ACN102N

HOW TO PASS ACN102N

ACN102N can be quite challenging for those who have not done accounting at school. It
helps to go over past papers and the long assignments given. Going over the past papers
allows you to understand what is expected of you in the exam. Also, if possible, I’d
recommend attending tutorial classes. Practice, practice, practice – with emphasis on
PRACTICE. This is very important if you want to pass, and pass well. The exam is
practical. Therefore, although you should know the theory, it’s more important to know
how to put it into practice.

The following are sections of the work I would recommend concentrating on:

1. Partnerships:
1.1 Liquidation of partnerships (simultaneous & piecemeal)
1.2 1st interim repayment
1.3 Profit-sharing ratios
1.4 Financial Statements (ALL)
1.5 Valuation Account & Capital & Current Accounts

2. Close Corporations
2.1 Financial Statements (ALL)

3. Cash Flow Statements (Direct & indirect Method)

4. Companies
4.1 General Journal entries (Shares)
4.2 Capitalisation Shares

5. Branches
5.1 Branch Accounts (at cost price & at selling price) Financial Statements & Bank
Account

6. Analysis & interpretation

6.1 Calculation & interpretation of ratios

TIME ALLOCATION in the exam is very important. The exam is 2 hours long and
covers a comprehensive volume of work. It helps to stick to the time allocated. If you do
not finish a question in the time limit, move on.

Do the questions you feel you know best first. Take 5 minutes to check through the paper
before you start.

Do not panic! Although it’s a fairly long paper, by getting worked up, 1 tends to get
careless and make unnecessary mistakes.

USEFUL LINKS

[Link] I found this website really helpful in my preparation for the exam.
STUDY NOTES

I received the following notes from a fellow student.

Study Unit 1:
Introduction to the preparation of financial statements
Intro
The Framework “conceptual framework” sets out the objectives and concepts that
underlie the preparation and presentation of financial statements. Prescriptive
(Normative) and Descriptive (explanatory) in nature.
The two main purposes
 To assist the accountant in preparing and presenting financial statements
 To serve as a general guideline to the users of financial statement in understanding
the latter
Issued by the International Accounting Standards Board (IASB) and adopted by the
Accounting Practices Board (APB) in South Africa and applies to most business (profit &
non-profit)

Financial Statements as part of Financial Reporting

The framework gives a descriptive approach as to what constitutes financial statements. It
excludes reports from directors, chairman of the company and similar items but
management has primary responsibility for the preparation and presentation of the
financial statements of the entity.

Objective of financial statements

It is to provide information about the financial position (plus change in position) and
financial performance to users of the information. It includes
 Balance Sheet: Financial Position of the entity
 Income Statement: Financial Performance of the entity
 Statement of Changes in equity: Changes in capital structure
 Cash Flow Statement: Changes in the financial position of the entity
Notes: Relevant additional information to give a clearer picture

Underlying assumptions when preparing financial statements

 Accrual Basis: the effects of transactions are recognized when they occur, Occur:
When transaction initially takes place.
Going Concern: it will continue operations for the foreseeable future. If not then the
“Framework” provides a structure

Qualitative characteristics of financial statements

 Understandability: An average person with a reasonable knowledge of business and
of account should not experience problems understanding the statements but
information that must be passed on to users out of necessity to serve the purpose of
accounting must not be omitted solely on the grounds that it might not be understood
by some of the users
 Relevance: Financial statements should disclose all items that are so important or
large that the exclusion thereof may influence the decision-maker to make a different
(incorrect) decision
 Reliability: Faithful representation, substance over form, neutrality, prudence and
completeness
 Comparability: The information in financial statements should be comparable with
information from prior periods, as well as with the information of similar entities

Constraints on qualitative characteristics

 Timeliness: Reliability is impaired by timeliness because delayed reporting, in order
to know all aspects, could be far outdated for good use. The balance is by satisfying
the decision-making needs best.
Costliness: The benefits derived from the info of the financial statements should exceed
the cost of preparing it

The elements of financial statements either fall under financial position (balance sheet)
or financial performance (income statement)

Financial Position (Balance Sheet)

Asset
Is a resource controlled by the entity as a result of past events and from which future
benefits are expected to flow to the entity
 Used to produce goods or render services to customers
 Exchanged for other assets
 Used to pay liability
 Distributed to owners of the entity
Physical form not essential (Eg. building, vehicles, goodwill, copyright)
Expenditure not main criteria (Eg. donation of assets or expense incurred but not an
asset)

Liabilities
A present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic
benefits
 Payment in cash
 Transfer of other assets
 Rendering of services
 Replacement of that obligation with another
 Conversion of the obligation to equity
Future plan of new expenditure is not a liability

Equity
The residual interest in the assets of the entity after deducting all its liabilities
That portion of the entity belonging to the owner

Financial Performance
(Income Statement)

Income is any inflow or economic gain during an accounting period besides

contributions from the bosses.
 Gains are incomes, which may or may not arise in the course of the ordinary activities
and should be shown separately, plus reported net of related expenses because this
info is useful for economic decision
Revenue arises from the course of ordinary activities

Expenses are any outflows or economic loss during an accounting period besides
drawings.
Losses (transactions outside course of ordinary activities are shown separately)

Overall considerations when preparing financial statements

Fair Presentation
Going Concern
Accrual Basis
Consistency of presentation
Materiality and aggregation
Offsetting
Comparative Information
See PG 18 & 19 (Not important)

Recognition and Disclosure

Recognition is the journal entry, which includes a numerical amount and description of
transaction, which either benefits or is detrimental to the entity.
It is not recognized if it is not possible to make a reasonable estimate of its cost or value
Disclosure is a note in the statements that gives useful info to the decision makers.

GAAP: Generally Accepted Accounting Practice

Refers to practices or recording and reporting only Companies have to comply but other
entities use it anyway

Study Unit 2
Establishment and financial statements of a partnership

Introduction
Definition: Legal relationship created by an agreement between 2-20 natural persons. The
agreement is legal between “partners” but the partnership is not a separate legal entity so
the partners contribute everything and they are responsible for all partnership obligations.

Reasons for the formation of partnership

 Increase the amount of capital
 Eliminating competition
 Uniting capital and technical expertise
Retaining skills and technical expertise

Legal Position of a partner

 SA has no specific legislation for partnerships and therefore it falls under common
law principals
 All partners have equal share in Assets (Unless agreed otherwise) and also have equal
obligation for Liabilities
 Taxes only apply to the separate partners

Establishment of a Partnership
 Action: Act is tacit agreement
 Agreement: By written agreement PG 47 for List of matters
Dissolution of a Partnership
 Mutual Agreement
 Reason for formation is obtained
 Agreed period is now finished
 Change in Partners
 Insolvency
 The unilateral action of one partner
 Illicit or unlawful acts by partner
 Over 20 Partners

Accounting Procedures and Specialised Accounts

 It must keep day-to-day records by using various subsidiary journals and ledgers
 Very similar to a sole proprietor but there are 2 approaches in preparing the
Partnership accounts
o Entity Approach: Every partner is a separate entity and any transactions fall under
Operating Expenses/Financing in Profit and Loss.
o Legal Approach: Every Partner is owner and is treated as such in the transaction of
the business.
o Either approach is fine with taxation
o We adopt the legal approach

Recording of equity
 Capital Accounts: One per partner in which record of capital contribution (Asset or
Cash) is recorded. Interest on Capital can be earned by stipulating an interest rate and
basis for calculation.
 Current Account: One per partner. This account records all the transactions between
the partners and the partnership
 Drawing: One per partner. Records all withdrawals (salaries, interest, assets etc) from
the partnership except a withdrawal of capital. Closed off to current account. Only
used if stipulated by the partnership. If not used then the current account is used.
 Reserves: Profit set aside for future use, the rest of profit is distributed accordingly.
Equity = Reserves +/- Current Account + Capital Account.
 Loan Accounts: A company may receive or give loans to/from partners. This is
treated as any other loan with interest etc and is reflected as an asset/liability in the
books.
 Appropriation Account: It is the final account that is used to appropriate the
profit/loss of the entity. This is done per ratio in agreement, per capital contribution,
or equally
 Salaries, Bonuses: Account per Partner, Debit Salaries X (Salaries due for whole
year) and Credit Current Account X. Then close Drawings X and Current Account X
Examples PG 51-68

Study Unit 3: Changes in the ownership structure of

partnerships

The calculation of profit-sharing ratios

Admission of a Partner
 (Existing Profit Share Ratio) – (Ratio that is relinquished*Profit share ratio of new
partner)
 See PG 74
Retired or Deceased Partner taken over by partners
 (Existing Profit Share Ratio) + (Ratio that is taken over*Profit share ratio of leaving
partner)
 The new profit-sharing ratio of the remaining partners remains the same as the
previous profit-sharing ratio between them
One Partner goes and a new one arrives
 Old Partners shares gone
 New Partner receives portion of shares (eg 1/2*2/5)
 Existing partners same as above
See PG 76

Recording a Change in ownership structure by way of a Personal Transaction

 The cash is paid into the personal account of the partner. No entry in books
 No valuation adjustments, goodwill, etc.
 Debit Partners Accounts Credit New Partners Accounts by ratio being bought
Recording a Change in ownership structure by a Transaction with the Partnership
Legal Perspective: All adjustments made, accounts Transferred. Adjustment not
reversed
 Step 1: Do all end-year adjustments, close nominal accounts and prepare preliminary
balance sheet. Last day of Partnership.
 Step 2: Close off all current accounts to capital accounts
 Step 3: Apportion any reserves to the old partnership according to their profit ratio
 Step 4: Record Valuation adjustments
 Step 5: Record Goodwill initially acquired. (Adjusted goodwill is under valuation)
 Step 6: Record Dissolution through Transferal Account. Retirement/Death PG 94
 Step 7: Record Reformation: Each asset & liability is apportioned by Capital Ratio
 Step 8: Reverse step 3 but apportioned to the Capital Ratio of the new partnership
 Step 9: Adjust Capital according to Profit Ratio. Step 8&9 only done if chosen.
Example PG 95-112
Going-Concern Perspective: Do Pre-adjustment trial balance; Do steps 3-5, Record
Restructure, Reverse 3-5 by New Capital Ratio, Adjust Capital to Profit Ratio. Eg 115-
125

See Income statement of Partnership undergone change PG 123

Valuation Adjustment
 The Fair Value thereof determines the selling price of a partnership.
 That is the Fair Value Assets – Fair Value Liabilities.
 A Valuation Adjustment if considered any adjustment that is recorded in an existing
asset or liability account of an existing partnership in preparation of its dissolution
 Recording Adjustments
o Use a Valuation Account which is debit/credited depending on the
adjustment.
o Valuation Account is closed off the different Capital Accounts, according
to the partnership ratio, before the dissolution of the existing Partnership. Examples
PG 78-81
 Reversing Valuation Adjustment in the books of a new partnership
o All valuation adjustment are reversed in the Valuation Account and the
balance is closed off to the Capital Account of the new partners at the new ratio
Goodwill
 It is ascribed to the sound reputation of a business.
 Goodwill Acquired(Customers) Goodwill Gained (employees)
 It is considered an intangible asset
 Goodwill acquired is disclosed separately as a Non-Current Asset
 Formula
o New Partners Contribution * Inverse of share acquired (Fair Value) – Net
Assets (Prior Goodwill)
o See 86 if clarification needed
 Transaction Goodwill Acquired: Debit Goodwill, Credit Capital Accounts (By
Ratio).
 A full reversal cannot be done according to GAAP
Adjusting Goodwill: It is a valuation adjustment

Study Unit 4: The Liquidation of a Partnership

Introduction
The difference between Sequestration (Insolvent) and Liquidation (Solvent) is very little
in accounting but here we only deal with Liquidation

There are Two Methods of Liquidation

Simultaneous Liquidation
 Step 1: Close Current & Drawings to Capital
 Step 2: Close off non-liquidable, intangible non-current assets (Goodwill, Reserves
etc) to Capital per Profit Ratio
 Step 3: Close off Assets with related contra-assets plus liabilities with anticipated
discounts to Liquidation Account
 Step 4: Record Sale (Bank) or Partner (Capital) takeover of Asset in Liquidation.
 Step 5: Record any other income earned in Liquidation
 Step 6: Record Liquidation Costs (Credit Bank) in Liquidation (Debit Liquidation)
 Step 7: Record Payment of Liabilities
 Step 8: Record any further expenses. Debit Liquidation Credit Bank.
 Steps 4-8 happen at random, not in order
 Step 9: If Profit Made Debit Liquidation Credit Capital per Profit Ratio. Opposite if
loss is made.
 Step 10: Bank should = Total Capital Accounts. Debit Capital Credit Bank.
Thereafter there are no accounts left. If Capital Account is in deficit then Partner must
pay up which is shown as an opposite transaction as above. If partner is insolvent then
it is the responsibility of other partners.
This is apportioned according to the Garner Vs Murray rule if no agreement is in place.
This is the ratio of Solvent Capital Amounts after Step 8. See PG 147. Debit Solvent
Account Credit Insolvent Account by this ratio
Examples PG 137-149

Piecemeal Liquidation
 Step 1: Close Current & Drawings to Capital
 Step 2: Close off non-liquidable, intangible non-current assets (Goodwill, Reserves
etc) to Capital per Profit Ratio. Calculate Order of Preference if Surplus Capital
method is used
 Step 3:
o Record the payment of expenses as they arise. Debit Liquidation Credit
Bank. Then the settlement of debts as per plan. Liquidation expenses enjoy
preference
o The liquidation of assets, the receipts of any further cash and the interim
repayments made to the partners as they arise. (Liquidation Acc)
Step 4 is same as Simultaneous Step 10 EG159-186

Liquidation Account
 Liquidation/Dissolution/ Realization Account
 Has Profit/Loss which is closed off to Capital Accounts
 Method 1:
o 1) All Asset Accounts (Except Bank), Contra Assets Account
(Depreciation etc) and Liability Accounts are closed off to the Liquidation Account
o 2) Any further Income received (Sale of Asset) or Expenses Paid
(Discount) is recorded in the Liquidation Account & net Profit/Loss is closed to
Capital Account
 Method 2:
o Similar to Method 1 but Assets and only those liabilities on which
settlement discounts are expected are closed to Liquidation Account. Mortgage loan
plus current-liability with no anticipated discount is not closed to the Liquidation
Account. If discount is unexpectedly received Debit Liability Credit Bank and
Credit Liquidation with discount amount.
Method 2 is used in chapter

Calculation of Interim Repayments

Surplus Capital Method
EG Tom R3000 Dick R2000 profit ratio is 2:1
 A) Calculate Rank (Dick 2500/1=2500 Tom 3000/2=1500. Therefore Dick is 1st &
Tom 2nd)
 B) Calculate and Arrange the surplus capital of the partners. Capital of 1st – (Capital
per unit 2nd *Unit of profit share) [2500-(1500*1)=1000]
o Table 4.1 PG 153 Table 4.3 PG 156
Loss-Absorption Capacity Method
 Calculated EVERYTIME cash becomes available
 A) Determine Capital Account Balances.
 B) Apportion any expense by profit ratio
 C) Apportion all unsold assets by profit ratio (Assumption is that no more assets will
be sold)
 D) Any Capital deficit is apportioned to other partners (Assuming partner is
insolvent). PG 159

Study Unit 5: Close Corporations

Attributes of a Close Corporation

 May have 1-10 members, only natural persons, members make contributions to
Capital which is stated in the founding statement
 It has an independent juristic personality. Members have limited liability and CC can
sue or be sued
Must remain specific liquidity and solvency requirements before certain payments (profit
distribution) can be made.

Advantages
 Continues to operate irrespective of changes in its membership
 Members have limited liability
 Easy to administer compared to a company
 A member or employee can be accountant (if qualified).
 May give financial assistance to potential members (if solvent after)
No transfer duties
Disadvantage
 Members have jurisdiction to act on behalf of the corporation
 Only natural persons.
 Annual financial statements must be approved by 51% members
 Decision must be agreed by 75% of members

Members Interest
 It is the members share in profits
 This can be amended in the association agreement
 No persons can jointly hold a share
 Share in CC does not need to be in proportion to contribution made
 To be a member, members interest must be bought from existing members or make a
contribution to the CC for an agreed amount of interest
Debit Bank/Asset Credit Members Contribution X

Tax Position of a close corporation and its members

 It is treated as a Company and must register as a tax payer
 Must make two compulsory provisional payments (Estimate Tax due) one at 6
months and one at 12 months (before end) of financial year end
 Provisional Payment: Debit SARS (Income Tax) Credit Bank
 Actual Tax (as per SARS): Debit Income Tax Expense Credit SARS (Income Tax)
 SARS (Income Tax) then has a debit balance (SARS owes CC) or credit balance (CC
must pay more) which is closed appropriately
Income Tax Expense is closed to Profit/Loss as an expense

Recording Distribution of Profit

 It is provided for if chosen by the members to do so and solvency/liquidity
requirements are met
 This distribution is only on basis as member (Employee, creditor or other members role
excluded)
 Debit Distribution to Members Credit Distribution to members Payable
 Debit Retained Earnings Credit Distribution to Members the amount not being
distributed
 Debit Distribution to members Payable Credit Bank when cash is actually paid to
members.
 If profit capitalized then it is treated as a loan from member with interest payable
agreement.
Example PG 212-221
Deregistration of CC PG 226 and Summery PG 227 but not needed for exam

Conversion of a private company into a Close Corporation

 A company may convert to a CC if it has 10 or less natural persons as share holders
 Must just do the necessary paper work
 Once converted, the first financial year end must stay the same as the company
 Debit Share Capital & Share Premium Credit Member Contribution according
capital contribution ratio.
Example PG 225
Prescribed forms of a CC PG 197
Registration of a CC PG 197 & 198
All theory PG 199 – 210 but not necessary for the exam

Study Unit 6: Companies

Table 6.1 PG 234 good to see

Characteristics of a company
 Can acquire more capital than any other business entity
 It is legal entity and shareholders have no claim to profits (unless declared as dividends) or to
assets unless liquidated
 Shares are easily transferable
 Shareholders only risk their shares. The company is solely responsible for its liabilities
Professionals run large companies, board of directors etc. Not the owners (shareholders)
The formation of a company PG 236 & 237. Not needed for exam

Share Transactions
The company invites the public to buy shares by using a prospectus (Document with all
necessary information of the company as prescribed by the Companies Act). Once the
Shareholder has made an investment he/she receives a certificate indicating the number
of shares the shareholder holds and shareholders details are entered into the share register
of the company. This is being replace by STRATE Share Transfer Records All
Transactions Electronic.
 Authorized Share Capital is the maximum shares a company may issue. This
maximum can be change by special resolution.
 Issued Share Capital: The actual number of shares issued
 Par Value: Simply nominal value at registration and not market value. Only
significance is it establishes the maximum responsibility of a shareholder in the event
of insolvency. Term Share Capital
 No Par Value: No nominal value: Term Stated Capital
No company can have both (unless in different classes) and can change visa versa
 Share Premium: Difference between par value and actual selling price. Funds created
can only be used for certain expenses.PG240
 Classes of Shares
o Ordinary Shares: Usually the only ones with voting rights. Do not bear
fixed dividends and do not guarantee fixed dividends or assets upon dissolution.
Preference Shares: Held by preference shareholders and entitled to fixed regular
dividends when sufficient profit is made. Have no voting rights unless preference
dividends are in arrears. Ordinary Preference shares, Cumulative, Participating,
Redeemable. See PG 241
The Issue of Shares
First Shares go to Subscribers of the Memorandum.
 Debit Bank Credit Subscribers to the Memorandum: X Shares
 Debit Subscribers to the Memorandum: X Shares Credit X Share(Par
Value)/Stated(No par Value) Capital.
The public is sent a prospectus for the rest, which applicants then fill out and pay in full.
Not all applicants are successful and money is returned
 Debit Bank Credit Application and allotment: X
 Debit Application and allotment: X Credit Ordinary Share/Stated Capital
 Debit Application and allotment: X Credit Bank. Unsuccessful Applicants
 Debit Share Issue Expense Credit Bank
Notes: X=Preference Shares/Ordinary Shares etc. Different types of share = different accounts
Schedule for Allotment of Shares PG 250. Must See
Conversion of Shares:
 Debit Ordinary Share Capital & Share Premium Credit Stated Capital: Ordinary
Share. This is from PV to NPV, For NPV to PV swap transaction but no amount can
go to Share Premium by law
Capitalization Shares (Bonus Shares) PG 252
 Debit Share Premium (Usually used first) & Retained Earnings Credit
Ordinary/Preference Share
Underwriting Shares PG 255
 Done to guarantee all shares are bought. Underwriter paid commission for all shares
issued to public
 Debit Underwriters Commission Credit X Underwriters. Commission Paid
 Debit X Underwriters Credit Share Capital or Share Premium. Allocation of shares
no sold
 Debit Bank Credit X Underwriter. Balance of allocated shares and commission paid
Notes: Commission and Share Expense often close off to Share Premium. Debit Share Premium

Dividends
It is the Return on the Shareholders original investment. It is only paid if a dividend has
been declared for the period. It not it is forfeited by shareholders unless they hold
Cumulative Preference Shares.
First Cumulative Preference shares (arrears and current) then Preference shares then
ordinary shares are paid from dividends
 Calculation of Preference Shares (Period*fixed percentage*total share value)
 Calculation of Ordinary Shares (Number of Shares*Cents per Share)
Interim dividends are dividends declared in the middle of the year but cannot be
declared unless previous final (year end) dividends are paid. Annual dividends are the
Interim and Final dividends of a year.
Debit X Dividends Credit Dividends Payable
X=Type of share class and shares (Each have own account)
Example PG 260

Debenture Transactions
 Debentures are very similar to Shares but are actually loans to the company.
 It reflected under non-current or current liabilities.
 Types are Secure, Unsecured, Redeemable and Convertible.
 The Issuing of Debentures is done in the same way as issuing of shares.
 They have a nominal value and nominal interest rate
They are sold at market price, which can be at a premium, a discount or equal to the
nominal value. Premium or discount is recorded in separate account, doesn’t change the
interest rate but is closed off in Interest on Debentures. See Example PG263-267 (Not
necessary to learn for exams)

Study Unit 7: Cash Flow Statements

The Main objective and advantages of a cash flow Statement
To disclose how the cash and cash equivalents of a business entity were generated and
managed.
Advantages are that it enables users to evaluate; the changes in the net assets of the
business entity, the ability of the business entity to affect the timing and the amounts of
its cash flows plus the financial structure (liquidity) of the business entity.
It is useful in detecting imminent financial problems; it enhances the comparability of the
reporting of different entities because it eliminates the effects of using different
accounting procedures

Cash it King. A company may be making a great profit but without positive cash flow the
company will eventually go bankrupt.
According to IAS 7 (AC 118) GAAP cash flow is required

The Format of a Cash Flow Statement

It is reported on the cash flows of a business during a designated financial period and
must distinguish between the cash flows or operating, investing and financing activities
 Cash: Cash on Hand and Demand Deposits
 Cash Equivalents: Shot term, highly liquid assets that are readily convertible to
known cash value
 Cash Flows: Inflows/Outflows
 Operating Activities: Revenue earned from ordinary business activities. Not Invest or
Finance
 Invest Activities: The acquisition and disposal of long-term assets and other
investments
 Financing Activities: Results in changes in the size & composition of the contributed
equity and loans.
See PG 286.

The main distinction is that cash flow statement is prepared on a cash basis of accounting.
It is complementary because it uses information from the other financial statements, but
only reports on the cash flows of the info from the other financial statements

The identification of non-cash entities in financial statements prepared on the

accrual basis of accounting
 Income earned in period but cash only received in next period (Credit Sales)
 Income earned during period but cash receive in previous period (Income received in
advance).
 Expenses during period but cash only paid in next period (Credit Purchases)
 Expenses during period but cash paid in previous period (Prepaid Expense)
 Revaluations of non-current assets
 Depreciation
 The net realizable value of current asset to be disclosed (Allowance for credit loss)
 Reversal of theses non-cash Transactions will gives the figures to formulate the cash
flow statement with.
 A specific statement will influence the calculation because of the time period it
portrays
o Cash is a flow concept
o Income statement and statement of changes in equity etc pertain to flow
under a certain period
o Balance sheet is for a specific date, Therefore for cash flow statement,
take Balance sheet amounts for one year and minus the amount from the Balance
Sheet in the previous year.
 Entries that may directly or indirectly include non-cash entries: Revenue,
“Distribution, administration and other expenses” and Balance sheet items
 Non-cash entries: Credit Purchase, Credit Sale, Depreciation, Allowance for Credit
Loss, Accrued expenses, Accrued Income, Prepaid Expense*, Income received in
advanced*, Profit/Loss on Sale of non-current asset, credit loss and Settlement
Discount Granted/Received. (*= Pertain to account of previous period because it would
have been adjusted as an expense/income for this year when the cash was received/paid last
year)

Preparation of Cash Flow Statement from financial statements prepared on the

accrual basis of accounting
 Balance sheets pertaining to the beginning and end of the financial period under
review
 The Income Statement
 Statement of changes in equity
 Notes

This can be recorded using

Direct Method
The Income Statement is used for this
Each item taken into account must be adjusted from an accrual to a cash amount by
 The opening and closing balances of the current assets and current liabilities in the
balance sheet
 The notes and any further additional information

 Calculation of cash receipts from customers Table 7.1 PG 294

 Calculation of cash paid to suppliers and employees Table 7.2 PG 296
Examples PG 298-304
Indirect Method
 Begin with Profit/Loss for period in income statement
 Subtract all non-cash entries
 Add cash entries which are excluded (interest)
 The differences in the balance sheets amounts are taken into account.
 A) Non-cash entries clearly disclosed by means of name (Depreciation etc) Note:
Certain non-cash entries need not be added back (credit loss).
 B) Interest Paid, income tax paid, drawings, distribution to members paid, proceeds
from the sale and the acquisition of financial assets are disclosed separately in the
cash flow statement
 Disclose the differences between current assets and current liabilities in balance sheet.
See Examples PG 307
Cash flows form operating activities
 Cash flows arising from operating activities is a key indicator to the business ability
to raise sufficient cash to maintain operations without financial assistance
Operating activities are mainly derived from main business activities which is recorded in
the income statement

Cash Flows from investing activities

Investing activities must be disclosed separately in Cash Flow because it indicates how
cash was spending for investments.
The gross cash receipts and cash payments cannot be offset against each other and should
be shown separately.
 Step 1: Determine whether there are differences between the opening and closing
balance of the investing accounts
 Step 2: Determine whether these differences pertain to cash flows
o It must be determined whether the differences where just purchases or
sales or both. Determine if assets were bought on credit (if there are
significant amount of credit purchases of assets it must be shown), from a
loan (cash inflow and outflow) or paid with cash. Same thing for sale of
asset
 Incase of valuation, depreciation or other non-cash entries, these must be subtracted
for differences in the balance sheet.
See Example 7.6

Cash Flow from financing activities

It is useful to determine the future claims on cash of a entity and to indicate how the
entity financed its activities. Finance activities pertain mainly to entries in the equity and
liabilities section
 Step 1: Determine whether there are any differences between the opening and closing
balances of the accounts that pertain to financing activities.
o Long term loans might have amounts in current and non-current sections
because of payment due for the next period, these amounts must be added
and compared to last years balance sheet to see if an amount was paid
during this period
 Step 2: Determine whether the difference pertains to cash flows: this information is
from notes and other information on hand

Cash and Cash Equivalents

 Movements in this section do not cause cash inflows or outflows and are not
disclosed in the cash flow statement
 The cash flow statement illustrates that the net increase or decrease in cash and cash
equivalent is equal to the sum of the net cash inflows and outflows from the
operating, investing, and financing activities.
See Example 7.8 PG 317 and Examples PG 319-336 plus Table 7.4

Study Unit 8: Analysis and interpretation of financial

statements

Financial Statements are the used and comprehensive way of communicating information
about the financial performance and position of an entity. But investors need to be able to
read between the lines to make better-informed position.
The objectives of financial statement analysis
Different aspects of analysis have a particular use to many diverse groups. Investors,
creditors, potential investors/creditors, management, employees

The analysis of financial statements is done by reclassifying the accounting data and
calculating of ratios (comparing two or more financial balances which have an economic
relationship).
The use of these ratios is to compare these ratios to previous years and other entities in
the same entity to get an idea of the areas in which the business is either performing well,
average or badly. When interpreting the results it is important to take external influences
into account (inflation, competition etc)

Ratios
Profitability Ratios
Return on Equity =(Profit for the Measures how Increase/Decrease are
(ROE) successful an entity is due to changes in
period before tax /
in using equity to expenses, profit mark-
Total Equity) X 100 attain its key financial ups, and in equity
(Before tax because it
objectives & it is the without a
eliminates the difference
tax rules of different return on the owner’s corresponding change
entities) investment. in profit
One year compared
with previous
year/years
Return on Total =(Profit for period Measures the Increase/Decrease can
Assets (ROA) profitability of an indicate lack of
before interest /
entity as a whole in utilization of assets
Total assets) X 100 relation to the total optimally or acquired
Before interest deducted
assets employed. It asset just before end
is to relate the profit for
profit derived form measures how of financial period
operations to invested effectively the entity’s
capital prior the total assets are being
expenses of the used to make profit
invested/borrowed One year compared
capital with previous
year/years
Gross Profit =(Gross Profit / Measures the entity’s Usually linked to
Percentage Sales) X 100 ability to generate variation in sales
gross profit from volume, selling prices
sales. Used by and cost of sales
management to
control inventory
costs by bargaining
for lower prices. Also
shows what is left to
cover other operating
expense
Profit Margin =(Profit for period / It indicates Increase/decrease due
Sales) X 100 management’s ability to change in make up
to operate with of distribution,
sufficient success. To administration and
ensure that a other expenses
reasonable amount of without a
 profit is available to corresponding change
owners in sales or selling
prices
Financial Leverage =Return on equity / It measures whether 1:1 is normal because
Return on Assets an entity is using it is the break-even
borrowed funds point.
successfully. It >1:1 is good because
indicates whether a profits are exceeding
entity is benefiting out the cost of borrowed
of the use of borrowed funds
funds or not. <1:1 is bad because it
is costing more to
borrow the funds than
it is making from the
borrowed funds
Financial Effect = Return on Equity It indicates what Increase/Decrease is
equity investors can be due to
– Return on Assets receive on their increase/decrease in
investment interest rates without
a corresponding
change in profit
Liquidity Ratios
Current Ratio = Current Assets / Measures the extent to 2:1 is generally
Current Liabilities which current assets acceptable norm or
can be used to meet standard. Can vary in
current liabilities. different industries
If in this range an
entity has a good
short-term financial
prospects.
Below this means the
entity could have
problems paying its
short-term obligation
If too high above 2:1
it is not good because
an entity could use
this extra to make
further income
Acid Test or quick = (Current Assets – Measure entities 1:1 is accepted norm,
ratio ability to pay short- any higher is great
Inventory) / Current
term debt by selling and any lower is
Liabilities all the entities current bad(make short-term
assets at short notice creditors think twice)
without the sale of
inventory. Inventory
is excluded because it
often takes longer to
convert into cash
(Credit sales,
discounts, bad debt
etc.) than other assets
Trade Receivables = (Average Trade Measures the The shorter the period
Collection Period efficiency of the the better. Usually
Receivables* /
entity’s debt associated with good
 Credit Sales) X 365 collection policy. The management of trade
*Trade Receivables time between credit receivables which
from this year and sale and cash received effects the availability
previous year divided by of cash
2
Trade Payable = (Average Trade Measures the time it It is compared to
settlement period takes to pay creditors. Trade receivable
Payable* / Credit
Every entity strives collection period to
Purchases^) X 365 for longer periods see if good or not
* Trade Payables from
because it give more There must be enough
this year and previous
year divided by 2 time to generate cash time to generate cash
^Open Inventory+ to be able to pay
Purchases – closing creditors
inventory
Inventory Turnover = Cost of Sales / Measures to The higher the better.
Rate Average inventory* approximate number Industries will have
*(Opening +Closing of times inventory norms though. Low
Inventory)/2 acquired is converted rates due to inefficient
into cash stock ordering which
leads to high costs
(storage, insurance,
etc.)
Inventory Holding = (Average The higher the Period Change could be due
Period the higher the to higher/lower
Inventory / Cost of
investment in demand for inventory
Sales) X 365 Inventory, not good or better/worse
because this cash can management
be used in
investments
Solvency Ratios
Debt Equity Ratio (Total Debts / Total It measures the Change due to
Equity) X 100 percentage of the increase/decrease of
entities total debts borrowed funds
compared with its without corresponding
equity. To high could change in equity
mean solvency issues
if interest rates go up
Times interest = Profit for the Measures the ability The higher the better,
earned Ratio period before of an entity to meets and possibly the
its interest obligations ability to take on more
interest / Finance from available profit. loans
Cost It indicates if the
entity will be able to
meet its interest
obligations as they
come due

Limitations of financial Statements

 In times of inflation, profits may be overstated and depreciation understated
 It is possible that the amounts used for the ratio’s are outdated
Ratios provide bases to compare but the one doing the analysis should be aware of
outside influence plus have good knowledge of entity and industry to make informed
decisions. Negative ratios might have good reasons so internal investigation may be
required before a decision based on the ratio is made
Example PG 351-356
Study Unit 9: Branches

A business may have different branches for a number of reasons but mainly it is to
increase its market and revenue. This chapter only deals with dependent Branches, which
are then fun by the head office. You also get independent branches, which only report to
head office now and then.
Accounting for dependant branches
All the accounting is done centrally at head office. Branches deposit all revenue into the
head office account. Branches may have petty cash for minor expense. At the end of the
period (Daily, Weekly, Monthly) a report must be given which is a summery of the
period’s transactions taken from source documents. This info being
 Particulars of cash and credit sales
 Particulars of debtors accounts which have been paid
 Cash received, discounts allowed and inventory returned by customers
 List of debtors on the date of the report
 Particulars of debtors accounts which are doubtful or irrecoverable
 Particulars of purchases made by the branch
Invoice sent to branch is either invoiced at cost or selling price

2 Methods:

1. At Cost Price
Two accounts are used to record all inventory transactions with its branch:
 Branch Inventory Account (Like Trading Account)
 Inventory to Branch Account
 Debit Branch Inventory Account Credit Inventory to Branch when Inventory is sent
to Branch
 If stock returned then reverse above transaction
 Debit Branch Inventory Account Credit Bank when inventory is bought by other
suppler
 Debit Branch Debtors Control/Bank Credit Branch Inventory Account for sales.
 Settlement Discount and similar transactions done the same as normal and closed to
Branch Inventory Account.
 Inventory marked down is treated exactly like sale because discount will reflect as
less profit made
 Embezzled or stolen cash is Debited to Branch Expenses and Credited to applicable
account. Loss will reflect as loss of gross profit
 Inter-branch inventory transactions is simple a transfer from account of one branch to
account of other. Branch Inventory
 Major expense paid from head office is Debit Branch Expense and Credit Bank.
Minor expense paid by branch is Credit Branch Petty Cash
 Inventory Transit: Head office to branch. Is recorded in Branch Inventory on the
credit side and brought down as a separate balance. Transit to Head office is recorded
on debit side but brought down as separate balance on credit side.
 Surplus/Shortage of inventory doesn’t require entry because it effects Profit/Loss of
branch
 Settlement Discount closed to Branch Inventory, Transit recorded and brought down
as separate balance in Branch Inventory. Branch Inventory closed off to Branch
Expense
 Inventory to Branch closed to Head office Trading account
 Branch Expense closed to Head office Profit and Loss
 Other accounts closed off normally
 Example PG 371- 373

At Selling Price
All transactions of inventory must be split into cost-price profit mark-up
 Branch Adjustment Account is and additional account used which, acts as trading
account.
 Branch Inventory Accounts as control account and Inventory to Branch is the same as
in Cost Price Method
 Calculation of Mark-up PG 374
 Inventory sent to Branch
o Debit Branch Inventory Credit Inventory to Branch (Cost Price)
o Debit Branch Inventory Credit Branch Adjustment (Mark-up)
 Returned Inventory: Reverse above transaction
 Sale: Debit Bank/Debtors Credit Branch Inventory
 Settlement Discount is now closed to Branch Adjustment
 Inventory mark down is Debit Branch Adjustment Credit Branch Inventory with
(Initial selling Price – New selling Price) See PG 379/380
o If discount is more than initial markup then also Debit Branch Expense
with (Initially Selling Price – Markup – New selling Price)
 Cash Embezzled is same as Cost Price Method
 Transfer with different Branches is the same but mark-up must be canceled
(Reversed) in branch transferred from and added in branch receiving See PG 382 for
example
 Branch Expense is the same
 Inventory in transit is the same in Branch Inventory as cost price but now markup
must be dealt with in Branch Adjustment in a similar manner.
 Inventory on hand is added to Credit side of Branch Inventory as balance and brought
down to debit side. The surplus/shortage reflected after this is posted the Branch
Adjustment.
 Examples PG 387 - 393

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