10677 168
25 Mar Sales 2,108 20 Mar Stationery 128
29 Mar Sales* 200 2,000 22 Mar Cash 10678 C 150
31 Mar Hobbs Ltd 30 720 26 Mar Misc expenses 70
31 Mar Pratley & Co 50 1,160 27 Mar Wages 10679 2,00030 Mar Electricity 10680 106
31 Mar Evans & Co 10681 45 855
31 Mar A Bennett 10682 26 494
31 Mar Balances c/d 423 8,259
80 706 13,632 71 706 13,632
1 Apr Balances b/d 423 8,259
* An alternative way of showing the transactions of 3 March and 29 March is to record the full amount of sales in the debitcash column, and then to show the amount banked as a separate transfer, ie debit bank, credit cash.
11
CHAPTER 7 The main cash book (b) (i) Purchases day book
(ii) Sales day book
(c) (i) Trade discount:
– given for bulk buying (also known as bulk discount), or for being in the trade, or for regularcustomers
– deducted from the invoice before entry in the books
– usually a larger percentage than cash discount
(ii) Cash discount (also known as settlement discount):
– given for prompt payment
– not deducted until account is paid
– can be disallowed if terms are not met
– usually a smaller percentage than trade discount
6.8
Source Subsidiary Account to Account to
Document Book be debited be credited
Invoice for goods sold on Sales day book V Singh Sales
credit to V Singh
(a) Invoice received for
goods bought on credit Purchases day Purchases Okaro Limited
from Okara Limited book
(b) Credit note issued to Sales returns Sales returns S Johnson
S Johnson day book
(c) Credit note received Purchases returns Roper & Purchases
1 Jan Balance b/d 415.15 23 Jan Direct debit: Omni Finance 207.95
13 Jan BACS credit: T K Supplies 716.50 31 Jan Balance c/d 923.70
1,131.65 1,131.65
1 Feb Balance b/d 923.70
(b) P GERRARDBANK RECONCILIATION STATEMENT AS AT 31 JANUARY 20-7
£ £
Balance at bank as per cash book 923.70
Add: unpresented cheques
Bryant & Sons cheque no. 001354 312.00
P Reid cheque no. 001355 176.50
488.50
1,412.20
Less: outstanding lodgement
G Shotton Limited 335.75
Balance at bank as per cash book 1,076.45
8.3 (a)
Dr Cash Book (bank columns) Cr
20-7 £ 20-7 £
1 May Balance b/d 300 2 May P Stone 867714 28
7 May Cash 162 14 May Alpha Ltd 867715 50
16 May C Brewster 89 29 May E Deakin 867716 110
23 May Cash 60 16 May Standing order: A-Z Insurance 25
30 May Cash 40 31 May Bank charges 10
31 May Balance c/d 428
651 651
1 Jun Balance b/d 428
(b) JANE DOYLEBANK RECONCILIATION STATEMENT AS AT 31 MAY 20-7
£
Balance at bank as per cash book 428
Add: unpresented cheque
E Deakin cheque no. 867716 110
538
Less: outstanding lodgement
cash banked 40
Balance at bank as per bank statement 498
12
CHAPTER 8 Bank reconciliation statements7.6 (i) Standing order Money paid out of the bank directly, at regular intervals, on the business’s order.Usually for the same fixed amount for goods and services supplied
DR Supplier/Creditor CR Bank
(ii) Credit transfer for payment by a customer Amounts paid directly into the bank by a debtor, who has the necessary bank codeinformation.
DR Bank CR Customer/Debtor
7.8 (a) and (b)
Dr Cash Book Cr
Date Details Disc Cash Bank Date Details Disc Cash Bank20-6 £ £ £ 20-6 £ £ £
1 Jan Balance b/d 50 1 Jan Balance b/d 1,236
6 Jan R Reed 567 2 Jan Bilton Office Supplies 3 164
13 Jan B Brown 4 366 11 Jan Rent 450
14 Jan Sales 752 27 Jan Wages 75
28 Jan Sales 642 20 Jan British Gas S/O 200
24 Jan C Denton & Co Ltd C/T 248 21 Jan Bank interest 28
31 Jan Cash C 1,319 31 Jan Bank C 1,31931 Jan Balances c/d 50 422
3. Telephone bill due to be paid in one month’s time
Section: Current liabilities
Reason: Short-term liability
– an amount owed by the business
– which needs to be paid within the next 12 months
Tutorial note: the accounting treatment for a bill which has not been paid at the balance sheetdate – called an accrual of expenses – is covered in detail in Chapter 12
4. Drawings for the year
Section: Capital/Financed by/Represented by
Reason: It is cash or goods taken out of the business by the owner,therefore it reduces the capital invested in the business.
10.2 (a)
Date Details Reference Dr Cr
20-8 £ £
31 Dec Stock GL 22,600
Trading GL 22,600Stock valuation at 31 December 20-8
transferred to trading account
(b)
Date Details Reference Dr Cr
20-8 £ £
31 Dec Profit and loss GL 890
Telephone expenses GL 890
Transfer to profit and loss account
of expenditure for the year
(c)
Date Details Reference Dr Cr
20-8 £ £
31 Dec Drawings GL 200
Motoring expenses GL 200
Transfer of private motoring to
drawings account
15
CHAPTER 10 The general journal and correction of errors
(b) AMARYLLIS TRADING
TRADING ACCOUNT FOR THE THREE MONTHS ENDED 31 DECEMBER 2001
£ £ £
Sales 21,053.57
Less Returns inwards 1,506.34
19,547.23
Less Cost of sales:
Opening stock 2,560.87
Add Purchases 13,045.97
Less Returns out 1,166.91
11,879.06
Add Carriage in 871.26
15,311.19
Less Closing stock 2,640.96
12,670.23
Gross profit 6,877.00
(c) (i) Cost of sales £12,670.23
(ii) Goods available for sale £15,311.19
(iii) Turnover £19,547.23
9.10 MEMORANDUM
Date TodayTo Mary Arbuthnot, proprietor of Mary’s Doll Shop
From Financial Accounting Student
Subject Balance sheet queries
1. Cost of new delivery van
Section: Fixed assets
Reason: An asset purchased for use in the business
– not for resale
– used over a long period/more than one year
– will help generate profits
– will depreciate with use
– is a tangible asset
2. Stock of dolls for resale
Section: Current assets
Reason: An asset remaining in the business for the short-term
The sales account has been totalled incorrectly. 3
An invoice has been completely omitted from the books. 3
A cheque has been debited in the cash book as £150
but credited in the customer’s account as £105. 3
10.10 (a)
Dr Suspense Account Cr
Date Details £ Date Details £
2004 2004
30 Apr Balance per T/B 450 30 Apr Sales 200
30 Apr Rent paid 250
450 450
Tutorial notes:
• Error (2) is an error of original entry which affects both the debit and credit side of the trial balance bythe same amount, and will not be revealed by the trial balance. Such an error is not entered in thesuspense account.
• Error (3) has been entered in the suspense account, above, as the net amount of £250(ie £650 – £400); as an alternative, it could have been entered as
– debit £400 (to take out the old amount in rent paid account)
– credit £650 (to enter the correct amount in rent paid account)
(b) Error of commission (or mispost):
• example – payment to ABrown entered to BBrown’s account
• explanation – although the entry has been misposted to the wrong person’s account, the trialbalance will still balance because the entry has been made on the correct side of the account.
(c) Sales ledger control account (see Chapter 11)
17
10.6 (a) Two from:
– trial balance
– bank reconci liat ion statement
– control accounts (see Chapter 11)
(b) JOURNAL
Account Dr Cr
£ £
(1) Sales 270
Suspense 270
(2) Returns inwards 500
Suspense 500
Returns inwards 300
Suspense 300
(3) Suspense 400
Discount received 400
(4) J Jones 350
A Jones 350
Tutorial note: The mispost between J Jones and A Jones needs to be corrected in the sales ledger,
but has no effect on suspense account.
10.8 (a) and (b)H G PATEL: TRIAL BALANCE AS AT 30 APRIL 2003
1 Feb Balances b/d 2,012.43 28 Feb Sales returns 221.67
28 Feb Credit sales 1,288.76 28 Feb Cheques receivedfrom debtors 911.43
28 Feb Cash discount allowed 23.37
28 F eb Set-off: purchases ledger 364.68
28 Feb Bad debts written off 59.28
28 Feb Balances c/d 1,720.76
3,301.19 3,301.19
1 Mar Balances b/d 1,720.76
(c) Reconciliation of sales ledger control account with debtor balances
1 February 20-8 28 February 20-8
£ p £ p
Arrow Valley Retailers 826.40 338.59
B Brick (Builders) Limited 59.28 –
Mereford Manufacturing Company 293.49 –
Redgrove Restorations 724.86 954.26
Wyvern Warehouse Limited 108.40 427.91Sales ledger control account 2,012.43 1,720.76
11.5 Dr Purchase Ledger Control Account Cr
2001 £ 2001 £
1 Mar Balance b/d 465 1 Mar Balance b/d 23,437
31 Mar Returns 4,679 31 Mar Purchases 245,897
Set-off: sales ledger 475 Cash refunds 450
Discounts 3,674 Balance c/d 749
Cash paid 236,498
Balance c/d 24,742
270,533 270,533
Balance b/d 749 Balance b/d 24,742
Tutorial note: The cash purchases figure of £25,679 is not shown in the control account because it does notinvolve the accounts of creditors – it is a cash purchase (ie debit purchases; credit bank/cash)
18
10.11 Jonathon Smith
Corrected Profit for the year ended 30 November 2004
£
Profit calculated by Jonathon 26,790
1. Sales undercast add 450
2. Discount allowed (2 x £140) less 280
3. Wages less 2,500
4. Fixed asset add 9,500
5. Error of commission – no effect on profi t
6. Closing stock (reduction in cost of sales) add 100
Corrected profit 34,060
11.3 (a) SALES LEDGER
Dr Arrow Valley Retailers Cr
20-8 £ p 20-8 £ p1 Feb Balance b/d 826.40 20 Feb Bank 805.743 Feb Sales 338.59 20 Feb Discount allowed 20.66
28 Feb Balance c/d 338.591,164.99 1,164.99
1 Mar Balance b/d 338.59
Dr B Brick (Builders) Limited Cr
20-8 £ p 20-8 £ p1 Feb Balance b/d 59.28 28 Feb Bad debts written off 59.28
Dr Mereford Manufacturing Company Cr
20-8 £ p 20-8 £ p1 Feb Balance b/d 293.49 24 Feb Sales returns 56.293 Feb Sales 127.48 28 Feb Set-off: purchases ledger 364.68
420.97 420.97
Dr Redgrove Restorations Cr
20-8 £ p 20-8 £ p1 Feb Balance b/d 724.86 7 Feb Sales returns 165.38
17 Feb Sales 394.78 28 Feb Balance c/d 954.261,119.64 1,119.64
1 Mar Balance b/d 954.26
Dr Wyvern Warehouse Limited Cr
20-8 £ p 20-8 £ p1 Feb Balance b/d 108.40 15 Feb Bank 105.69
17 Feb Sales 427.91 15 Feb Discount allowed 2.7128 Feb Balance c/d 427.91
12.1 (a) Expense in profit and loss account of £56,760; balance sheet shows wages and salaries accrued(current liability) of £1,120.
(b) Expense in profit and loss account of £2,852; balance sheet shows rates prepaid (current asset) of£713.
(c) Expense in profit and loss account of £1,800; balance sheet shows computer rental prepaid (currentasset) of £150.
12.2 SOUTHTOWN SUPPLIES
TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-9
£ £
Sales 420,000
Opening stock 70,000
Purchases 280,000
350,000
Less Closing stock 60,000
Cost of sales 290,000
Gross profit 130,000
Less expenses:
Rent and rates 10,250 – 550 9,700
Electricity 3,100
Telephone 1,820
Salaries 35,600 + 450 36,050
Vehicle expenses 13,750
64,420
Net profit 65,580
12.7 HAZELHARRIS
TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-4
£ £
Sales 614,000
Opening stock 63,000Purchases 465,000
528,000
Less Closing stock 88,000Cost of sales 440,000
Gross profit 174,000
Add Discount received 8,140182,140
Less expenses:
Building repairs 8,480Vehicle expenses 2,680
Wages and salaries 86,060 + 3,180 89,240
Discount allowed 10,610Rates and insurance 6,070 – 450 5,620
General expenses 15,860Depreciation: vehicles 12,000 x 20% 2,400
furniture and fittings 2 5,000 x 10% 2,500
137,390
Net profit 44,750
19
CHAPTER 12 Adjustments to final accounts11.6 Dr Sales Ledger Control Account Cr
20-5 £ 20-5 £
1 Jan Balance b/d 44,359 31 Jan Bank 23,045
31 Jan Sales 27,632 31 Jan Discount allowed 1,126
31 Jan Returned cheque 275 31 Jan Sales returns 2,964
31 Jan Set-off: purchases ledger 247
31 Jan Balance c/d 44,884
72,266 72,266
1 Feb Balance b/d 44,884
Tutorial note: The mispost of £685 between J Hampton and Hampton Limited needs to be corrected in thesales ledger, but has no effect on the control account.
11.7 (a)
Dr Sales Ledger Control Account Cr
2003 Details £ 2003 Details £
1 Nov Balance b/d 5,476 30 Nov Returns inwards 590
30 Nov Sales 26,500 30 Nov Bank (receipts from customers) 18,900
30 Nov Set-off: purchases ledger 400
30 Nov Balance c/d 12,086
31,976 31,976
1 Dec Balance b/d 12,086
Dr Purchases Ledger Control Account Cr
2003 Details £ 2003 Details £
30 Nov Returns outwards 450 1 Nov Balance b/d 2,960
30 Nov Bank (payments to 30 Nov Purchases 19,600
suppliers) 16,300
30 Nov Set-off: sales ledger 400
30 Nov Balance c/d 5,410
22,560 22,560
1 Dec Balance b/d 5,410
(b) • The balances of the individual accounts of debtors in the sales ledger are totalled.
• The balances of the individual accounts of creditors in the purchases ledger are totalled.
• These totals should agree with the balances of sales ledger control account and purchases ledgercontrol account respectively.
(c) • Some types of errors (such as a mispost/error of commission) will not be revealed by the controlaccount. Thus the accounts will be thought to be correct when they are not.
• A control account may indicate that there is an error within a ledger section but it will not pinpointwhere the error has occurred.
13.2 • The final accounts of a sole trader comprise:
– trading and profit and loss account
– balance sheet
• The trading and profit and loss account shows:
income minue expenses equals net profit (or loss)
• The trading account shows gross profit, while the profit and loss account shows net profit (or loss)
• The balance shows shows:
assets minus liabilities equals capital
• Assets are items owned by the business; liabilities are amounts owed by the business; capital is theamount of the owner’s investment.
13.3 (a) The Partnership Act 1890 defines a partnership as “the relation which subsists between personscarrying on a business in common with a view of profit”.
(b) Where no partnership agreement exists, then the following accounting rules from the Partnership Act1890 must be followed:
• profits and losses are to be shared equally between the partners
• no partner is entit led to a salary
• partners are not entitled to receive interest on their capital
• interest is not to be charged on partners’ drawings
• when a partner contributes more capital than agreed, he or she is entitled to receive interest atfive per cent per annum on the excess
Note: the question asks for any three provisions.
13.5 Points to cover include:
* Definition of a limited company
– separate legal entity
– owned by shareholders
– managed by di rectors
• Types of compani es
– public l imited company
– private limited company
– company l imited by guarantee
• Advantages of forming a limited company
– l imited liabil ity
– separate legal entity
– abi li ty to raise f inance
– membership
– other factors
21
(b)
MEMORANDUM
To: The Owner, Beta Batteries
From: Student Accountant
Date: Today
Subject: Account of J Booth
I note that a customer of Beta Batteries, J Booth, has been declared bankrupt whilst owing you
£350. You are of the opinion that none of the debt will be recovered.
The accounting treatment is that the amount of £350 should be treated as a bad debt written off. To
do this you will need to:
– debit bad debts written off account
– credit J Booth’s account in your sales ledger
If you use a sales ledger control account you should also credit this memorandum account with the
amount.
For the year end accounts, you will need to transfer the amount of the bad debt to profit and loss
account as an expense:
– debit profit and loss account
– credit bad debts written off account
The effect of writing off this bad debt will be to reduce your net profit by £350 and, at the same time,
the debtors’ figure in your balance sheet will be reduced by the amount, so reducing the net assets
This presumes that the business to which the final accounts relate will continue to trade in the foreseeablefuture. The trading and profit and loss account and balance sheet are prepared on the basis that there isno intention to reduce significantly the size of the business or to liquidate the business. If the business wasnot a going concern, assets would have very different values, and the balance sheet would be affectedconsiderably.
Example: As a going concern, fixed assets are valued at cost, less accumulated depreciation to date; stockis valued at cost (unless net realisable value is lower).
• Accruals concept
This means that expenses and income for goods and services are matched to the same time period.
Examples: The accrual of an expense in profit and loss account which has been used in the accountingperiod but not yet paid for. The prepayment of an expense for the next accounting period. The recording ofopening and closing stocks in the trading account. The use of debtors' and creditors' accounts to recordamounts owing to the business, or owed by the business.
• Materiality concept
This means that some items in accounts have such a low monetary (money) value that it is not worthwhilerecording them separately. Examples include:
– small expense items which may not justify their own separate expense account and are, instead,grouped together in a sundry expenses account
– end-of-year stocks of office stationery are often not valued for the purpose of final accounts becausethe amount is not material and does not justify the time and effort involved
– low-cost fixed assets are often charged as an expense in profit and loss account because, whilestrictly these should be treated as fixed assets and depreciated each year, in practice they are treatedas profit and loss account expenses as the amounts involved are not material – such as a calculator,
a staplerMateriality depends very much on the size of the business – what is material and what is not becomes amatter of judgement.
• Business entity concept
This refers to the fact that final accounts record and report on the activities of a particular business. Forexample, the personal assets and liabilities of those who play a part in owning or running the business arenot included on the business balance sheet.
14.2 (a) The concept of prudence means
– not anticipating profit until it is reasonably certain that it will be realised
– providing for all known liabilities
– not giving an over-optimistic presentation of the business
– not overstating the value of assets
(b) Examples (question asks for one example):
– valuation of stock, at the lower of cost and net realisable value
– depreciation of fixed assets, to measure the amount of the fall in value of fixed assets over time
– bad debts written off, to reduce the debtors’ figure to give a realistic view of the amount that thebusiness can expect to receive
– provision for doubtful debts (see Chapter 15), to reduce the debtors’ figure
(c) The concept of consistency means that, when a business adopts particular accounting policies, itshould continue to use such policies consistently
(d) Examples (question asks for one example)
– valuation of stock
– depreciation of fixed assets
– bad debts written off
– provision for doubtful debts (see Chapter 15)
By applying the consistency concept, direct comparison between the final accounts of different yearscan be made.
14.5 (a) The kettle should be valued at £16.
Workings: £31 – £15 = £16 net realisable value (which is lower than the cost of £18)
(b) Stock should be valued at the lower of cost or net realisable value whichever is the lower.
This is an example of using the prudence concept.
14.8
Concept Gross Net Current Current CapitalProfit Profit Assets Liabilities
1. Accruals no decrease no increase decrease change £4,000 change £4,000 £4,000
2. Consistency no decrease no no decrease
change £15,000 change change £15,000
3. Prudence or decrease decrease decrease no decreaseConsistency £18,000 £18,000 £18,000 change £18,000
4. Business no increase no no noentity change £13,000 change change change
14.10 (a) jacket, £40 (note: replacement cost is not applicable here)
shirt, £25
suit, £80
trousers, £25 – £10 = £15
electric trouser press, £80
(b) • The prudence concept says that final accounts should always, where there is any doubt, report aconservative figure for profit or the valuation of assets.
• In stock valuation it is applied by using the lower of cost and net realisable value. (Note that netrealisable value is the selling price of the goods, less further costs to get the stock into a saleablecondition.)
• A lower closing stock figure means that profits are not overstated – thus the amount drawn by theowner(s) will be reduced, so helping to ensure the continued financial viability of the business.
22
CHAPTER 14 Accounting concepts and stock valuation
PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 NOVEMBER 2004
£ £
Gross profit 68,772
Add income:
Discount received 119
Rent receivable 720
69,611
Less expenses:
Wages 26,320
Bad debts 340
Rent and rates 4,630
Other expenses 21,435
Discount allowed 286
Income in provision for doubtful debts *230
Depreciation of fixed assets **9,000
Loss on sale of van ***100
62,341
Net profit 7,270
* £1,120 – £890 = £230
** £27,000 provision for depreciation at start of year – £6,000 depreciation on van sold = £21,000,which is deducted from £30,000 provision for depreciation at end of year = £9,000 depreciation
for year (as shown in profit and loss account)
*** £
Net book value (£8,000 – £6,000) 2,000
Sale price 1,900
Loss on sale 100
16.1 (a) Capital expenditure £
cost of van 11,650
air conditioning 550
fitted shelving 350
total 12,550
(b) Revenue expenditure
tax disc 165
cost of extended warranty 220
tank of fuel 40
insurance premium 450
total 875
16.4 (a) ABEL BROWN
TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2001
£ £
Sales 278,400
Less Cost of sales:
Opening stock 12,700
Purchases 153,900
166,600
Less Closing stock 14,100 152,500
Gross profit 125,900
Less expenses:
Wages 75,400Rent 2,280
Other expenses 25,120
Depreciation 15,000 117,800
Net profit 8,100
Workings: • Wages £74,750 + £650 owing
• Rent £2,500 – £220 prepaid
• Depreciation £150,000 x 10%
(b) New net profi t: £11 ,100
Workings:
• Depreciation, using the straight-line method, at present is £15,000 (see above)
• Reducing balance depreciation will be 20% (£150,000 – £90,000) = 20% x £60,000 = £12,000
• Therefore reducing balance depreciation is £3,000 less this year than straight-line method, soprofits will increase from £8,100 (see above) to £11,100.
16.5 JOHN HENSONTRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-8
TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 MARCH 2006
£ £
Sales 587,461
Less Returns inwards 837
586,624
Opening stock 39,771
Purchases 280,797 – 2,170 goods for own use 278,627
318,398Less Closing stock 40,135
Cost of sales 278,263
Gross profit 308,361
Less expenses:
Wages 128,528 + 1,383 129,911
Motor expenses 47,870 – 18,500 29,370
Rates 7,810
Insurances 7,780 – 286 7,494
Bad debts written off 1,368
General expenses 33,713
Provision for depreciation:
premises 2,900
equipment 1,140motor vehicles 13,448
227,154
Net profit 81,207
Depreciation calculations
• Premises: £145,000 x 2% = £2,900
• Equipment: £11,400 x 10% = £1,140
• Motor vehicles £42,000 + £18,500 acquisition = £60,500 – £26,880 depreciation to date =£33,620 x 40% = £13,448
(b) Additional information 4
• This is a prepayment of expenses.• The amount is deducted from the expense to be shown in profit and loss account, ie £7,780
expense – £286 prepayment = £7,494 to profit and loss account.
• The amount will be shown as a current asset in the balance sheet.
• The £286 will be included in the cost for insurances charged to next year’s profit and lossaccount.
• The accounting concept is accruals (or matching) – expenses and revenues for goods andservices are matched to the same time period, here the year ended 31 March 2006.
• The owner has taken some of the goods in which the business trades for his own use.
• The amount, here £2,170, is deducted from purchases and added to the owner’s drawings(which will be deducted from capital in the balance sheet).
• The reason for reducing purchases is to ensure that only those purchases used in the businessare recorded, which are then matched to the sales derived from them.
• The accounting concept is business entity which keeps separate from the business the personalassets and liabilities of the owner.
(c) • A provision for doubtful debts should be created so that the balance sheet figure of net debtorsis a reliable estimate of the amount that will be received.
• If a provision is not made, then profits will be overstated by the amount of doubtful debts.
• Creation of a provision for doubtful debts is shown as an expense in profit and loss account, anddeducted from debtors in the balance sheet.
• The accounting concept is prudence.
16.8 (a) SIOBHAN HUGGETT
TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 APRIL 2004
£ £
Sales 293,100Opening stock 7,800
Purchases 123,400
131,200
Less Closing stock 8,700
Cost of sales 122,500
Gross profit 170,600
Add income:
Reduction in provision for doubtful debts 40
170,640
Less expenses:
Wages and general expenses 117,800
Business rates 13,330
Bad debts written off 750
Provision for depreciation:
fixtures and fittings 10,800
vehicles 31,840
174,520
Net loss 3,880
Workings:
• Purchases: £149,400 – £3,000 goods for own use – £23,000 fixtures = £123,400
• Closing stock: valued at the lower of cost, £8,700, and net realisable value, £11,500
• Provision for doubtful debts: £9,000 debtors x 3% provision = £270, which is deducted from £310existing provision = £40 reduction in provision for doubtful debts
• Wages and general expenses: £116,200 + £1,600 accrual = £117,800
• Business rates: £13,510 – £180 prepayment = £13,330
• Provision for depreciation of fixtures and fittings: £85,000 + £23,000 acquisition =£108,000 x 10% = £10,800
• Provision for depreciation of vehicles: £160,000 – £80,400 depreciation to date = £79,600 x 40%= £31,840
(b) Example of capital expenditure: purchase of fixtures
Example of revenue expenditure: wages and general expenses
(c) Capital expenditure is expenditure incurred on the purchase, alteration or improvement of fixedassets.
Revenue expenditure is expenditure incurred on running expenses.
Capital expenditure is shown on the balance sheet (subject to the accounting concept of materiality),while revenue expenditure is an expense in the profit and loss account. It is important to classify theseitems of expenditure correctly in the accounting system so that the final accounts report reliably onthe financial state of the business – profit is stated accurately and the balance sheet shows the assets
owned by the business.
16.9 (a) WULLIE McDUFF
PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 SEPTEMBER 2005
• Provision for doubtful debts: £35,000 debtors x 2.5% provision = £875, which is deducted from£940 existing provision = £65 reduction in provision for doubtfut debts.
• Rent and rates: £12,460 – £320 prepayment = £12,140
• General expenses: £36,980 + £918 accrual = £37,898
• Loss on sale of vehicle: £20,000 cost – £15,000 depreciation to date = £5,000 net book value atdate of sale – £4,800 sale proceeds = £200 loss on sale.
• Provision for depreciation of premises: £120,000 x 2% = £2,400
• Provision for depreciation of vehicles: £60,000 – £30,000 depreciation to date = £30,000 x 25%
= £7,500
(b) The private limited is the most common form of limited company and is defined as ‘any company thatis not a public company’ (Companies Act 2006). Many private limited companies are smallcompanies, often in family ownership and it would seem appropriate for Wullie McDuff to consider thisform of business organisation.
Advantages include:
• limited liability – the shareholders of the company can only lose the amount of their investment(together with any money unpaid on their shares); the personal assets of the shareholders arenot available to the company’s creditors
• separate legal entity – a limited company is separate from the owners
• ability to raise finance – the smaller company can raise funds from venture capital companies,relatives and friends; debentures can be issued to raise long-term finance from lenders andinvestors
• a limited company may have a higher standing and status in the business community,allowing itto benefit from economies of scale, and making it of sufficient size to employ specialists
Disadvantages include
• membership – all ordinary shareholders have voting rights, so Wullie may lose some control ofthe business
• documentation – there is more documentation – eg the preparation of formal annual accounts –for a company to produce than for a sole trader business; the costs of administering a companyare higher than for a sole trader
Conclusion • Wullie must consider the advantages and disadvantages of changing his business into a private
limited company. If he is seeking to expand the business and raise finance, it would be sensibleto consider this option. At the same time he would gain the benefit of limited liability.
17.1 (a) • Ordinary shares are the most commonly issued class of share. They take a share of the profitswhich remain after all other expenses of the business. The main risk of ordinary shares is that partor all of the value of the shares will be lost if the company loses money or becomes insolvent.
• Preference shares usually carry a fixed rate of dividend which is paid in preference to that ofordinary shareholders. In the event of the company ceasing to trade, the preference shareholderswill also receive repayment of capital before the ordinary shareholders.
(b) • Nominal value is the face value of a share which is entered in the accounts, eg 5p, 10p, 25p, 50por £1.
• Market value is the price at which issued shares are traded, ie bought and sold.(c) • Capital reserves are created as a result of a non-trading profit; examples include revaluation
reserve, share premium account.
• Revenue reserves are retained profits from the profit and loss account; examples include profit andloss account, retained profits, general reserve.
(d) • Abonus issue is the capitalisation of reserves – either capital or revenue – in the form of free sharesissued to existing shareholders in proportion to their holdings; no cash flows into the company.
• A rights issue is the raising of cash by offering shares to existing shareholders, in proportion to theirholdings, at a favourable price.
17.2 (a) debenture interest is shown as an expense in profit and loss account
(b) directors' remuneration is shown as an expense in profit and loss account
(c) corporation tax is shown in the appropriation section of the profit and loss account, and any amount
not yet paid is shown as a current liability on the balance sheet(d) dividends proposed are shown in the appropriation section of profit and loss account and as a
current liability on the balance sheet
(e) revaluation reserve is shown as a capital reserve as a part of the shareholders' funds section of thebalance sheet
(f) goodwill is shown as an intangible asset in the fixed assets section of the balance sheet; it isamortised in the same way as tangible fixed assets are depreciated
17.4 (a) MASON MOTORS LTDPROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-1
£
Net profit before taxation 75,000
Less corporation tax 20,050
Profit for year after taxation 54,950
Less final ordinary dividend proposed 10,000
44,950
Less transfer to general reserve 20,000
Retained profit for year 24,950
Add balance o f re ta ined pro fit s a t beg inni ng o f year 100, 000
Balance of retained profits at end of year 124,950
28
CHAPTER 17 Financial statements of limited companies
(b) Retained profits is profit which has been kept in the company. It belongs to the shareholders, but isrepresented by assets in the balance sheet and is not a bank balance available to rebuild thegarage forecourt.
17.7 (a) SRIAN PLCPROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 MAY 2003
£ £
Net profit before taxation *9,300,000
Less corporation tax 2,600,000
Profit for year after taxation 6,700,000
Less ordinary dividends – paid 800,000
– proposed 1,300,000
2,100,000
4,600,000
Less transfer to general reserve 1,000,000
Retained profit for year 3,600,000
* Draft profit 12,000,000
Less:
directors’ f ees 1,500,000
debenture interest 1,200,000
Net profit 9,300,000
(b) Issue of ordinary shares
– ordinary shares are not normally repayable, so the company will have the finance for theforeseeable future
– the new shareholders will have voting rights
– not essential to pay dividends every year, although a failure to do so might cause difficulties withfuture share issues
– the power of the existing shareholders will be diluted because there will be more shares in issue
– the company’s gearing ratio will be improved
Issue of debentures
– a different type of financing based on loans and interest, rather than shares and dividends
– the interest charge will rise by £1,800,000 from £1,200,000 to £3,000,000
– interest must be paid whether or not profits are made
– a failure to pay interest could lead the company into insolvency
– no voting rights, so no dilution of shareholders’ power
– debentures must be repaid at an agreed date in future
– interest rate is fixed, whatever may happen to the level of interest rates
– debenture holders likely to require security for their loan in the form of a mortgage over companyassets; this may restrict the use the company can make of the assets
– if repayment not made at due date, debenture holders can realise assets to obtain repayment
– the company’s gearing ratio will be worsened
Gearing ratio
Without having information on the company’s revenue reserves (retained profit and general reserve), thegearing ratio is currently:
Loan capital = £20,000,000 = 0.8:1 or 80%Share cap ita l £25 ,000,000
This is already a high gearing ratio which investors will not wish to see going above 1:1 or 100%.
If ordinary shares are issued to raise the money for expansion, the gearing ratio (including sharepremium account) becomes:
If debentures are issued, the gearing ratio becomes:
£50,000,000* = 2:1 or 200%£25,000,000
* 6% debentures £20,000,000 + £30,000,000
This is an extremely high gearing ratio, well above the ‘normal’maximum of 1:1 or 100% acceptable toinvestors. It may be that Srian plc will have difficulty in meeting the annual interest costs of this option.
Conclusion
It seems to be preferable for Srian to finance its expansion scheme with an issue of ordinary shares.This has a much lower gearing ratio than the issue of debentures – the company may have difficulty inthe future meeting the extra annual interest cost of £1,800,000.
17.9 (a) STOULBY LIMITEDPROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2006
£ £
Net profit before taxation 650,000
Less corporation tax 155,000
Profit for year after taxation 495,000
Less ordinary dividends – paid 63,000
– proposed *100,000
163,000
332,000
Less transfer to general reserve 120,000
Retained profit for year 212,000
Add balance of retained profi ts (profit and loss account) at beginning of year 410,000
Balance of retained profits at end of year 622,000
(b) SHARE CAPITAL AND RESERVES AT 31 DECEMBER 2006
£ £
Issued Share capital
4,000,000 ordinary shares of 50p each 2,000,000
Capital Reserve
Share premium account 500,000
Revenue Reserves
General reserve *420,000
Profit and loss account 622,000
1,042,000
SHAREHOLDERS’FUNDS 3,542,000
* £300,000 + £120,000 transfer
(c) Revenue reserves are profits from trading activities which have been retained in the company to helpbuild the company for the future.
(d) Profit and loss account or general reserve
(e) Revenue reserves can be used to fund dividend payments or to provide bonus shares to shareholders.
17.10 (a)
£
Retained profit for year as per draft final accounts 150,000
Less transfer to general reserve 45,000
Less ordinary dividend 35,000
Less preference dividend 4,000
Corrected retained profit for year 66,000
(b) DAVID MARK LIMITED
SUMMARISED BALANCE SHEET AS AT 31 DECEMBER 2002
£ £ £
Fixed Assets 700,000
Current Assets
Stock 85,000
Debtors 60,000
Bank balance 167,000
312,000
Less Current Liabilities
Trade creditors 37,000
Proposed dividends *39,000
76,000
Net Current Assets or Working Capital 236,000
NET ASSETS 936,000
FINANCED BY
Ordinary shares 350,000
8% Preference shares 100,000
Share premium account 50,000
General reserve 120,000
Profit and loss account 316,000
SHAREHOLDERS’FUNDS 936,000
* £35,000 + £4,000
(c ) • Li mit ed company, o r
• Private Limited Company
(d) • The term ‘Ltd’means that the shareholders of David Mark Limited have limited liability.
• This means that they could lose their investment but cannot be asked to contribute further in thecase of liquidation (unless the shares are not fully paid).
Date: TodaySubject: Making profits whilst having a bank overdraft
Reasons
a company can make a profit but have a bank overdraft for a number of reasons, including:
• the application of the realisation concept – timing of receipts and payments
• purchase of fixed assets
• repayment of loans
Explanation
• receipts from debtors and payments to creditors are likely to occur some weeks after the sales
and purchases have been recorded in the trading account
• the purchase of fixed assets affects cash but has no effect on profit
• repayment of loans affects cash but has no effect on profits
Hawk Limited
• 20% of cash from sales is received in the month of sale; then 60% is paid in the next month,
with 20% two months after sale
• the sales of £60,000 forecast to be made in December are higher than each of October and
November; the cash received from December’s sales will be £11,760 in December, £24,000 inJanuary and £12,000 in February – thus, at the end of December, £36,000 is outstanding
• in December, the company plans to buy new fixed assets at a cost of £19,510
• in December, the company plans to make a repayment on the loan of £20,000
(d) See Chaper 20.
• Automatic updating – as amendments are made, the entire budget is changed easily.
• What-if calculations – the effect of possible changes can be considered, eg a reduction in the
period of credit allowed to customers.
19.7 (a)
35
JIM SMITHCASH BUDGET FOR THE SIX MONTHS ENDING 30 JUNE 20...
Jan Feb Mar Apr May Jun
£ £ £ £ £ £
Receipts
Capital introduced 10,000
Debtors – 1,250 3,000 4,000 4,000 4,500
Total receipts for month 10,000 1,250 3,000 4,000 4,000 4,500