Introduction to financial reporting

Financial reporting is the recording, analysing, and summarising of financial data to

present the financial performance of a business.

Financial data is the name given to the actual transactions carried out by a business these
transactions are recorded in various books in different stage AND finally, the transactions
are summarized and prepare financial statements.

TYPES OF BUSINESS ENTITY:

SOLE TRADER:
- A sole tradership is a business owned and run by one individual, perhaps employing
one or two assistants and controlling their work.

PARTNERSHIP:
- These are arrangements between individuals to carry on business in common with a
view to profit. A partnership, however, involves obligations to others, and so a
partnership is usually governed by a partnership agreement.

LIMITED LIABILITY COMPANIES:

- Limited liability status means that the business's debts and the personal debts of the
business's owners (shareholders) are legally separate.
In law, sole traders and partnerships are not separate entities from their owners. However,
a limited liability company is legally a separate entity from its owners. Contracts can
therefore be issued in the company's name.
For accounting purposes, all three entities are treated as separate from their owners. This is
called the business entity concept.
Merits and Demerits of Sole Trader:
MERITS DEMERITS
- Limited paperwork - Owner is personally liable for all
debts
- Owner has complete control - Personal property may be vulnerable
for debts
- Owner is entitled to profits - Large sums of capital are less likely to
be available
- Less stringent reporting obligations - May be issues of continuity of
business
- Can be highly flexible

Merits and Demerits of Partnership:

MERITS DEMERITS
- Less stringent reporting obligations - Partners are jointly personally liable
for all debts
- Additional capital can be raised - There are costs associated with
because more people setting up partnership agreements
- Division of roles and responsibilities - There may be issues of continuity of
business
- Sharing of risk and losses between
more people

Merits and Demerits of Companies:

MERITS DEMERITS
- Limited liability makes investment - Publish annual financial statements
less risky
- Limited liability makes raising finance - Comply with legal and accounting
easier requirements.
- Tax advantages to being a limited - There may be issues of continuity of
liability company. business
- Sharing of risk and losses between - Financial statements of larger limited
more people liability companies have to be
audited
- It is relatively easy to transfer shares - Share issues are regulated by law
from one owner to another
ACCOUNTING
FINANCIAL ACCOUNTING MANAGMENT ACCOUNTING
• Production of summary financial • Preparation of accounting reports for
statement / accounting reports for external internal users E.g. management, employees
users
• Prepared annual (six-monthly or quarterly • Normally prepared on monthly basis
in some countries)
• Generally required by law • Not mandatory
• Reflects past performance and current • Production of detail accounts, used by
position management to control the business and
plan for the future
• Information is calculated and presented in • Includes budget and forecast of future
accordance with International Financial activities as well as reflecting past
Reporting standards (IFRS or IAS) performance

USERS OF FINANCIAL STATEMENT:

- Investors (owners)
- Trade Receivables (Customers)
- Trade Payables (Suppliers)
- Lenders
- Government
- Public
- Financial Advisors
- Employees

STAKEHOLDERS
A stakeholder is anyone who can affect the business or is affected by the business. They are
users of the prepared financial statements.
Internal Stakeholder: External Stakeholders:
- Business owner - Customers
- Employees of the company - Suppliers
- Government and Local authorities
- Shareholders
- External Lenders
- Auditors
- Public
ELEMENTS OF ACCOUNTING

ASSET LIABILITY EQUITY/ CAPITAL

REVENUE EXPENSE

ASSET:
“An asset is a resource controlled by the enterprise as a result of past events and from
which future economic benefits are expected to flow to the enterprise”
E.g. cash, building, furniture etc.

There are two types of Assets:

1. Current Asset:
These are assets bought with the intention of resale and are held only for a short
time. These may be cash or expected to generate cash or other economic benefits
within 12 months.
e.g. inventory, receivables, bank, cash etc.

2. Non-Current Asset:
These are assets bought with the intention of use rather than resale. They are
expected to be used by a business for more than a year to help generate income.
These are held and used in operations for a long time. These may be tangible or
intangible.
e.g. machinery, building, Land, software, patent etc.
LIABILITY:
“A liability is a present obligation arising from past event, the settlement of which is
expected to result in an outflow of economic benefits.”
E.g. Loan, Trade payables, overdrafts etc.

There are two types of Liability:

1. Current Liability:
These are liabilities payable in less than 12 months’ time from the reporting date
e.g. Trade payable, overdraft.

2. Non-Current Liability:
These are liabilities payable after more than 12 months’ time from the reporting date
e.g. loan etc

EQUITY / CAPITAL:
-It is the amount invested in a business by the owner
- It is amounts that the business owes to the owner.
- This is a special kind of liability
- In a limited liability company, capital usually takes the form of shares.
- Equity is the residual interest in the assets of the entity after deducting all its liabilities

REVENUE:
Revenue is the income generated by the operations of a business for a period.

EXPENSE:
Expenses are the costs of running the business for the same period.
THE FINANCIAL STATEMENTS OF A BUSINESS ARE:
- STATEMENT OF PROFIT OR LOSS (SOPL)
- STATEMENT OF FINANCIAL POSITION (SOFP)
- STATEMENT IF CHANGES IN EQUITY (SOCIE)
- STATEMENT OF CASH FLOW
- DISCLOSURE NOTE
Accounting Concepts:
Accrual Basis:
This means that transactions are recorded when revenue are earned and when expenses
are incurred. This pays no regard to the timing of the cash payment or receipt.

Prudence:
It is the exercise of caution when making judgements under conditions of uncertainty. In
preparing a business’s financial statements, assets and income should not be overstated,
while liabilities and expenses should not be understated.

Materiality:
An item is regarded as material if its omission or misstatement is likely to change the
perceptions or understanding of the users of that information – i.e., they may make
inappropriate decision based upon the misstated information.

Going concern:
Financial statements are prepared on the assumption that the entity is a going concern, and
will continue to operate for the foreseeable future.

Business entity Concept:

Financial accenting information presented in the financial statement relates only to the
activities of the business and not to those of the owners.
From an accounting perspective the business is treated as being separate from its owners.

Substance over Form;

Faithful representation of a transaction is only possible if it is accounted for according to its
substance and economic reality.
 DOUBLE-ENTRY BOOKKEEPING

This chapter introduces you to the nature of business transactions and documentation and
how transactions are recorded in the accounting records
In every business a number of transactions and events will take place every day
The main transactions that take place include sales, purchases (of goods and of services)
and payroll related transactions. Others include rental costs, raising finance, repayment of
finance, and taxation
Most transactions a supporting document will be created to confirm the transaction has
taken place

Data sources

Books of prime entry

Leger accounts

Trial balance

Financial statement
BUSINESS DOCUMENTATION AND SOURCES OF DATA
Documentation is vital to the financial accountant, who uses the information on the
documents as a data source to initiate the measurement and recording of the transactions.

Some important documents or source of data are:

- Quotation
- Purchase order
- Sales order
- Goods dispatch note
- Goods received note
- Invoice
- Receipt
- Credit Note
- Debit Note

NATURE OF TRANSACTIOS:
There are two natures of transaction they are Cash transaction and Credit transaction.
With a cash transaction, the buyer pays for the goods or services immediately as they are
received or possibly in advance. Cash is directly involved in a cash transaction e.g., payment
through bank or payment through cash in hand.
With a credit transaction, the buyer doesn’t have to pay for the goods or services on receipt
but is allowed some time. Payments and receipts are postponed for some future time
(credit period) e.g. business buys goods for resale and payment is made after one month

BOOKS OF PRIME ENTRY:

- All transactions are initially recorded in a book of prime entry.
- This is a simple note of the transaction, the relevant customer/ supplier and the
amount of the transaction.
- It is, in essence, a long list of daily transactions.
 BOOKS OF PRIME ENTRY TRANSACTION TYPE
Sales day book Credit sales
Purchase day book Credit purchases
Sales return day book Returns of goods sold on credit
Purchase return day book Return of goods bought on credit
Cash book All bank transactions
Petty cash book All small cash transactions
The journal All transactions not recorded elsewhere

A petty cash book is a cash book for small payments and receipt. There are usually more
small payments than receipts.
e.g.: Stamps, Taxi fare, Received from staff for photocopying, Stationery
All petty cash must be supported by invoices and Petty cash vouchers must be signed by the
claimant and the person responsible for running the petty cash.

Imprest system in petty cashbook:

An amount of money in petty cash is kept at an agreed sum or 'float' This is called the
imprest amount.
Expense items are recorded on vouchers as they occur which is deducted from the float
The total float is replenished/restored regularly
The balance amount will be transferred from main cashier to petty cashier to fill the float.

Illustration:
The Accounting Equation:

Asset Liability Equity

Each time a transaction is recorded, both effects must be taken into account. These two
effects are equal and opposite as such, the accounting equation will always be maintained.
A statement of financial position will always satisfy the accounting equation above.

Equation on capital:
Assets – Liabilities = Equity (or Capital

The term ‘net assets’ is sometimes used to mean ‘assets minus liabilities
- Profit adds to capital and losses reduce capital.
- Drawings or (in the case of a company) dividends also reduce capital.
- An owner might introduce new capital into the business
From these observations, the following conclusions can be made

Opening net assets + Profit + Capital introduced – Drawings = Closing net assets.
This is called the business equation.

Ledger Accounts;
The sum total of the day's transactions is recorded in the accounting ledgers of the entity.
The term 'general ledger' is used to refer to the overall system of ledger accounts within a
business. It houses all the separate ledgers required to produce a complete trial balance
and, consequently, set of financial statements.
Duality, double entry and the accounting equation
Each transaction that a business enters into affects the financial statements in two ways
For example, a business buys a vehicle for cash. The two effects on the business are:
1. It has increased the vehicle assets
2. There is a decrease in cash available to the business

Transactions and events are eventually recorded in the relevant ledger accounts using a
double entry to reflect the duality concept explained previously.
There is a ledger account for each asset, liability, equity, income and expense item.
One account will be debited and the other credited.
Whether an entry is to the debit or credit side of an account depends on the type of
account and the transaction

DEBIT AND CREDIT RULES ON ELEMETS

Summary of steps to record a transaction:
1. Identify the ledger accounts that are affected.
2. Consider whether the account balances are being increased or decreased.
3. Decide whether each account should be debited or credited.
4. Check that a debit entry and a credit entry have been made and they are both for the
same amount.
The process of transferring the details of transactions from the books of prime entry to the
accounts in the ledgers is called ‘posting’ the transactions.

Balancing off a ledger account.

Once the transactions for a period have been recorded, it will be necessary to find the
balance on the ledger account:
1. Total both sides of the T-account and find the larger total.
2. Put the larger total in the total box on the debit and credit side.
3. Insert a balancing figure to the side of the T-account which does not currently add up
to the amount in the total box. Call this balancing figure ‘balance c/f’ (carried
forward) or ‘balance c/d’ (carried down).

4. Carry the balance down diagonally and call it ‘balance b/f’ (brought forward) or
‘balance b/d’ (brought down).

Closing of ledger accounts:

At the year end, the ledger accounts must be closed off in preparation for the recording of
transactions in the next accounting period.

Statement of financial position ledger accounts:

Assets/liabilities at the end of a period = Assets/liabilities at start of the next period
Balancing the account will result in:
- a balance c/f (being the at the end of the accounting period)
- a balance b/f (being the at the start of the next accounting period).
Profit or loss ledger accounts:
At the end of a period any amounts that relate to that period are transferred out of the
income and expenditure accounts into another ledger account called profit or loss. This is
done by closing the account.
- Do not show a balance c/f or balance b/f but instead put the balancing figure on the
smallest side and label it ‘profit or loss'.
 Returns, Discounts and Sales Tax
Recording sales and purchases:
Sales return: -
it is customer returning goods due to any reason to the business
Purchase return: –
It is the business returning goods to the supplier due to any reason

Discounts
Discounts are mainly classified into two:
1. TRADE DISCOUNT:
-Given to try and increase the volume of sales
-Reducing the selling price
-Deducted at the point of sale
-Trade discount does not get recorded separately
2. CASH DISCOUNT/(settlement Discount):
-Make credit customers to pay goods purchased quicker
-It comes only in case of credit purchase and sales
-Disc allowed is a reduction in revenue.
-Known as settlement or prompt payment discount
Variable consideration in case of settlement discount
CASE 1 – Not Expected to pay early
❖ prepare the sales invoice for the full amount if the customer is not expected to pay early
and claim the settlement discount. If, as expected, the customer does not pay early, the full
amount is due as normal

Journal entry at the time of sale:

(for e.g. sale amount is $1000 and discount is $100)
Dr Receivables $1000
Cr sales $1000

Journal entry at the time of settlement has 2 situations (same e.g., as above)
(i)Discount not taken: (ii) Discount taken:
Dr Cash $1000 Dr cash $900
Cr Receivables $1000 Dr Discount allowed $100
Cr Receivables $1000

CASE 2 – Expected to pay early

❖ prepare the invoice for the reduced amount (after applying the settlement discount) if
the customer is expected to pay early and be entitled to the settlement discount.
• Subsequently, if the customer does not pay early and is no longer entitled to the discount,
the full amount is due and the additional amount received would be treated as revenue
from the original sales transaction

Journal entry at the time of sale:

(for e.g. sale amount is $1000 and discount is $100)
Dr Receivables $900
Dr Discount allowed $100
Cr sales $1000
Journal entry at the time of settlement has 2 situations (same e.g., as above)
(i)Discount not taken: (ii) Discount taken:
Dr Cash $1000 Dr cash $900
Cr Receivables $900 Dr Receivables $900
Cr Discount allowed $100

Sales Tax
Sales tax is the tax on products levied on the final consumer of a product
Sales tax is charged and paid on purchases (input tax)
Sales tax charged and collected on sales (output tax)

In order to charge sales tax, a business must be registered for sales tax.
A sales tax registered trader must carry out the following tasks.
(a) Charge sales tax on the goods and services sold. This is output sales tax.
(b) Pay sales tax on goods and services purchased from other businesses. This is input sales
tax.
(c) Pay to the tax authorities the difference between the sales tax collected on sales and the
sales tax paid to suppliers for purchases.

Irrecoverable sales tax

There are some circumstances in which sales tax paid on inputs cannot be reclaimed Where
a trader is not registered for sales tax or where inputs are not related to taxable business
activities In these cases the trader must bear the cost of the sales tax and account for it
accordingly.
Amount Inclusive and Exclusive of tax
You are likely to come across sales and purchases figures quoted as gross or net of sales tax.
The gross amount of a sale or purchase is the amount inclusive of sales tax.
The net amount of a sale or purchase is the amount exclusive of sales tax.

E.g. if the net amount of a purchase is $100, and the rate of sales tax is 15%, the amounts
are as follows.
Net amt exclusive of sales tax: = $100
Sales tax: = $100 x 15% = $15
Gross amt inclusive of sales tax: = $100 + $15 = $115

if the gross amount of a purchase is $80, and the rate of sales tax is 15%, the sales tax and
net amounts are as follows.
Gross amt = $80
Net amt = $80 / 115%= $69.57
Sales tax = $80 – $69.57 = $10.43

Accounting for sales tax

Sales tax charged on sales is collected by the business on behalf of the tax authorities.
It does not form part of the revenue of the business.
If a business sells goods for $600 + sales tax $90,
i.e., for $690 total price, the sales account should only record the $600 excluding sales tax.

Journal entry:
DEBIT Cash or trade receivables $690
CREDIT Sales $600
CREDIT Sales tax control account (output sales tax) $90
If input sales tax is recoverable, the cost of purchases should exclude the sales tax and be
recorded net of tax.

For example, if a business purchases goods on credit for $400 + sales tax $60, the
transaction would be recorded as follows.
Journal entry
DEBIT Purchases $400
DEBIT Sales tax control account (input sales tax recoverable) $60
CREDIT Trade payables $460

An outstanding payable for sales tax will appear as a current liability in the statement of
financial position.
Occasionally, a business will be owed money by the authorities. In such a situation, the sales
tax refund owed by the authorities would be a current asset in the statement of financial
position.
 THE REGULATORY FRAMEWORK
WHY REGULATION???
◦ Purpose of this section is to give a general picture of some of the factors which have
shaped financial accounting.
◦ Will concentrate on the accounts of limited liability companies, as these are the accounts
most closely regulated by statute or otherwise.
◦ The form and content of the accounts is regulated primarily by national legislation.
◦ Many figures in financial statements are derived from the application of judgement in
applying fundamental accounting assumptions and conventions.
◦ This can lead to subjectivity. Accounting standards were developed to try to address this
subjectivity.
◦ Financial statements are prepared on the basis of a number of fundamental accounting
assumptions and conventions.

ACCOUNTING STANDARDS
◦ In an attempt to deal with some of the subjectivity, and to achieve comparability between
different organisations, accounting standards were developed.
◦ These are developed at both a national level and international.
◦ We are concerned with International Financial Reporting Standards (IFRSs).

◦ IFRSs are produced by the International Accounting Standards Board (IASB)

International Accounting Standards Board (IASB)
◦ The International Accounting Standards Board (IASB) is an independent, privately funded
body that develops and approves IFRSs.
◦ Prior to 2003, standards were issued as International Accounting Standards (IASs). In 2003
IFRS 1 was issued and all new standards are now designated as IFRSs.
◦ The members of the IASB come from several countries and have a variety of backgrounds,
with a mix of auditors, preparers of financial statements, users of financial statements and
academics.
◦ The IASB operates under the oversight of the IFRS Foundation.

The objectives of the IFRS Foundation:

◦ Develop a single set of high quality, understandable, enforceable and globally accepted
IFRSs through its standard-setting body, the IASB
◦ Promote the use and rigorous application of those standards
◦ Take account of the financial reporting needs of emerging economies and small and
medium sized entities (SMEs)
◦ Bring about convergence of national accounting standards and IFRSs to high quality
solutions.
The IFRS Foundation is made up of several trustees, who essentially monitor and fund the
IASB, the IFRS Advisory Council and the IFRS Interpretations Committee.
IFRS Advisory Council
◦ A forum used by the IASB to consult with the outside world.
◦ Advise the IASB and ISSB on a range of issues, from the IASB's work programme for
developing new IFRSs to giving practical advice on the implementation of particular
standards.

IFRS Interpretations Committee

◦ The IFRS Interpretations Committee has two main responsibilities.
◦ To review, on a timely basis, newly identified financial reporting issues not specifically
addressed in IFRSs
◦ To clarify issues where unsatisfactory or conflicting interpretations have developed.

ISSB International Sustainability Standards Board

International investors with global investment portfolios are increasingly calling for high
quality, transparent, reliable and comparable reporting by companies on sustainability
issues such as climate and other environmental, social and governance (ESG) matters.
In September 2020, the IFRS Foundation Trustees published a consultation paper to
determine whether there is a need for international sustainability standards and whether
the IFRS Foundation should play a role in developing such standards.

As a result, the Trustees announced the creation of a new board (ISSB) in November 2021
to meet the demand for sustainability standards. SSB’s role is to deliver comprehensive
global sustainability-related disclosure standards that provide investors and other capital
market participants with information about companies’ sustainability-related risks and
opportunities.
The ISSB has set out four key objectives:

1. to develop standards for a global baseline of sustainability disclosures;

2. to meet the information needs of investors;

3. to enable companies to provide comprehensive sustainability information to global

capital markets; and

4. to facilitate interoperability with disclosures that are jurisdiction-specific and/or

aimed at broader stakeholder groups.
Standard-setting process:

Procedures for development of an IFRS standard:

◦ Board identifies a subject and appoint advisory committee to advise on the issue.
◦ Board also publishes a discussion paper for public comment
◦ Board publishes exposure draft for public comment, being a sample version.
◦ Then the Board publishes the final text of IFRS standard.

Conceptual Framework
The conceptual framework is a statement of generally accepted assumptions and principles
that provides a frame of reference for developing new practices and evaluating existing
ones.

The purpose of the Conceptual Framework for Financial Reporting (Conceptual Framework)
is to assist:
• the IASB (Board) in developing IFRS standards
• the preparers of financial statements in developing consistent accounting policies

• all parties to understand and interpret the standards.

The Conceptual Framework is not a standard. Therefore, nothing in the Conceptual

Framework can override a specific IFRS.

The Conceptual Framework for Financial Reporting identifies two fundamental qualitative
characteristics and four enhancing qualitative characteristics relating to useful financial
information.
Qualitative characteristics of Financial Statement

Fundamental qualitative Characteristics:

-Faithful representation:
Faithful representation means the financial statements describe financial events and
conditions fairly in words and numbers. The information given should be complete, neutral,
free from bias and free from errors.

-Relevance:
Information is relevant if it capable of making difference in the decision made by users.
Materiality is one aspect of relevance.
Information is material if its omission or misstatement could influence the decision of users
of the financial statements.
Enhancing qualitative characteristics:
-Comparability:
Users must be able to compare the financial statements of an enterprise over time to
identify trends in the financial position and performance.

-Verifiability:
Information should be capable of either direct verification or indirect verification.

-Timeliness:
This means that users of information have access to that information within timescale
which are appropriate for their decision-making purposes.

-Understandability:
Information in financial statement must be understandable to its users. This may depend
upon how knowledgeable individual are when evaluating financial information.

Corporate Governance:
“The system by which business corporation are directed and controlled”.
Corporate governance is a set of rules intended to create transparency and protected the
interested of shareholders and stakeholders. It Is set to prescribe the role and
responsibilities of directors as the stewards of the company, which helps align the director’s
interest with that of the shareholders.
Corporate governance mechanism is needed to ensure that the companies not only take
account of the views of powerful shareholders with more considerable shareholdings but
also act in the interest of shareholders owning a smaller portion of shares.

Duties and responsibilities of director:

The Director of a company have a fiduciary duty to act in good faith on behalf of a company.
A business’s director is responsible for preparing the financial statement, ensuring
appropriate accounting system are in place and place and keeping proper records.
ACCA Code of Ethics and Conduct
The ACCA Code of Ethics and Conduct is binding on all ACCA member, Student and partners
in an ACCA practice. The ethical concepts that apply to the preparation of accounting
information are:

Integrity:
Integrity is about being straight forward. It means reporting financial information honestly,
not misleading the users of financial statement, and producing a balancing picture of the
company’s affairs.

Objectivity:
In preparing financial statement, accountant should be unbiased when they make judgment
about what should be included in them. They should be influenced by their self-interest or
pressure from others towards distorting the financial statement.

Professional Competence and Due Care:

Accountants preparing or reviewing financial statement must have sufficient knowledge to
do so properly. They also need to carry out their work carefully, avoiding errors.

Professional Behaviour:
Avoiding behaviour in a way that could generally damage the accounting profession’s
reputation.

Confidentiality:
Confidential information should not be disclosed unless there is specific permission or legal
or professional duty
 NON-CURRENT ASSETS
Non-current assets are assets which are bought by the business for continuing use
Intended to be used by the business on a continuing basis and include both tangible and
intangible assets.

IAS 16 Property, plant and equipment

Recognition in the accounts
(a) It is probable that future economic benefits associated with the asset will flow to the
entity.
(b) The cost of the asset to the entity can be measured reliably

Initial measurement
Once an item of PPE qualifies for recognition as an asset, it will initially be measured at cost.

Components of cost:
Purchase price, including any import duties paid, also deducting any trade discount and
sales tax paid.
Initial estimate of the costs of dismantling and removing the item and restoring the site on
which it is located
Directly attributable costs of bringing the asset to working condition for its intended use
Only staff costs arising directly from the construction or acquisition of the asset can be
capitalised as part of the cost of the asset.

The costs of training staff to use a new asset cannot be capitalised because it is not
probable that economic benefits will be generated from training the staff, as we can't
guarantee that those staff will stay and use the asset.
Subsequent expenditure
Subsequent expenditure is added to the carrying amount of the asset, but only when there
is an enhancement for asset or excess of previous output or return from asset.

There are two types of expenditure:

1. Capital expenditure:
It is long term in nature as the business intends to receive the benefits of the
expenditure over a long period.
Expenditure on the acquisition of non-current assets required for use in the business
and expenditure on existing non-current asset aimed at increasing their earning
capacity.

2. Revenue expenditure:
Expenditure relates to the current accounting period and is used to generate revenue
in the business.
Expenditure relating to running the business (e.g. amin costs) or maintaining the
earning capacity of non-current assets (e.g. repair and renewal)

Depreciation
Depreciation on non-current assets arises from the accrual assumption
Asset consumes economic benefits over a number of accounting periods so cannot charge
entire value of asset in a single period.
So, cost must be spread over assets useful life.
Two methods of depreciation are specified in your syllabus.
• The straight-line method
• The reducing balance method
Residual value
The residual value is the net amount which the entity expects to obtain for an asset at the
end of its useful life after deducting the expected costs of disposal.
Depreciable amount of a depreciable asset is the historical cost or other amount substituted
for historical cost in the financial statements, less the estimated residual value.
(i.e., depreciable amount will be value of asset less scrap value)

The straight-line method:

most commonly used method of depreciation
The total depreciable amount is charged in equal instalments to each accounting period
over the expected useful life of the asset.

Annual depreciation charge = Cost of asset - residual value

Expected useful life of the asset

Reducing balance method:

Calculates the annual depreciation charge as a fixed percentage of the carrying amount of
the asset
Under the reducing balance method, unlike the straight-line method, we do not deduct the
residual value from the cost before depreciating.
Carrying value of asset x % of depreciation
Change in method of depreciation
Once that decision has been made, the chosen method of depreciation should be applied
consistently from year to year.
However, IAS 16 requires that the depreciation method should be reviewed periodically.
If there has been a significant change in the expected pattern of economic benefits from
those assets, the method should be changed.
The remaining carrying amount is depreciated under the new method, i.e., only current and
future periods are affected; the change is not retrospective.

Change in expected useful life or residual value of an asset

The depreciation charge on a non-current asset depends not only on the cost (or value) of
the asset and its estimated residual value but also on its estimated useful life
If a business plan to increase useful life of asset, then we will have to find new depreciation

New depreciation = carrying amount - residual value

Revised useful life

Entries for depreciation

DEBIT Depreciation expense (statement of profit or loss)
CREDIT Accumulated depreciation account (statement of financial position)

In the statement of financial position of the business, the total balance on the accumulated
depreciation account is set against the value of non-current asset accounts (i.e. non-current
assets at cost or revalued amount) to derive the carrying amount of the non-current assets.
Revaluation of non-current assets
IAS 16 allows entities to choose between keeping an asset recorded at cost or revaluing it to
fair value. some non-current assets should be revalued, otherwise the total value of the
assets of the business might seem unrealistically low.

IAS 16 requires that when an item of property, plant and equipment is revalued, the whole
class of assets to which it belongs should be revalued
When non-current assets are revalued, depreciation should be charged on the revalued
amount
In SOPL, it is shown in the other comprehensive income.
In SOFP, the 'gain' is transferred to a revaluation reserve

Transfer of excess depreciation:

It means that sometimes entity may opt to transfer excess depreciation from the
revaluation surplus to retained earnings. (so, it will not affect the SOPL and SOFP and its
effect will be shown in SOCIE)
Excess depreciation:
It is simply the difference between depreciation charge calculated on revalued amount less
depreciation charge calculated on historic cost of the asset (i.e., Difference between the old
and new depreciation of the asset)

Journal entry:
Dr Revaluation surplus
Cr Retained earnings
Non-current asset disposals
When a non-current asset is sold, there is likely to be a profit or loss on disposal
This is the difference between the net sale price of the asset and its carrying amount at the
time of disposal.
These gains or losses are reported in the income and expenses part of the statement of
profit or loss
Journal entry:
Dr Accumulated depreciation Depreciation to date
Dr cash selling value
Cr cost Cost of asset
Cr Profit/loss a/c Profit of disposal

Profit or loss on disposal = Net sales value – carrying value

 IAS 38 - INTANGIBLE ASSETS
An intangible asset is a non-current asset that is identifiable and without physical
substance.
Characteristics of an intangible non-current asset:
• A resource controlled by the entity as a result of past events from which the entity
expects to derive future economic benefits
• it lacks physical substance

Intangible assets that have been purchased can be capitalised and included in the statement
of financial position as non-current assets. However, intangible assets internally generated
by the business cannot be capitalised. Typically, this includes goodwill and brands.

Research and development

IAS 38 defines research as 'original and planned investigation undertaken with the prospect
of gaining new scientific or technical knowledge and understanding'
Development is defined as 'the application of research findings or other knowledge to a
plan or design for the production

Accounting treatment:
All research expenditure should be written off to the statement of profit or loss as it is
incurred
Development costs must be capitalised as an intangible asset

Subsequent treatment of development expenditure

The asset should be amortised over the period that is expected to benefit
Amortisation should commence with commercial production and charged over the period
over which the business expects to generate economic benefits.
Each project should be reviewed at the year end to ensure that the ‘Capitalization’ criteria
are still met.

Probable future economic benefit

Intention to complete
Resource availability to complete development to sell or use
Ability to use or sell
Technical feasibility of completing the asset
Expenditure measure reliably

(Amortization start from the day of production or sell

normally in straight line
if no useful life annual impairment review is conducted)

Measurement of intangible assets

An intangible asset shall be measured initially at cost
IAS 38 permits either the cost model or the valuation model to be used for subsequent
measurement
In cost model, an intangible asset 'shall be carried at its cost, less any accumulated
amortisation

Valuation model can be applied, in a similar way to IAS 16 dealing with revaluation of
property, plant and equipment, any upward revaluation is recorded as an item of other
comprehensive income for the year and taken to a separate revaluation surplus for
intangible assets within equity on the statement of financial position
 IAS 2 - INVENTORY
INVENTORY IN THE FINANCIAL STATEMENTS
• Inventory is only recorded in the ledger accounts at the end of the accounting period.
During the year the relevant sales and purchases are recorded but the increase and
decrease in inventory assets is ignored
Inventory brought forward from the previous year is assumed to have been used to
generate assets for sale.
The unused inventory at the end of the year is removed from purchase costs and carried
forward as an asset into the next year

VALUATION OF INVENTORY
• Inventory consists of:

➢goods purchased for resale

➢raw materials and components (used in the production process)

➢ partly-finished goods (usually called work in progress –WIP)

➢finished goods (which have been manufactured by the business)

Inventory is included in the statement of financial position at: LOWER OF COST OR NRV
We can identify the principal situations in which NRV is likely to be less than cost.
(a) An increase in costs or a fall in selling price
(b) A physical deterioration in the condition of inventory
(c) Obsolescence of products
(d) A decision as part of the company's marketing strategy to manufacture and sell products
at a loss
(e) Errors in production or purchasing

Example:
James Business sells three products X, Y, and Z. The following information was available at
the year end.
X Y Z
$ $ $
Cost 7 10 19
Fair value less further cost to sell (NRV) 10 8 15
Units 100 200 300
What was the value of the closing inventory?
A $8,400
B $6,800
C $7,100
D $7,200

Accounting for Inventory:

Opening inventory
Dr Cost of Goods Sold (SOPL) ---------- opening inventory is added as expense
Cr Inventory -------------------------------- Inventory Decrease

Closing inventory
Dr Inventory --------------------------------Inventory increase
Cr Cost of goods sold (SOPL)----------- Expense/cost decrease
METHODS OF CALCULATING THE COST OF INVENTORY

FIFO LIFO AVCO

-FIRST IN FIRST OUT -LAST IN FIRST OUT -AVERAGE COST

FIFO (first in, first out)
• Using this technique, we assume that components are used in the order in which they are
received from suppliers. The components issued are deemed to have formed part of the
oldest consignment still unused and are costed accordingly.

LIFO (last in, first out).

• We assume that components used formed part of the most recent delivery, and
inventories are the oldest receipts.
• It is not applicable as per IAS 2

AVCO (average cost).

• As purchase prices change with each new consignment, the average price of components
held is constantly changed. Each component held at any moment is assumed to have been
purchased at the average price of all components held at that moment.

• AVCO method is classified into 2:

1. Continuous average cost method
With this inventory valuation method, an updated average cost per unit is calculated
following a purchase of goods. The cost of any subsequent sales are then accounted
for at that weighted average cost per unit.
 2. Periodic average cost method
With this inventory valuation method, an average cost per unit is calculated based
upon the cost of opening inventory plus the cost of all purchases made during the
accounting period. This method of inventory valuation is calculated at the end of an
accounting period.

ILLUSTATION:
A firm has the following transactions with its product R.
Year 1
• Opening inventory: nil
• Buys 10 units at $300 per unit
• Buys 12 units at $250 per unit
• Sells 8 units at $400 per unit
• Buys 6 units at $200 per unit
• Sells 12 units at $400 per unit
Using FIFO, calculate the closing inventory on an item by item basis for year 1

ILLUSTATION 2:
Invicta has closing inventory of 5 units at a cost of $3.50 per unit at 31 December 20X5.
During the first week of January 20X6, Invicta entered into the following transactions:
Purchases
• 2nd January – 5 units at $4.00 per unit
• 4th January – 5 units at $5.00 per unit
• 6th January – 5 units at $5.50 per unit
• Invicta sold 7 units for $10.00 per unit on 5th January.
Calculate the value of the closing inventory at the end of the first week of trading using both
AVCO method.
 ACCURALS AND PREPAYMENTS
We have already seen that the profit for a period should be calculated by matching
revenues and expenses which relate to that period.
Expenses might not be paid for during the period to which they relate which is not our
concern as we prepare our accounts on an accrual basis.

ACCRUED AND PREAPAID CONCEPT:

Accrued expenses (outstanding) are the expenses which relate to an accounting period but
have not been paid

Accrued incomes (outstanding) are incomes which relate to an accounting period but have
not been received.

Prepaid expenses are expenses which are not related to an accounting period but have paid
in advance.

Prepaid incomes (unearned) are incomes which are not related to an accounting period but
have received in advance.
ACCOUNTING PERIOD:
• It is the period for which a company is preparing its financial statements.
• It is usually 12 months; it can be any time period.
• So, companies assess the performance for that particular accounting period

Double entry for accruals and prepayments:

Accrual(expense)
Dr Expense
Cr liability

Prepayment (expense)
Dr Asset
Cr Expense
EFFECT ON PROFIT AND NET ASSET

QUESTIONS
Q.1) A business compiling its financial statements for the year to 31 July each year pays rent
quarterly in advance on 1 January, 1 April, 1 July and 1 October each year. The annual rent
was increased from $60,000 per year to $72,000 per year as from 1 October 20X3. What
figure should appear for rent expense in the business's statement of profit or loss and other
comprehensive income for the year ended 31 July 20X4?
A $69,000
B $62,000
C $70,000
D $63,000

Q.2) A company pays rent quarterly in arrears on 1 January, 1 April, 1 July and 1 October
each year. The rent was increased from $90,000 per year to $120,000 per year as from 1
October 20X2. What rent expense and accrual should be included in the company's financial
statements for the year ended 31 January 20X3?
 RECEIVABLES

WHAT ARE RECEIVABLES

• Very few businesses expect to be paid immediately in cash.
• Most businesses buy and sell to one another on credit terms.
• This has the benefit of allowing businesses to keep trading without having to provide cash
• So, they collect the amount from customer in a future period, so the customers are called
Trade receivables.
• Customer will be given a credit limit and business will have a proper credit control system.

IRRECOVERABLE DEBT (BAD DEBT)

• This concept arises when the customers fail to pay.
• An irrecoverable (‘bad') debt is a debt which is definitely not expected to be paid
• Business might decide to give up expecting payment and to write the debt off.

DOUBLE ENTRY FOR WRITE OFF

Entry when a sale on credit is made to a customer:
• DEBIT Receivables
• CREDIT Sales

The ledger entries to write off an irrecoverable debt are:

• DEBIT Irrecoverable debts expense (statement of profit or loss)
• CREDIT Trade receivables (statement of financial position)
ALLOWANCE FOR RECEIVABLES
• There may be some debts included in the accounts where there is some cause for concern
but which are not yet definitely irrecoverable.
• It is prudent to recognise the possible expense
• This is netted off against trade receivables in the statement of financial position to give a
net figure for receivables that are probably recoverable.

An allowance for receivables is set up with the following journal entry:

• Dr Irrecoverable debts expense $X
• Cr Allowance for receivables $X

STEPS IN ALLOWANCE FOR RECIEVABLES

1 Write off irrecoverable debts.
2 Calculate the receivables balance as adjusted for the write-offs.
3 Ascertain the allowance for receivables required.
4 Compare to the brought forward allowance.
5 Account for the change in allowance to determine the increase of decrease
6 Show increase as an expense in SOPL and decrease as income in SOPL
7 In the SOFP, deduct the amount of closing allowance from the receivables balance to get
net receivables.
I.e.,
Irrecoverable expense increase
Dr Irrecoverable debt expense
Cr Allowance for receivables

Irrecoverable expense decrease

Dr Allowance for receivables

Receivables ledger A/c

Balance b/d Cash from credit customers
Sales Return inward
Refund from customers Irrecoverable debt
Interest on late payments Contra with payables
Settlement discount allowed
Written off
Balance c/f
QUESTIONS
Q.1)

Q.2)
Newell’s receivables ledger control account shows a balance at the end of the year of
$58,200 before making the following adjustments:
(i) Newell decides to write off debts amounting to $8,900 as he believes they are
irrecoverable.
(ii) He also decides to make specific allowance for Carroll’s debt of $1,350, Jeff’s debt of
$750 and Mary’s debt of $1,416.
Newell’s allowance for receivables at the previous year end was $5,650.
What is the charge to the statement of profit or loss in respect of the above information?
A $6,766
B $11,034
C $6,829
D $10,971
Q.3)
At 1 July 20X5, V Co’s allowance for receivables was $48,000. At 30 June 20X6, trade
receivables amounted to $838,000. It was decided to write off $72,000 of these debts and
adjust the specific allowance for receivables to $60,000.
What are the final amounts for inclusion in V Co’s statement of financial position at 30
June 20X6?
 IAS – 37 Provision, Contingent Liability and
Contingent assets

what does provision mean

➢ A provision is a liability of uncertain timing or amount

➢ IAS 37 distinguishes provision from other liability, such as trade payables and
accruals. This is on the basis that for a provision there is uncertainty about the timing
or amount

IAS 37 states that a provision should be recognised as a liability in the financial statements
when all three of the following conditions met.
✓ Present obligation (legal or constructive) as a result of past events
✓ It is probable (more than 50% likely) as a result of a past event
✓ Reliable estimate

When a business first sets a provision, the full amount of the provision should be debited to
the SOPL and credited to the SOFP
DEBIT Expenses (SOPL)
Credit Provision (SOFP)

CONTIGENT LIAIBLITY
➢ It is possible obligation that arises from the past events and whose existence will be
confirmed only by the occurrence or non-occurrence of uncertain future

➢ Of an obligation is probable (50% - 95%), it is not a contingent liability, it is instead a

provision is needed.

➢ It is disclosed in financial statement when it is possible (5% - 50%)

Contingent assets
➢ A possible asset that arises from past events and whose existence will be confirmed
by the occurrence of one or more uncertain future events.

➢ A contingent asset must not be recognised in the account, but should be disclosed if
it is probable that the economic benefits associated with the asset will flow to the
entity

➢ If the flow of economic benefits associated with the contingent asset becomes
virtually certain (95% - 100%) it should be recognised as an asset in the statement of
financial position
QUESTIONS
Q.1)
A former director of Biss Co has commenced an action against the company claiming
substantial damages for wrongful dismissal. The company's solicitors have advised that the
former director is unlikely to succeed with his claim, although the chance of Biss Co paying
any monies to the ex-director is not remote. The solicitors' estimates of Biss Co's potential
liabilities are:
Legal costs (to be incurred whether the claim is successful or not) $ 50,000
Settlement of claim if successful $ 500,000
$550,000

According to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, how should this
claim be treated in Bliss Co's financial statements?
A Provision of $550,000
B Disclose a contingent liability of $550,000
C Disclose a provision of $50,000 and a contingent liability of $500,000
D Provision for $500,000 and a contingent liability of $50,000

Q.2)
Mobiles Co sells goods with a one-year warranty under which customers are covered for
any defect that becomes apparent within a year of purchase. In calendar year 20X4, Mobiles
Co sold 100,000 units.
The company expects warranty claims for 5% of units sold. Half of these claims will be for a
major defect, with an average claim value of $50. The other half of these claims will be for a
minor defect, with an average claim value of $10.
What amount should Mobiles Co include as a provision in the statement of financial
position for the year ended 31 December 20X4?
A $125,000
B $ 25,000
C $300,000
D $150,000
Q.3)
X Co sells goods with a one-year warranty and had a provision for warranty claims of
$64,000 at 31 December 20X0. During the year ended 31 December 20X1, $25,000 in claims
were paid to customers. On 31 December 20X1, X Co estimated that the following claims
will be paid in the following year:

What amount should X Co record in the statement of profit or loss for the year ended 31
December 20X1 in respect of the provision?
A $57,500
B $6,500
C $18,500
D $39,000

Q.4)
For which of the following items is a provision required in accordance with IAS 37
Provisions, Contingent Liabilities and Contingent Assets?
Provision required Provision not required
A retail outlet has a policy of providing
refunds over and above the statutory
requirement to do so. This policy is
well publicised and customers have
made use of this facility in the past.
A customer has made a legal claim
against an entity, claiming that faulty
goods sold to them caused damage to
their property. The entity’s lawyers
have advised that the claim will
possibly succeed and, if it does,
compensation of $10,000 will be
payable
 Control account reconciliations
Posting from sales day book

SALES DAY BOOK

Receivable ledger/ Nominal ledger

sales ledger

Receivable ledger Sales account

control a/c

Posting from purchase day book

sdsd

PURCHASE DAY
BOOK

Payable ledger/ Nominal ledger

Purchase ledger

Payable ledger Purchase account

control a/c
Receivable and Payable ledger
These are related to the individual accounts of payables and receivables of the business.
These are not related to the double entry system of accounting.
Ledgers are different from control accounts of receivable and payable

Receivable ledger control A/c

Payable ledger control A/c

Reconciliation of supplier’s statement with supplier’s ledger account
It is common business practice for suppliers to send monthly statements to their regular
credit customers
listing the transactions that have occurred between the supplier and the customer during
the month
On receiving a statement from a supplier, a reconciliation check can be carried out
Any differences between the statement balance and the ledger account balance should be
investigated and explained

Reason for differences

[Link] supplier might have omitted a transaction from the statement
2. The customer might have omitted a transaction from its accounting records

Transactions that might have been omitted include sales/purchase transactions, payments,
discounts, contra entries and returns/credit notes.

If all the differences are identified, explained and where necessary corrected, the two
balances should be equal
- The amended balance on the supplier’s statement and the amended balance on the
supplier’s account in the payable’s ledger.
 The trial balance, errors and suspense accounts

Types of errors
it is possible to describe five frequent types of error. They are as follows.

❑Errors of omission

❑Errors of transposition

❑Errors of principle

❑Errors of commission

❑Compensating errors

How to deal with errors?

Once an error has been detected, it needs to be put right.
(a) If the correction involves a double entry in the ledger accounts, then it is done by using a
journal entry.
(b) When the error breaks the rule of double entry, then it is corrected by the use of a
suspense account as well as a journal entry.

➢ ERRORS OF OMISSION
An error of omission means failing to record a transaction at all, or making a debit or
credit entry

TYPES OF OMISSION

COMPLETE OMISSION PARTIAL OMISSION

• Here both debit and credit are • Here either debit or credit entry is
omitted omitted
• Trial balance agree even after this • Trial balance doesn’t agree after this
error error
Example:
Complete or full omission
If a business receives an invoice from a supplier for $250, the transaction might be
omitted from the books entirely. As a result, both the total debits and the total credits of
the business will be incorrect by $250.
Partial omission
If a business receives an invoice from a supplier for $300, the payables control
account might be credited, but the debit entry in the purchases account might be
omitted. In this case, the total credits would not equal total debits (because total
debits are $300 less than they ought to be).

➢ ERROR OF TRANSPOSITION
An error of transposition is when two digits in a figure are accidentally recorded the
wrong way round in debit or credit.

For example, suppose that a sale is recorded in the sales account as $5,325, but it has
been incorrectly recorded in the total receivables account as $5,235.

You can often detect a transposition error by checking whether the difference
between debits and credits can be divided exactly by 9. For example, $5,325 – $5,235
= $90; $90/9 = 10.

THIS ERROR WILL DISAGREE THE TRIAL BALANCE

➢ ERRORS OF PRINCIPLE
An error of principle involves making a double entry in the belief that the transaction
is being entered in the correct accounts, but subsequently finding out that the
accounting entry breaks the 'rules' of an accounting principle or concept.

A typical example of such an error is to treat certain revenue expenditure incorrectly

as capital expenditure. Also, another example is showing the drawings as a normal
expense
THIS ERROR WILL NOT CAUSE THE DISAGREE OF TRIAL BALANCE
 ➢ ERROR OF COMMISSION
Errors of commission are where the bookkeeper makes a mistake in carrying out their
task of recording transactions in the accounts.

Here are 3 common types of errors of commission.

• Putting a debit entry or a credit entry in the wrong account-doesn’t disagree TB
• Errors of casting day books (adding up) - doesn’t disagree TB
• Putting debit instead of credit and vice versa - disagree TB

EXAMPLES:
a) Telephone expenses of $540 are debited to the electricity expenses account.
Here although total debits and total credits balance, telephone expenses are
understated by $540 and electricity expenses are overstated by the same amount.

b) The total daily credit sales in the sales day book should be $28,425, but are
incorrectly added up as $28,825
The total sales in the sales day book are then used to credit total sales and debit total
receivables in the ledger accounts. Although total debits and total credits are still equal,
they are incorrect by $400.

c) The purchase of asset is credited in the asset account $4000

Here the asset account is reduced by $8000 (reduction is twice as one is the for mistake
done and other is for the correct amount to be shown)

➢ COMPENSATING ERRORS
Compensating errors are errors which are, coincidentally, equal and opposite to one
another.

EXAMPLE:
In the administration expenses account, $2,500 might be written instead of $3,500
while, in the sundry income account, $3,500 might be written instead of $4,500. Both
the debits and the credits would be $1000 too low, and the mistake would not be
apparent when the trial balance is cast.
THIS ERROR DOESN’T DISAGREE THE T B
Errors detected by a trial balance
❑Errors of transposition

❑Errors of omission (if the omission is one-sided)

❑Errors of commission (if one-sided, or two debit entries are made)

Rectification of errors
Errors which leave total debits and credits in the ledger accounts in balance can be
corrected by using journal entries. Otherwise, a suspense account has to be opened first,
and later cleared by a journal entry.

Suspense account
A suspense account is a temporary account which can be opened for a number of reasons

❖A trial balance is drawn up which does not balance (debit and credit is not equal)

❖The bookkeeper of a business knows where to post the one side of a transaction, but
does not know where to post the other

Process of rectification
1. What is the correct entry?
2. What wrong entry has been made (if any)?
3. What is the entry needed to correct the error? – Rectification entry

Use suspense account when needed. This is when the rectification entry has only one part
of entry.
Example:
1. Cash sale $600 and purchase a/c has been credited instead of sales a/c
Correct entry wrong entry Rectification entry
Dr cash $600 Dr cash $600 Dr purchase $600
Cr sales $600 Cr Purchase $600 Cr sales $600

[Link] sale $600 and purchase a/c has been debited instead of sales a/c
Correct entry wrong entry Rectification entry
Dr cash $600 Dr purchase $600 Dr suspense $1200
Cr sales $600 Dr cash $600 Cr purchase $600
Cr sales $600

Errors which will not affect TB Errors which will affect TB (Disagree)
-Error of omission (complete) -Single side entry
-Error of commission (1 & 2 in note) -Debit not equal to credit
-Error of principle -Same side entry
-Compensating error -Casting error in one side
-Reversal of entry -Opening balance not b/d
-Error of original entry (amount change -Extraction error (while extracting from
during entry) Ledger to TB)
 FINANCIAL STATEMENT
(SOLE TRADER AND COMPANIES)

The financial statements of a business are :

o STATEMENT OF PROFIT OR LOSS (SOPL)

o STATEMENT OF FINANCIAL POSITION (SOFP)

o STATEMENT OF CASHFLOW

o STATEMENT OF CHANGES IN EQUITY o DISCLOSURE NOTES

Financial Statement of companies:
Limited liability companies offer limited liability to their owners
Here,
o Owners = shareholders or members
o large number of owners
o Owners appoint directors to run business on their behalf
o Owners receive share of profits in form of dividends
SHARE CAPITAL:
The proprietors' capital in a limited liability company consists of share capital.

When a company is set up for the first time it issues shares, which are paid for by investors,
who then become shareholders of the company

Shares are denominated in units of 25 cents, 50 cents, $1 or whatever seems appropriate.

This is referred to as their nominal value. Share can be issued above par value in which
excess is shown in share premium account.

JOURNAL ENTRY ON SHARE ISSUE

DR CASH CR SHARE CAPITAL (use par value)
CR SHARE PREMIUM (excess of par value)
TYPES OF SHARES
the two types of shares: Preference shares and ordinary shares.

PREFERENCE SHARE:
Preference shares are shares which confer certain preferential rights on their holder.
Preference shareholders carry the right to a final dividend which is expressed as a
percentage of their par value
They have a priority right to a return of their capital over ordinary shareholders if the
company goes into liquidation.
They do not carry a right to vote.

TYPES OF PREFERENCE SHARE:

[Link] Preference Shares mean that the company will redeem (repay) the nominal
value of those shares at a later date.
Redeemable preference shares are treated like loans and are included as non-current
liabilities in the statement of financial position.
Dividends paid on redeemable preference shares are treated like interest paid on loans and
are included in financial costs in the statement of profit or loss.

[Link] PREFERENCE SHARE are treated just like other shares. They form part of
equity and their dividends are treated as appropriations of profit.

ORDINARY SHARES:
-Ordinary shares are by far the most common type of share.
-They are entitled to all profits left after payment of any preference dividend.
-The amount of ordinary dividends normally fluctuates.
-Ordinary shareholders are thus the effective owners of a company
-They own the 'equity' of the business, and any reserves of the business
RIGHT ISSUE OF SHARES
-A rights issue is an issue of shares for cash.
-The 'rights' are offered to existing shareholders, who can sell them if they wish.
-This is beneficial for the existing shareholders in that the shares are usually issued at a
Discount to the current market price

(note that it is less than market value not less than nominal value)

ADVANTAGES DISADVANTAGE
-Raises cash for the company -Dilutes shareholders holdings if they do
not take up right issue
-Keeps reserves available for future
dividends

BONUS ISSUE OF SHARES

Bonus shares are free shares given existing shareholders.
A company may wish to increase its share capital without wishing to raise additional finance
by issuing new shares.
It is open to such a company to reclassify some of its reserves as share capital. This is purely
a paper exercise which raises no funds.
Always issued in PAR VALUE.

JOURNAL ENTRY ON BONUS ISSUE

DR SHARE PREMIUM A/C
CR SHARE CAPITAL A/C
LOAN NOTE OR BONDS
-These are long-term liabilities.
-They are means of raising finance, in the same way as issuing share capital raises finance.
-They are different from share capital
-Shareholders are members of a company, while providers of loan note are creditors.
-Shareholders receive dividends (appropriations of profit) whereas the holders of loan note
are entitled to a fixed rate of interest
-The holder of loan capital is generally in a less risky position than the shareholder

DIVIDENTS
-Dividends represent the distribution of profits to shareholders.
-They are usually expressed as an amount per share e.g. 10c per share
-The total dividend to be included in the financial statements for the year is the sum of the
dividends actually paid in the year.
-At the end of an accounting year, a company's managers may have proposed a final
dividend payment, but this will not yet have been paid. The proposed dividend does not
appear in the accounts but will be disclosed in the notes.
-Dividend is recorded when it is declared and the payment entry is given at the time of
dividend payment

JOURNAL ENTRY ON DIVIDEND

Entry on dividend declared
Dr Retained earnings
Cr Dividend payable

Entry on dividend paid

Dr Dividend payable
Cr Cash/bank

-Proposed dividend is shown in the disclosure notes

-Dividend doesn’t affect the SOPL but only the cashflow statement and statement of
changes in equity

TAXATION
-Companies are liable for corporate income tax on their profits (known in the UK as
corporation tax)
-Tax is paid several months after the end of the accounting period

At the period end, an estimated amount is accrued based on the year’s profits by passing
following double entry:
Dr Tax expense (statement of profit or loss)
Cr Tax payable (liability in SOFP)
UNDER AND OVER PROVISION OF TAX
-An over-provision arises where the estimated tax is more than the actual tax paid This
reduces the following year’s tax charge in the statement of profit or loss.
-An under-provision arises where estimated tax is less than the actual tax paid. This
increases the following years tax charge in the statement of profit or loss

CURRENT YEAR TAX EXPENSES = CURRENT YEAR ESTIMATE + UNDER PROVISION

OR
CURRENT YEAR ESTIMATE – OVER PROVISION

-This adjusted amount is shown in SOPL

-In SOFP the current year full liability will be shown

IFRS 15 Revenue from Contracts with Customers

Revenue is defined as an income arising during an entity’s ordinary activities.
Revenue should be recorded at the fair value of the consideration received or receivable
after accounting for trade discounts. Consideration received represents cash sales, and
consideration receivable represents credit sales.

IFRS 15 sets out five steps that must be gone through to recognise revenue:

1. Identify the Contract with the Customer

A contract is an agreement between two or more parties that creates
enforceable rights and obligations.

- Approved by parties
- Terms of payment
- Monitory value probable consideration
2. Identify the performance obligations in the contract
A performance obligation is a promise in a contract with a customer to
transfer:
• a good or service (or bundle of goods/services) that is distinct

• a series of goods/services that are substantially the same and are

transferred in the same way

If a promise to transfer a good/service is not distinct from other goods and

services in a contract, the goods/services are combined into
a single performance obligation.

A good or service is distinct if both of the following criteria are met:

• The customer can benefit from the good or service on its own or when
combined with the customer's available resources
• The promise to transfer the good or service is separately identifiable from
other goods/services in the contract

3. Determine the transaction price

The transaction price is the amount of consideration an entity expects to
be entitled to in exchange for transferring promised goods/services

4. Allocate the transaction price to the performance obligation

The transaction price is allocated to all performance obligations in
proportion to the stand-alone selling price of the goods/services.
 Stand-alone selling price is the price at which an entity would sell a
promised good/service separately to a customer.’’

5. Recognise Revenue
Revenue is recognised when (or as) a performance obligation is satisfied by
transferring a promised good/service (an asset) to the customer.
• An asset is transferred when (or as) the customer gains control of the

asset.
• The performance obligation will be satisfied over time or at a point.

QUESTIONS:
Q.1) The following is an extract from the trial balance of Gardeners:
$ $
Non-current assets 50,000
Inventory 2,600
Capital 28,000
Receivables and payables 4,500 5,000
Allowance for receivables 320
Cash 290
Purchases and Sales revenue 78,900 120,000
Rental expense 3,400
Sundry expenses 13,900
Bank interest 270 .
153,590 153,590 .
The following items have not yet been accounted for:
• Rent of $200 was prepaid.
• Inventory valuation at the end of the accounting period was $1,900.
• The allowance for receivables should be amended to $200.
WHAT IS THE PROFIT FOR THE YEAR?
Q.2) At 30 June 20X2 a company's capital structure was as follows:
Ordinary share capital
500,000 shares of 25c each $125,000
Share premium account $100,000
In the year ended 30 June 20X3 the company made a rights issue of one share for every two
held at $1 per share and this was taken up in full. Later in the year the company made a
bonus issue of one share for every five held, using the share premium account for the
purpose. What was the company's capital structure (Share capital and share premium) at
30 June 20X3?
 INCOMPLETE RECORDS

INCOMPLETE RECORDS

Identification of profit figure Identification of individual

account balances within
financial statement

Method:
Accounting equations Method:
Ledger account ratios

CALCULATING MISSING FIGURES AND BALANCES

➢ Accounting equation method
➢ Balance figures approach
➢ Using cash/bank balance
➢ Profit ratios – mark up and margin relationship

The ledger account (balancing figure) approach

LEDGER ACCOUNT MISSING FIGURES
-Receivables Credit sales, money received from
receivables
-Payables Credit purchases, Money paid to payables
-cash at bank Drawings, money stolen
-Cash in hand Cash sales, Cash stolen
 EVENTS AFTER REPORTING PERIOD (IAS -10)

Events after the reporting period ‘are those events, favourable and unfavourable, that occur
between the end of the reporting period and the date when the financial statements are
authorized or approved for issue’

EVENTS AFTER THE REPORTING PERIOD

REPORTING DATE AUTHORISING DATE ISSUE DATE

They can be classified as either:

- Adjusting events or
- Non-adjusting events

ADJUSTING EVENTS
Adjusting events are ‘those that provide evidence of conditions that existed at the end of
the reporting period’
- the financial statements must be adjusted to reflect those conditions

NON-ADJUSTING EVENTS
Non-adjusting events are ‘those that are indicative of conditions that arose after the
reporting period’
- the financial statements are not normally adjusted to reflect those conditions
- may need a disclosure note to the FS if considered to be material
- Becomes an adjusting event if going concern basis is no longer appropriate
 ADJUSTING EVENTS NON ADJUSTING EVENTS
-Settlement of a court case relating to an -Mergers and acquisitions
issue which arose before the reporting date
-Bankruptcy of a customer -Issue of shares and/or debentures
-Change in inventory values -Loss of non-current assets or inventories as
a result of a fire or flood
-Discovery of error or fraud which occurred -Decline in the value of property and
before the reporting date investments

NON-ADJUSTING EVENTS AFTER THE REPORTING PERIOD:

a. A major business combination after the reporting date or disposal of a major
subsidiary
b. Major purchase and disposal od assets, or expropriation of a major assets by
government
c. The destruction of a major production plant by a fire after the balance sheet date
d. Announcing or commencing the implementation of a major restructuring
e. Major ordinary and potential share transactions after the reporting date
f. Abnormally large changes after the reporting date in asset prices or foreign exchange
rates
g. Changes in tax rates or tax law enacted or announced after the reporting date
h. Commencing major litigation arising solely out of events that occurred after the
reporting date
i. Decline in the market value of investment between reporting date and the date of
approval of FS
j. Declaration of an equity dividend

Question)
 BANK RECONCILLIATION STATEMENT (BRS)

Cash book and Bank statement

• Here Cash book is the ledger used to record receipts and payments of cash through the
bank account.
• The balance on this account is the amount that the business believes that it has in its bank
account (debit balance) or the size of its bank overdraft (credit balance).
• The bank will send regular statements to the business entity, listing all the transactions
that the bank has recorded in the account for the entity and the current balance on the
account. This statement is a bank statement.
• However, the two figures will not always be the same, and the reconciliation needs to
show that the differences can be properly accounted for.

Why reconciliation
• Bank reconciliations are a useful check on the accuracy of accounting records for balance
in the bank account or cash book in the main ledger and the balance shown in the bank
statement.
• A reconciliation can therefore be carried out, to check that the two amounts agree with
each other.

Causes of differences b/n the bank statement and the cash book
There are three causes for differences between the cash book and bank statement:
o Unrecorded Items
o Timing Differences
o Errors in cashbook or bank statement
Unrecorded items
• These are items recorded in bank statement but not in the cash book

Case 1; Payment made by bank but not recorded in Cash book

a) Standing orders & direct debits
b) bank services interest charges

Case 2; cash received by bank but not recorded in cash book

a) interest received or dividend received
b) direct transfer by customer to bank account

Timing difference
These items have been recorded in the cash book, but due to the bank clearing process
have not yet been recorded in the bank statement.

Unpresented cheques - Cheques sent to supplier but not yet deducted from bank
(cashbook decreased, Bank statement increased)

Uncleared lodgements - cheques received by the business but not added to bank
(cashbook increased, Bank statement decreased)

Errors in the cash book or bank statement

• The business may make a mistake in their cash book. The cash book balance will need to
be adjusted for these items.
• The bank may make a mistake
• e.g., record a transaction relating to a different person within our business’ bank
statement. The bank statement balance will need to be adjusted for these items.

CASH BOOK ADJUSTMENT

Balance as per cashbook XXX/(XXX)

Adjust unrecorded items XXX/(XXX)
Adjust cashbook errors XXX/(XXX)

Revised or adjusted cashbook balance XXX/(XXX)

*Revised cashbook balance is also known as final balance or balance in SOFP

BANK RECONCILIATION STATEMENT

Revised cashbook balance XXX/(XXX)

Unpresented cheques XXX
Outstanding lodgements (XXX)
Adjust bank errors XXX/(XXX)

Balance as per passbook (XXX/(XXX)

POINTS TO REMEMBER
✓ Beware of overdrawn balances on the bank statement.

✓ Beware of debits/credits to bank statements.

✓ Note that the bank balance on the statement of financial position is always the balance
per the revised cash book.

✓ If the question is regarding adjusted cash balance and to find balance as per passbook
then ignore unrecorded item and cash book errors
 Interpretation of financial statements
Purpose of financial ratios analysis
• Comparisons over a number of years.
By looking at the ratios of a company over a number of years, it might be possible
to detect improvements or a deterioration in the financial performance or financial position
of the entity.
• Comparisons with the similar ratios of other, similar companies for the same period.
• In some cases, perhaps, comparisons with ‘industry average’ ratios.

Types of Ratios
The main financial ratios can be classified as:

❑ Financial performance: return on capital, profitability and use of assets

❑Working capital ‘turnover’ ratios

❑Liquidity ratios

❑Debt and Gearing ratios

-Return on capital, Profitability and Asset turnover

◦ The aim of ‘profitability ratios’ is to assess the financial performance of a profitmaking
entity and the return that it makes on the capital invest.

RETURN ON CAPITAL EMPLOYED (ROCE)

Profit-making companies should try to make a profit that is large enough in relation to the
amount of money or capital invested in the business.
PROFITABILITY RATIOS
◦ The profit/sales ratio is the ratio of the profit that has been achieved for every $1 of sales.

There are 3 types profitability ratios:

◦ A. Gross profit ratio (Gross profit / sales *100)
◦ B. Net profit ratio (Net profit / sales *100)
◦ C. Operating profit ratio (Operating profit / sales *100)

A high gross profit ratio and a low net profit ratio indicate high overhead costs for
administrative expenses and selling and distribution costs.

ASSET TURNOVER RATIO

It measures the amount of sales achieved during the period for each $1 of investment in
assets.

It is measured as ‘x times a year’

ROCE = ATR *OPERATING PROFIT MARGIN

WORKING CAPITAL EFFICIENCY RATIOS

◦ Working capital efficiency ratios measure the efficiency how entity has managed its
receivables, inventory and trade payables.
◦ The ratios are usually measured in terms of an average number of days.

The working capital ratios are a useful measure of whether the entity has too much or too
little invested in working capital.
The three ratios are receivables days, inventory turnover days and payables days.
RECEIVABLE DAYS
This ratio estimates the time that it takes on average to collect the payment from customers
after the sale has been made.

Trade receivables should be the average value of receivables during the year
However, the value for receivables at the end of the year is also commonly used

PAYABLES DAYS
This ratio estimates the average time to pay suppliers

Trade payables should be the average value of trade payables during the year.
When the value of purchases is not available, the cost of sales should be used instead.

INVENTORY TURNOVER DAYS

◦ This ratio is an estimate of the average time that inventory is held before it is used or sold.

Inventory should be the average value of inventory during the year.

The value for inventory at the end of the year is also commonly used
LIQUIDITY RATIOS
◦ Liquidity means having cash or access to cash readily available to meet obligations to make
payments.
◦ There are two ratios for measuring liquidity:
-Current ratio
-Quick ratio, also called the acid test ratio.

CURRENT RATIO
◦ The current ratio is the ratio of current assets to current liabilities.

QUICK RATIO OR ACID TEST RATIO

◦ The quick ratio or acid test ratio is the ratio of current assets excluding inventory to current
liabilities.
◦ Inventory is excluded from current assets on the assumption that it is not a very liquid
item.

It is sometimes suggested that there is an ‘ideal’ current ratio of 2.0 times

DEBT RATIOS
◦ Debt ratios are used to assess Gearing ratio (leverage)

Gearing ratios
◦ Gearing, also called leverage
◦ It measures the total long-term debt of a company as a percentage of either EQUIRT
CAPITAL OR DEBT + EQUITY CAPITAL which will be mentioned in question
Points on Gearing
◦ A company is said to be high-geared or highly-leveraged when its debt capital exceeds its
share capital and reserves.
◦ This means that a company is high-geared when the gearing ratio is above either 50% or
100%,

A high level of gearing may indicate the following:

◦ The entity has a high level of debt, which means that it might be difficult for the entity to
borrow more when it needs to raise new capital.
◦ High gearing can indicate a risk that the entity will be unable to meet its payment
obligations

INTEREST COVER RATIO

◦ Interest cover measures the ability of the company to meet its obligations to pay interest

PBIT is calculated by adding the interest charges for the year to the profit before taxation.
An interest cover ratio of less than 3.0 times is considered very low, suggesting that the
company could be at risk from too much debt in relation to profit it earns
 IAS 7 - Statement of Cashflow
What is cashflow statement
Statements of cash flows are a useful addition to the financial statements of a company
because accounting profit is not the only indicator of performance. They concentrate on the
sources and uses of cash and are a useful indicator of a company's liquidity and solvency.

'profit' does not always give a useful or meaningful picture of a company's operations.

Shareholders might believe that if a company makes a profit after tax of, say, $100,000 then
this is the amount that it could afford to pay as a dividend.

The statement of cash flows provides historical information about cash and cash
equivalents, classifying cash flows between operating, investing and financing activities.

Cash comprises cash on hand and demand deposits.

-Operating activities are the principal revenue-producing activities of the business and
other activities that are not investing or financing activities.
-Investing activities are the acquisition and disposal of non-current assets and other
investments by the business.
-Financing activities are activities that result in changes in the size and composition of the
equity capital and borrowings of the entity.

*ALL NON-CASH ITEMS REMOVED TO PREPARE CF STATEMENT

PREPARATION CASHFLOW STATEMENT
IAS 7 requires statements of cash flows to report cash flows during the period classified by
operating, investing and financing activities.
By classifying cash flows between different activities in this way, users can see the impact on
cash and cash equivalents of each one, and their relationships with each other.

Operating activities
This is perhaps the key part of the statement of cash flows because it shows whether, and to
what extent, companies can generate cash from their operations.
They relate to the main revenue-producing activities of the enterprise
There are two methods of presenting cash flows from operations

Investing activities
The cash flows classified under this heading show the extent of new investment in assets
which will generate future profit and cash flows.
examples of cash flows arising from investing activities.
o Cash payments to acquire property, plant and equipment, and other non-current assets.
o Cash receipts from sales of property, plant and equipment, intangibles etc
o Cash payments to acquire shares or debentures of other enterprises
o Cash receipts from sales of shares or debentures of other enterprises

Financing activities
This section of the statement of cash flows shows the cash which the came into the
business as capital and also loans taken.
This is an indicator of likely future interest and dividend payments.
examples of cash flows which might arise under these headings.
o Cash proceeds from issuing shares
o Cash proceeds from issuing debentures, loans, notes, bond and other borrowings
o Cash repayments of amounts borrowed
TWO METHODS CF STATEMENT
The standard offers a choice of method for this part of the statement of cash flows.
(a) Direct method: disclose major classes of gross cash receipts and gross cash payments
(b) Indirect method: net profit or loss is adjusted for the effects of transactions of a non-
cash nature and items of income or expense associated with investing or financing cash
flows
**THE DIFFERENCE IS ONLY IN THE PRESENTATION OF CF FROM OPERATING ACTIVITIES

PRO-FORMA OF DIRECT METHOD

PRO-FORMA OF INDIRECT METHOD

ADJUSTMENT OF WORKING CAPITAL
Current asset
Change in Receivables & inventories
Increases in receivables/inventory = Deduct from profit
Decrease in receivables/inventory = Add to profit

Current liability
Change in payables
Increase in payables = add to profit
Decrease in payables = deduct from profit

FULL STATEMENT OF CASHFLOW

CALCULATION OF CASH PAID FOR NON-CURRENT ASSET
 CONSOLIDATION OF COMPANIES

▪ Consolidation means presenting the results, assets and liabilities of a group of companies
as if they were one company.
▪ The central company, called a parent, generally owns most or all of the shares in the other
companies, which are called subsidiaries.
▪ In the legal point of view, the results of a group must be presented as a whole. In other
words, they need to be consolidated

HOW CONSOLIDATION WORKS?

▪ Consolidation means adding together
▪ Consolidation means cancellation of like items internal to the group
▪ Consolidate as if you owned everything then show the extent to which you do not own

SUBSIDIARIES:
▪ A subsidiary is an entity controlled by another entity.
▪ An investor controls an investee when the investor is exposed, or has rights, to variable
returns from its involvement with the investee and has the ability to affect those returns
through its power over the investee.

The following situations show where control exists, even when the parent owns only 50% or
less of the voting power of an entity.
(a) The parent has power over more than 50% of the voting rights by agreement with other
investors.
(b) The parent has power to govern the financial and operating policies of the entity by
statute or under an agreement.
(c) The parent has the power to appoint or remove a majority of members of the board of
directors.
(d) The parent has power to cast a majority of votes at meetings of the board of directors.
NON-CONTROLLING INTEREST (NCI)

▪ The equity in a subsidiary not attributable, directly or indirectly, to a parent.

CONTENT OF CONSOLIDATED FS
▪ Consolidated financial statements are issued to the shareholders of the parent and
provide information for those shareholders on all the companies controlled by the parent.

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

Step in consolidated statement of financial position:
1. Establish the group structure (W1)
2. Calculate the net assets of subsidiary (W2)
3. Calculate the goodwill on acquisition (W3)
4. Calculate the non-controlling interests (NCI) (W4)
5. Calculate the group retained earnings (W5)
Establish the group structure (W1)
▪ The first step is to establish percentage ownership and control.
▪ The percentage ownership is calculated by dividing the number of shares owned by the
parent in the subsidiary by the total number of shares the subsidiary has in issue

Calculate the net assets of subsidiary (W2)

Acquisition date Reporting date
$ $
Share capital X X
Share premium X X
Revaluation surplus X X
Retained earnings X X

Fair value adjustment- land and building X X

X X
Difference of this total is called Post acquisition reserve or post-acquisition retained
earnings.

Calculate the goodwill on acquisition (W3)

▪ FV of consideration paid:
Cash paid X
FV of shares issued by parent (MV of shares) X
▪ FV of NCI at acquisition X
▪ Less: FV of net assets at acquisition (W2) (X)
▪ Goodwill on acquisition X
Calculate the non-controlling interests (NCI) (W4)
Non-controlling interest – SOFP
Fair value of NCI at acquisition (W3) X
NCI share of post-acquisition reserve (W2) X
Less: PURP * NCI% (if subsidiary is seller) (X)

X .

Calculate the group retained earnings (W5)

100% of the parent’s retained earnings XXX
Parent’s share of the subsidiary’s post acq retained earnings XXX
Less: PURP full amount (if parent is seller) (XXX)
Less : PURP * parent %( if subs is seller) (XXX) .
XXX .

(PURP- Provision for unrealised profit)

INTRA-GROUP TRADING
A consolidation adjustment is required to remove unrealized profit on intra-group trading.
(a) Although A Co makes a profit as soon as it sells goods to B Co, the group does not make
a sale or achieve a profit until an outside customer buys the goods from B Co.
(b) Any purchases from A Co which remain unsold by B Co at the year-end will be included
in B Co's inventory. Their statement of financial position value will be their cost to B Co
which include profit as well, which is not the same as their cost to the group

Deduct the sales value from the revenue and cost of sales
Deduct PURP from inventory
Add PURP to the cost of sales as well
ACQUISITION PART WAY THROUGH THE YEAR
When a parent acquires a subsidiary part way through the year, the profits for the period
need to be apportioned between pre- and post-acquisition.
Only post-acquisition profits are included in the group's consolidated statement of financial
position.

Profits earned before acquisition – so that we can calculate goodwill

Profits earned after acquisition – so that we can calculate group retained earnings

CONSOLIDATES SOPL
-Here the profit is calculated as if the company is acquired completely later the profit is split
to NCI and Parent
-If the acquisition is part way through the year, then all items of subsidiary in SOPL
apportioned accordingly

ASSOCIATES
▪ An associate is an entity over which another entity exerts significant influence.
▪ Associates are accounted for in the consolidated statements of a group using the equity
method.
▪ This is the 'power to participate', but not to 'control’.
▪ significant influence can be determined by the holding of voting rights (usually attached to
ordinary shares) in the entity.
▪ IAS 28 states that if an investor holds 20% or more of the voting power of the entity, it can
be presumed that the investor has significant influence over the entity
Significant influence can be presumed not to exist if the investor holds less than 20% of the
voting power of the entity, unless it can be demonstrated
▪ (a) Representation on the board of directors
▪ (b) Participation in the policy making process
▪ (c) Material transactions between investor and investee
▪ (d) Interchange of management personnel
▪ (e) Provision of essential technical information

EQUITY METHOD CALCUALATION

▪ IAS 28 requires the use of the equity method of accounting for investments in associates.
▪ Should take account of its share of the earnings of the associate.
▪ Only the group share of the associate's profit after tax is added to the group profit.
▪ A figure for investment in associates is shown in the consolidated statement of financial
position which must be stated at cost at the time of the acquisition of the associate.

Cost of investment in associate XXXX

Share of A's profit for the year XXXX
Less dividend received (XXX) .
Investment in associate XXX .