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Financial Accounting 188

Chapter 1: Nature and Objective of

Accounting
+
Chapter 2: The Conceptual Framework
for Financial Reporting

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Forms of Entities
Form Sole Prop. Partnership
Close Company
corporation
Ownership One owner 2 or more 1 – 10 Shareholders
partners members
Liability Not a separate Not a separate Separate legal Separate legal
legal entity legal entity entity entity
Enforcement No acts No acts Close Companies
Corporation Act
Act
Profit Profits belong Profits Profits Profits belong
to owner distributed in allocated as to company
specific ratios profit share to and paid out
members to
shareholders
as dividends

Fundamental Qualitative Characteristics

 Financial info is useful when it is relevant and faithfully represented
 Relevance is info that can make a difference (influence decisions)
o Predictive value
 Info that can be used by users to make their own predictions
o Confirming value
 Info that provides feedback about previous evaluations
 -
Faithful representation of events = useful information
o Completeness
 Material omission can result in information being false and
misleading and therefore unreliable and irrelevant
o Neutrality
 Information is neutral as it is presented not to achieve a
predetermined result
o Free from error
 Info must be free from error in terms of description and the
process to produce the info

Enhancing characteristics
 Comparability
o People want to be able to judge tendencies over time and between
similar entities to evaluate their own relative financial position
(performance)
o Measurements and presentation for similar transactions must be done
consistently within the entity and across different entities
 Verifiability
o Means different knowledgeable and independent observers could
make sense of the info and reach a consensus

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 Timeliness
o Linked to consistency, info should be available for users to make
decisions
 Understandibility
o Info should be presented in a user friendly manner

Underlying assumptions
 Financial statements are usually prepared according to the accrual basis
o This means that transactions are recorded as they occur
o Financial statements on the accrual basis provide info on past
transactions that resulted in the movement of cash as well as future
payments of the entities obligations or future recovery of amount due to
the entity
 In a going concern, financial statements are prepared with the assumption
-

that the entity will continue to be in business for the foreseeable future
o The entity does not plan to scale down or turn assets into cash

Elements of Financial Statements

 They are classified according to their economic characteristics
 They relate directly to measurement of financial position (assets, liabilities,
and equity) as reflected in the balance sheet
 They related directly to measurement of performance (income and expenses)
as reflected in income statements

1. Assets
 A resource that is controlled by the entity as a result of events in the past and
from which future economic benefits will flow to the entity
 Non-current asset
o Long-term (more than 12 months)
o Primary purpose is to utilise asset for a long period of time to maximise
the generation of income
 Current asset
o Short term (less than 12 months)
o Primary purpose is to sell as quickly as possible to convert the asset
into a more liquid asset such as cash

2. Liabilities
 A present obligation of an entity arising from past events, the settlement of
which is expected to result in an outflow of resources from the entity
 Non-current liability
o Long-term (more than 12 months)
o Bond/mortgage
 Current liability
o Short term (less than 12 months)
o Creditors/bank overdraft

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*
3. Equity
 The residual interest in the assets of the entity after deducting all its liabilities
 Capital [C]
o The difference between capital contributions and capital withdrawals
 Profit/loss
o The difference between income and expenses
o Profit [+Po] = proceeds of sale > cost price
 Increases Owner’s equity
o Loss [-Lo] = proceeds of sale < cost price
 Decreases owners’ equity

4. Income
 The increase in economic benefits during the accounting period, in the form of
inflows or enhancements of assets, or decrease in liabilities that result in an
increase in equity
o Revenue [ +I ]
 Arises from the ordinary activities of an entity
o Profits (aka gains)
 Do not necessarily arise from ordinary activities of an entity

A
5. Expenses
 The decrease in economic benefits during the accounting period in the form of
outflows of assets or incurrence of liabilities that result in a decrease in equity
o Current expenses [-E]
 Expenses arising from ordinary activities of an entity for the
accounting period
o Losses [-Lo]
 Result from the sale of non-current assets as well as unforeseen
disasters such as fires/floods

A + D + E/Lo = L + C + Ci + I/Po

Recognition and Measuring of Elements of financial statements

 The process of including an item, which complies with the definition of an
element above and satisfies the criteria of recognition, in the balance sheet or
income statement
 An item should be recognised when
o It is probable that future economic benefits will flow to or from the entity
o Item has a cost or value which can be measured reliably
 Fair value is the amount for which an asset should be exchanged or a liability
settled, between two knowledgeable, willing parties in an arm’s length
transaction

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Measuring the elements of financial statements

 The process of determining the amount at which the elements of the financial
statements are recognised and reflected
 This depends on the choice of measurement basis
o Historical cost
 Assets: cash/cash equivalents paid
 Liabilities: settlement amount
o Current cost
 Assets: cash/cash equivalents to acquire the same asset today
 Liabilities: undiscounted cash/cash equiv. needed to settle the
obligation today
o Realisable cost
 Assets: cash/cash equiv. that could currently be obtained by
selling the assets in an orderly disposal
 Liabilities: cash/cash equiv. expected to be paid to settle the
liability in the ordinary course of business
o Present value
 Assets: present discounted value of the future net cash inflows
expected to be generated in the normal course of business
 Liabilities: present discounted value of the future net cash
outflows required to settle the liabilities in the normal course of
business

The Entity Concept

 A separate set of financial records and financial statements are required for
each enterprise/entity as well as for the owners/shareholders of the
enterprise/entity
 The entity receives its equity/capital from its shareholders and external
lenders of money
o These funds are used to purchase assets in the name of the entity,
which in turn can be used to generate income for the entity

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Financial Accounting 188

Chapter 3: Accounting Equation and

Financial Statements

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The Accounting Equation

1. The Accounting Equation
 Will always balance!
 Assets = Equity + Liabilities
 Owner of the business provides capital/equity to the business which gives him
interest in the business (A=E)
 The business can also make use of loans/liabilities as additional financing
(A = E + L)
 The business uses capital and liabilities to purchase assets
o The double entry rule states that an increase on the left side of the
equation will bring about an equal increase on the right hand side of
the equation
 Equity is remaining interest after all liabilities have been deducted (E = A – L)

2. Expanded accounting equation

 Equity is now separated into four components
o Capital contributions, Income, Capital Withdrawals and Expenses
 Therefore the expanded equation will look like this:
Assets = [Cap Contr. + Income – Cap Withdrawals – Expenses] + Liabilities
 Items that have negative impact on equity can be carried over to the asset
side of the equation:
Assets + Cap Withdrawals + Expenses = Cap Contr. + Income + Liabilities
 A good way to remember this is DAX = CIL
o DAX refers to Drawings, Assets and Expenses
o CIL refers to Capital, Income and Liabilities

The Objective of Financial Statements

 To provide info on the financial position, financial performance and cash flow
of an entity
 Financial statements are prepared during the financial/accounting period
o Financial period for internal reporting = 1 month
o Financial year does not have to correspond with calendar year

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Components of Financial Statements

 Balance sheet
o Represents the financial position of an entity at a specific point in time
o Financial position is the wealth or ability of an entity as well as a
breakdown of the individuals that have an interest there in
o Layout is based on the accounting equation
 Income statement
o Presents the financial results of an entity for a specific financial period
o The financial results are the gains or losses that contribute toward an
improvement or decline in financial performance of an entity
 Statement of changes in equity
o Reconciliation of equity at the beginning of the financial year with
equity at the end of the financial year
 Cash flow statement
o Provides info on the ability of the entity to produce cash and cash
equivalents, and the demand of the entity to utilise that cash flow

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Financial Accounting 188

Chapter 4: Accounting Systems

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Objective of an accounting system

 All transactions to do with the same activity are processes
 These systems must disclose info necessary for decision making to the
management of the entity
 The same system must also provide info for external reporting to users of the
financial statements on the position and results of the entity

Requirements of the System

 Relevant and accurate info disclosed on time
 Internal control measures to protect assets and ensure reliable info
 Flexible enough to adapt in order to accommodate changes

Purchases and Creditors System

1. Objective of the system
 All purchases authorised
 Ensure goods that have been ordered are received
 Prices on invoice correspond to those agreed on
 Obligations recorded accurately
 Creditors paid on time

2. Flow of system
Credit Cash
Source  Goods received note  Cheque counterfoil
Document  Purchase invoice  Receipt
 Cash invoice
Purchases Purchase Journal (PJ) Cash Payments Journal (CPJ)
Purchase Purchase Returns Journal Cash Receipts Journal (CRJ)
Returns (PRJ)
Pay Creditor Cash Payments Journal General Ledger

3. Purchases
 Can be done on cash or credit
o Cash: purchase transaction and cash payment transaction occur
simultaneously
 Cash purchases are recorded in the CPJ
o Credit: purchase transaction occurs immediately, payment occurs at a
later date
 Recorded in the PJ

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4. Creditor
 Someone who is owed money
o The creditor has a claim against the entity
o Creditor may grant a cash discount if the entity pays on time
 Payment of creditor is recorded on cheque counterfoil in the CPJ together
with cash discounts received

5. Purchase Returns
 An entity can claim a discount from a supplier if purchased items are not up to
standard
 Reasons for returns include
o Return of damaged goods
o Reduction in price after invoice was issued
o Trade discount omitted on invoice
o Correction of error on invoice
 If an entity wants to claim a discount from a supplier, they must send a debit
note to the creditor, and if the creditor is willing to grant the discount they will
send a credit note as a reply
 Cash: transaction recorded from duplicate debit notes or original credit notes
in the CRJ
 Credit: transaction recorded from duplicate debit notes in the PRJ

6. Discount received [is an income]

 Can be divided into two groups
o Purchase/trade discount
 Normally received when an entity buys in bulk from a supplier
 Amount of the discount is directly subtracted from the purchase
price which then recorded at discounted amount
is

 Trade discount is NOT recorded at all

o Cash/settlement discount
 Normally received if entity pays creditor on time only when
 Is recorded
they've paid.
otherwise it's
a TRADE DISCOUNT

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Sales and Debtor System

1. Objective
 All sales must be recorded on time
 The correct amount must be invoiced
 All payments must be recorded
 Control over collection from debtors is essential

2. Flow of system
Credit Cash
Source doc.  Sales invoice  Cash register slip
 Receipt
 Cash invoice
Sales Sales Journal (SJ) Cash Receipts Journal (CRJ)
Sales Return Sales Returns Journal Cash Payments Journal (CPJ)
(SRJ)
Receipt from Cash Receipts Journal
Debtor (CRJ)
Debtors ledger General Ledger (accumulated
(individual transactions transactions)
in individual accounts)

3. Sales
 Can be done on cash or credit
 In both situations there are two transactions
o A sales transaction
o A cash receipts transaction
 Cash: occurs immediately
o Cash sales from inventory/other income received in cash recorded in
cash receipt journal
o Cash sales of other assets are recorded in the general journal
 Source docs are cash register slips, duplicate cash invoice of
duplicate receipts
 Credit: transaction occurs immediately, but cash is received later
o Credit sales from inventory or rendering of services on credit are
recorded in the sales journal
o Credit sales from other assets are recorded in the general journal
 Source doc: sales invoice

4. Debtors
 Someone to whom credit is granted
o Entity has claim against a debtor
o Debtor is granted extended period in which to pay back the creditor
o Monthly statements are sent to debtors

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o Entity may allow cash discount if debtor settles account on time

 Payments received from debtors are recorded from the duplicate receipts in
the CPJ together with cash discounts allowed

5. Returns
 Sold items are not always up to standard, so a consumer may demand
discount from an entity
 Reasons for granting claims
o Return of damaged goods
o Reduction in price after invoice was issued
o Omission of trade discount on invoice
o Correction of errors on invoices
 If customer wants to claim discount from the entity they need to send a debit
note to the entity, if the entity is willing to grant the discount, they will send a
credit note as a reply
 Cash: sales returns are recorded from original debit notes or duplicate credit
notes in the CPJ
 Credit: sales returns are recorded from original debit notes or duplicate credit
notes in the SRJ

6. Discount allowed
 Can be divided into two groups
 Sales/trade discount
o Normally granted to consumer who purchase on bulk
o Directly subtracted from sales price
 Not recorded at all
 Reduced sales price replaces original sales price, sale recorded
at decreased value
 Settlement/cash discount
o If consumer settles their account on time, the entity may grant a cash
discount
o Cash discount allowed is recorded in the CRJ together with the
payments received from the debtor

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Financial Accounting 188

Chapter 5: Transactions

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Transactions regarding Assets

1. Purchase an asset for cash
 Entity purchase additional equipment from supplier and pays by cheque
 Accounting equation – Assets increase (equipment) and Assets decrease
(Bank)
 Double entry
o Debit equipment
o Credit bank

2. Payment received from debtor

 Entity receives cheque from debtor as settlement of his account
 Accounting equation – Assets increase (Bank) and Assets decrease (Debtor)
 Double entry
o Debit bank
o Credit debtors

Transactions regarding Assets and

Liabilities
1. Purchase an asset on credit
 Entity purchases delivery vehicle on credit from supplier
 Accounting equation – Assets increase (Vehicles) and Liabilities increase
(Creditors)
 Double entry
o Debit vehicles
o Credit creditors

2. Paying a creditor
 Entity pays creditor by cheque
 Accounting equation – Assets decrease (Bank) and Liabilities decrease
(Creditors)
 Double entry
o Credit bank
o Debit creditors

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3. Borrowing money from financial institution

 Entity incurred a long term loan from a bank
 Accounting equation – assets increase (bank) and liabilities a
decrease
in (long
term loans)
 Double entry
o Debit bank
o Credit long term loans

Transactions regarding equity

1. Capital contributions
 Owner of entity deposits portion of his personal funds into entity’s bank
account
 Accounting equation – assets increase (bank) and equity increases (capital
contributions)
 Double entry
o Debit bank
o Credit capital contributions

2. Withdrawals by owner
 Owner pays personal account by business cheque
 Accounting equation – assets decrease (bank) and equity decreases
(withdrawals)
 Double entry
o Credit bank
o Debit withdrawals

3. Services rendered for cash

 Entity rendered services for cash
 Accounting equation – Assets increase (Bank) and equity increases (Income)
 Double entry
o Debit bank
o Credit services rendered

4. Services rendered on credit

 Entity rendered services for credit
 Accounting equation – assets increase (Debtors) and equity increases
(Income)
 Double entry
o Debit debtors
o Credit services rendered

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5. Cash expenses
 Entity pays salaries and wages by EFT
 Accounting equation – equity decreases (expenses) and assets decrease
(bank)
 Double entry
o Debit salaries and wages
o Credit bank

6. Expenses on credit
 Entity purchases stationary on credit
 Accounting equation – equity decreases (expenses) and liabilities increase
(creditors)
 Double entry
o Debit stationary
o Credit creditors

7. Purchase returns
 Entity sends debit note to creditor together with damaged stationary
 Accounting equation – liabilities decrease (creditor) and equity increases
(expenses increase)
 Double entry
o Debit creditors
o Credit stationary

8. Sales returns
 Entity issues credit note to debtor to correct error on invoice
 Accounting equation – equity decreases (income decreases) and assets
decrease (Debtors)
 Double entry
o Debit sales returns
o Credit debtors

9. Payments of creditor and discount received

 Entity settles account of creditor and receives cash discount
 Accounting equation – assets decrease (bank) and liabilities decrease
(creditors) and equity increases (discount received)
 Double entry
o Credit bank + discount received
o Debit creditors

10. Payments from debtor and discount allowed

• Entity settles account of debtor and allows cash discount
• Accounting equation – assets increase (bank) and assets decrease (debtors) and
equity decreases (discount allowed)
• Double entry
o Debit bank + discount allowed
o Credit debtors
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Recording of transactions on T-accounts

 Derived from accounting equation and clear illustration of double entry system
 It has two sides, on which only positive figures are shown
 Left side = Debit side
o Net debit balances
o All positive elements of DAX (Assets, Withdrawals and
Expenses/losses)
 An increase in these elements will be recorded on the debit side
of the account
 A decrease in these elements will be recorded on the credit side
of the account
 Right side = Credit side
o Net credit balances
o All positive elements of CIL (Liabilities, Capital, Capital Contributions
and Income/profit)
 An increase in these elements will be recorded on the credit side
of the account
 A decrease in these elements will be recorded on the debit side
of the account

.
& -
-
- t

t -
-

t T t
-
-
-

+
+
-

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Financial Accounting 188

Chapter 6: The Accounting Cycle

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Steps in the Accounting Cycle

1. Capturing data on source documents
2. Recording of transactions in journals
3. Posting to the ledger accounts
4. Prepare a trial balance
5. Adjustments and corrections of errors
6. Prepare financial statements
7. Report (enhanced or reduced financial position)

Capturing data on source documents

 Nature, amount, date and parties involved should be indicated on the source
document
 Source documents that are mostly used for cash receipts and cash
payments transactions
o Receipts
o Bank deposit slips
o Cash register slips
o Credit card slips
o Cheque counterfoils
o Proof of EFT
o Cash invoices
o Bank deposits as proof of
 Debit orders or stop charges
 Bank charges, interest received/paid or direct payments
 Source docs mostly used for cash and credit purchases and creditor
system
o Requisition
o Order form
o Goods receipt note
o Purchase invoice
o Cash invoice
o Cash register slip
o Creditor monthly statement
o Cheque counterfoils
o Bank statements for direct payments
o Debit notes
 Purchaser of goods issues a debit note when goods previously
bought are returned
 Debit notes cancel previous transactions
 Source docs mostly used for cash and credit purchases and debtors
systems
o Delivery note
o Sales invoice
o Cash invoice
o Cash register slip

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o Debtor monthly statement

o Receipt
o Bank deposit slip
o Bank statement for direct deposits
o Credit notes
 Seller issues a credit note when goods previously sold are
received back
 Credit note cancels sales transaction

Recording of transactions in journals

 Transactions are events that can be measured in terms of money and can
influence the financial position of the entity
o They are recorded from source docs in journals
&

 Similar transactions are grouped and recorded in a specific journal

 Regarding purchases and the creditors system
o The Purchase Journal
o The Purchase Returns Journal
o The Cash Payments Journal
 Regarding sales and the debtors system
o The Sales Journal
o The Sales Return Journal
o The Cash Receipts Journal
 The General Journal is used for certain cash and various other transactions
that do not fit into the above mentioned journals

Posting to the Ledger Accounts

 All transactions that refer to a certain item are recorded in an account
 A ledger is a collection of all the accounts
 The General Ledger consists of Assets, Liabilities, Capital, Income, and
Expense accounts
 More specific accounts include
o Debtors’ Control: summary of all the debtors of the entity in the
debtors ledger
o Creditors’ Control: summary of all the creditors of the entity in the
creditors ledger
o Trade Account: contains all the information regarding sales and cost
of sales
o Profit and Loss Account: contains all the information regarding
income and expenses
 Balancing is the process of calculating the net debit and credit of each ledger
account in order to get a debit or credit balance
 Recording of transactions from source documents in the journals is posted to
the ledger at the end of each month
o Balance of the ledger amounts are in turn used to prepare the trail
balance

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Prepare a Trial Balance

 The Trial Balance is a list of all accounts in the general ledger and their
balances/totals
o It tests the double entry system as well of the accounting accuracy of
entries
 The-pre-adjusted trial balance includes the balance of all the balance sheet
and income statement accounts in the general ledger
o The pre-adjusted balance is adjusted monthly and serves as a starting
point for the preparation of management accounts for internal decision
making
 Only these balance sheet accounts appear in the - after-closing trial balance:
o Individual: Net Profit
o Company: Retained Earnings

Adjustments and Corrections of Errors

 Normally a number of year-end adjustments need to be completed after the
trial balance has been prepared
o Irrecoverable debt
o Inventory (when periodic inventory system is used)
o Depreciation (when not provided during the year)
o Accruals and provisions
o Prepaid expenses
o Accrued income (income from accumulated resources that only
pay out dividends a certain time per year)
o Income received in advance
 Adjustments result in certain income and expense accounts being increases
or decreased at the end of the accounting period to present the actual
amounts for the financial periods involved
o Adjustments are comprehensively recorded in the general journal and
different accounts in the general ledger
o After adjustments have been made, the final trial balance can be made

Report
o Is the company in an enhanced or a reduced financial position?

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Financial Accounting 188

Chapter 7: Journals
Chapter 8: Ledger
Chapter 9: Trial Balance

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Chapter 7: Journals
1. Nature and function of journals
 Journals are the accounting records of an entity in which all accounting
activities of the entity is recorded
 Info in journals must be recorded comprehensively and accurately, and are
-

therefore set out so that the following information is made clear

o The nature of the specific document
o The serial number of the specific document
o The other party involved in the activity
o The date on which it took place
o The amount at which the activity took place
o The ledger account that will be debited/credited as a result of the
classification
o The nature of the journal entry
 Repetitive info will be combined and recorded in separate journals and posted
to the ledger collectively
o The journals below are generally used for this purpose
 Cash Payments Journal Cash invoice, bank statement, debit order, credit card, cash register slip
Cash
 Cash Receipts Journal Receipts, cash invoice, bank statements, deposit slíps, cash register slips, credit card
 Purchase Journal Purchase invoice
 Purchase Return Journal Debit notes we issued
Credit
 Sales Journal Sales invoice
 Sales Return Journal Credit notes we issued
 General Journal Owner contributes or withdraws, selling of assets = minutes of a meeting
 Not repetitive transactions are put into the GJ
 Transactions with no source doc is also put in the GJ

2. Layout of the journals

 Transaction date and doc number must be recorded accurately
 Transaction must be classified and recorded in correct columns in journals
 Columns in journals can be created for repetitive activities during a month
o The total of each column will be posted to the same ledger account
 Non-repetitive activities are recorded in the Sundry column and will be posted
individually to the relevant ledger accounts
 All the columns must be added
o Accuracy of the total column will be verified by cross-casting to ensure
the accounting equation balances before posting to the ledger can take
place
 Total of the columns and amounts in the Sundry column are then posted to
the ledger

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Chapter 8: Ledger
1. Nature and function of a ledger
 The purpose of a ledger account is to gather and classify suitable and usable
info

2. Layout of the ledger accounts

 All ledger accounts have a similar layout and contain the same appropriate
info
o The name of the account
o The date on which the transaction/event occurred
o The amount at which the transaction/event occurred
o The source of the info
o Details of the contra account of the journal
 Example:
Name of the Account
Date Details Fol. Amount Date Details Fol. Amount

3. Rules for recording of transactions in ledger accounts

 Each transaction has two accounts
o One is debited and the other is credited
 The two accounts can be a combination of
o Two assets
o An asset and a liability
o An asset and an equity
o An equity and a liability
 Remember DAX = CIL

4. Control accounts
 Entities often group separate accounts in the same group in a ledger that is
separate from the general ledger
 The transactions in the debtors’/creditor’s ledgers are replaced with a
combined debtor’s/creditors’ control accounts in the ledger
 Only the accumulated total of a number of transactions will be recorded in the
control account in the general ledger
o The individual transactions will be recorded in the separate
debtors’/creditors’ accounts in the debtors’/creditors’ ledger
 Control accounts are also used for property, plant and equipment (PPE),
investments, salaries, and wages
Creditors Car ↓
t Debta's tr -
-

Balance

I
CbJ
R
Balance

55 PJ
PRI
Debtal ledger =

many T-accounts

that look like

debtors Arl -eith , lege

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Chapter 9: Trial Balance

1. Nature and function of the trial balance
 A trial balance is a list that is prepared from all the balances in the general
ledger to verify whether the double entry for each transaction has been
completed
↑1. In other words, that one account is debited and another account is
credited

2. Errors that will be indicated by the trial balance

 The trial balance is an aid in finding errors
1. If it does not balance, there is evidently an error
T
 The following errors may lead to the trial balance not balancing:
1. The trial balance was incorrectly added
2. The balance in the ledger was carried forward incorrectly
 The amount is incorrect
 Debit on the credit side or credit on the debit side
 Balance was left out
 Balance carried forward twice
3. Balance in ledger account incorrect
 Summation incorrect
 Summation correct but the balance was incorrectly calculated
4. Posting from journal incorrect
 Debit posted as credit or vice versa
 Amount incorrect
 Entry was omitted
 Entry was posted twice
5. Journal entry incorrect
 When the trial does not balance, the error must be searched for in a
systematic manner
 It is recommended that the steps followed to prepare the trial balance should
be applied in reverse:
1. Add trial balance again
2. Post ledger account balances to trial balance
 Look for amount and the correct side
3. Check summation and calculation of ledger balances
4. Do the posting from the journal to the ledger
5. Calculate the differences on the trial balance
 Difference of 1000, 100, 10 or 1 indicates a summation error
 If the difference is divisible by 2 then the debit balance equal to
half of the difference has been recorded on the credit side
 If the difference is divisible by 9 then figures have been
changed around such as 230 instead of 320

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3. Limitations of the trial balance

 The fact that the total debit balances in a trial balance corresponds to the total
of the credit balances is proof only of a corresponding debit amount for each
credit amount in the accounting records
o This is not an indication that there are no errors in the accounting
records
 The following errors may exist even though the trial balance balances
o Omission errors
 Where the accounting transaction or event as a whole is not
recorded in the accounting records
o Posting errors
 Where an accounting transaction or event has been recorded in
the accounting records, but the debit and/or credit part has been
recorded in an incorrect ledger account
o Compensating errors
 Where the total of any errors on the debit side corresponds
precisely with an error in the credit side
o Recording errors
 Where a document as a whole is recorded in the incorrect
journal or the amount was incorrectly recorded in the correct
journal
o Principle errors
 Where an accounting event was classified incorrectly and the
different amounts of the entry were consequently on the correct
side of the ledger account but recorded in the incorrect ledger
account

4. Posting from the ledger to the trial balance

 Pre-adjusted trial balance
o The pre-adjusted trial balance is a list of all the balances in the general
ledger
o The balances of both the balance sheet and income statement
accounts appear in the trial balance
 Post-adjusted trial balance
o The post-adjusted trial balance is prepared after the pre-adjusted trial
balances was adjusted for the following activities
 Closing journals of income statement accounts
 Cost of Sales
 Trade Account
 Profit and Loss account
 Adjustments
 Correction of errors

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Financial Accounting 188

Chapter 10: Price Determination

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The Nature of Profit

 The main objective of an entity is to show profit by selling goods or providing
services
o The profit made by an entity is regarded as both compensation for
initiatives from management’s side, and compensation to owners for
the risk taken to invest in the entity
o The profit made can be used to repay the owners of the entity for their
use of the capital, or the profit can be employed in the entity to
generate growth and progress
o Profit is the difference between the amount received for the selling of
goods or the provision of services (income) and the amount paid for
the goods, including all the expenses occurred or the amount spent in
providing the service (expense)

Profit determination of service entities

 A service-providing entity uses its assets, incurs expenses and applies its
skills, abilities and expertise in order to provide a service
 Profit is estimated by comparing the income earned from services provided
with the expenses occurred in the same period
 This can be determined as follows
Income 2 500
Plus: Other Income 500
Less: Expenses (2 000)
Profit 1 000

Profit determination of trading entities

 Trading entities purchase goods in order to sell them at a profit
 The objective is to sell the inventory of the entity at the highest price, ASAP
o The difference between the return of sales and the cost price of goods
sold is the gross profit
 GP = Sales Returns – Value of Goods Sold
o Other expenses, such as trade expenses, will reduce the gross profit
o The balance of the profit and loss account in the ledger indicates the
profit
 Profit of a trading entity is calculated as follows
Sales 3 000
Less: Cost of Sales (1 000)
Equals: Gross Profit 2 000
Plus: Other income 500
Less: Trade expenses (1 500)
Profit 1 000

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Convenience Accounts
 These are accounts created to make reporting easier
Convenience Account Items included in account Purpose of the account
Cost of Sales  Opening Inventory To determine the cost of
 Purchases sales
 Closing inventory
 Other items that
effect cost of
inventory
Trade Account  Sales To determine gross profit
 Cost of Sales
Profit and Loss Account  Gross profit To determine the profit for
 Other operating the period
income and
expenses

Determining Gross Profit

 Gross profit is the profit that results from the entity’s primary operations prior
to allowing for any other income and expenses
 Example:
Sales 15 000
Cost of Sales (11 2250)
Gross Profits 3 750

 Gross profit is determined separately as it is an indication of the performance

of the trading entity regarding its primary operation: selling goods at a profit
 Gross profit is normally expressed as a percentage of either the sales price
(SP) or the cost price (CP)
o Normally an entity aims for a predetermined gross profit percentage
and includes this in the entity’s budget
 The budgeted gross profit percentage is one of the factors that
has to be taken into account when determining the sales price of
the entity’s goods
o The actual gross profit is determined periodically and compared to the
budgeted gross profit percentage
 The following play a role in determining the actual gross profit and will often
explain the differences between the budgeted and actual gross profit
o Actual sales prices and discount allowed
o Actual purchase price and discounts received
o Loss of goods
o Accuracy of stock trading and measurement of inventory

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Example 1
 Two different types of gross profit percentages can be estimated
1. Gross profit as a percentage on sales price
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 3 750
 = = 25%
𝑆𝑎𝑙𝑒𝑠 15 000
2. Gross profit as a percentage on cost price
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 3 750
 = = 33,33%
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 11 250
Example 2
 Gross profit is consistently realised at 20% on cost price and sales for the
year amounts to R90 000
 CP + GP = SP, therefore:
 100 + 20 = 120
1. Calculate cost of sales
𝐶𝑜𝑠𝑡 𝑃𝑟𝑖𝑐𝑒 100
 𝑆𝑎𝑙𝑒𝑠 𝑥 = 90 000 𝑥 = R75 000
𝑆𝑎𝑙𝑒𝑠 𝑝𝑟𝑖𝑐𝑒𝑒 120

2. Calculate the gross profit

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 20
 𝑆𝑎𝑙𝑒𝑠 𝑥 = 90 000 𝑥 = R15 000
𝑆𝑎𝑙𝑒𝑠 𝑝𝑟𝑖𝑐𝑒𝑒 120
 For the equation, try to remember “the one you want over the one you have”
Example 3
 Gross profit is consistently realised at 20% on selling price and the sales for
the year amounts to R90 000
 CP + GP = SP, therefore:
 80 + 20 = 100
1. Calculate the cost of sales
𝐶𝑜𝑠𝑡 𝑃𝑟𝑖𝑐𝑒 80
 𝑆𝑎𝑙𝑒𝑠 𝑥 = 90 000 𝑥 = R72 000
𝑆𝑎𝑙𝑒𝑠 𝑝𝑟𝑖𝑐𝑒𝑒 100

2. Calculate the gross profit

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 20
 𝑆𝑎𝑙𝑒𝑠 𝑥 = 90 000 𝑥 = R72 000
𝑆𝑎𝑙𝑒𝑠 𝑝𝑟𝑖𝑐𝑒𝑒 100

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Estimating cost of sales

 In practise it is not always possible for an entity to sell all of its goods in the
same period that the goods have been purchased
 Goods that have been purchased during the year are kept in stock until it is
sold
 By determining the gross profit, only the cost of sold goods (Cost of Sales) is
matched with the sales price of the corresponding goods
 The sales price of the goods is therefore not matched with the cost price of
purchased goods (cost of purchases)
 The cost price of sales is estimated as follows:
Opening Inventory 1 000
Plus: Purchases at cost price (Purchases less purchase returns) 150
Equals: Cost of items available for sale 1 150
Less: Closing Inventory (250)
Equals: Cost of Sales 900

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Financial Accounting 188

Chapter 11: Inventory

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Definition
 Inventory is an asset that
o Is purchased/manufactured to sell at the highest price (trading
inventory)
o Is in the process of production of such sale (work in progress)
o Is in the form of raw materials or supplies to be consumed in the
production process or in the rendering of services (raw material and
consumables)

Recognition
 Primary issue in accounting for inventory is the amount of costs to be
recognised as an asset and to be carried forward until the related revenues
are recognised
 The cost price of opening inventory can be allocated as follows during the
year:
o Recognised as an expense
 Inventory sold (CoS), including inventory losses
 CoS is subtracted from sales to determine gross profit
o Recognised as an asset
 Unsold, unfinished and unused inventory is recognised as a
current asset – closing inventory

Measurement and valuation of the

inventory
 Inventory is measured at the lowest of historical cost price (CP) or net
realisable value (NRV)

1. Cost price
 Sales – Cost price of items sold = Gross Profit
 This includes all costs incurred to bring the inventory to its present location
and condition (ready for sale)
o Location: transport costs
o Condition: cost of raw materials, direct labour costs
 Abnormal amounts of inventory losses or write-downs, storage charges,
admin cost and sales cost are not included in the cost price of inventory
 Free on Board Location means that all costs incurred before it left that
location are not included in the cost price

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2. Net-realisable value (NRV)

 The estimated selling price, less the estimated cost of completion and the
estimated cost necessary to make the sale
o NRV = SP – Trade Discount – Advertising costs
 If CP < NRV, inventory is left at CP since CP is lower
 If CP > NRV, decrease inventory from CP to NRV
o The asset (inventory) must not be shown as too high as this can result
in a loss
o The amount going from CP to NRV will be written off as CoS
 Cost of inventory may not be recoverable if
o They become wholly or partially obsolete
o If their selling has declined
o Estimated costs of completion or the costs to be incurred to make the
sale have increased
 Inventory is written down as it is viewed that assets should not be carried at
an amount that is in excess of the amount expected to be realised from their
sale or use
o Inventory shouldn’t be marked at a price above what can be expected
to make from their sale
Example
 A company purchases and bottles water to sell on a profit
 Costs per water bottle

 Therefore, the cost of a bottle of water = R1,90

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 Let’s say that 10 000 bottles are close to their expiration date and need to be
sold ASAP
o They will be sold at 40% trade discount, 20c will be spent of advertising
costs and 50c will be spent on other costs both per bottle
o The bottles are also normally sold at CP plus 30% (R2,47 per bottle,
therefore:

 The write-down of inventory to NRV will be recorded as follows:

o Total CoS – NRV = X
o 19 000 – 7 820 = x
o X = R11 180
Dt Cost of Sales 11 180
Cr Inventory 11 180
 In the above example, Total CoS was worked out by multiplying 10 000
(quantity) with R1,90 (CP per water bottle)

3. Physical inventory count

 At the end of the financial year a physical inventory count is performed to
determine the quantity of the inventory on hand (closing inventory)
o Enterprises often have regular counts throughout the year (perpetual)
 Goods must only be included if the business holds the right ownership of the
goods OR the enterprise has an obligation to pay for the goods

Inventory Systems
 An inventory system handles a large quantity of inventory and shows the
movement of these items
 It indicates the number of items on hand, the price per unit, the value of
inventory on hand and the inventory sold

1. Periodic inventory system

 Physical inventory count is only done at the end of the year
 Physical inventory numbers are used as the closing inventory balance

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 Cost of Sales is calculated as follows:

 This is done when the product is not easily individually identifiable

 Cost of inventory does not justify the cost to individually account for each
transaction
 The disadvantage of this system is that there is no mechanism for controlling
of the inventory
 Closing entries for the periodic system:
o Purchase returns (PR) and discount received (income) CLOSED OFF
TO purchases (expense account)
o Purchases CLOSED OFF TO CoS (expense account) (debit side of
CoS)
o Other expenses, opening inventory and closing inventory CLOSED
OFF TO Cost of Sales
 These are technically not closed off as they go on the debit side
of CoS, and CoS is closed off on the credit side
o Sales Returns (SR) and Discount allowed (expense) CLOSED OFF TO
Sales (Income account)
o CoS and Sales CLOSED OFF TO Trade account
o Trade account, operating income and operating expenses CLOSED
OFF TO Profit and Loss account
o Profit and Loss account CLOSED OFF TO Equity account (Capital
Account)
 Journal entries are as follows:

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2. Perpetual inventory system

 This is the most effective inventory system
 Inventory records are updated after each purchase and sale of inventory
 Cost price of inventory is always available
 This system is used when
o The product is easily identifiable
o The value of the product justifies the cost to account each transaction
individually
 Physical inventory = inventory records at cost price
 Journal entries are as follows:

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3. Key differences between the systems:

Periodic Perpetual
Purchases of inventory to Purchases Purchases of inventory to Inventory
(Debit) (Debit)
CP of inventory sold (CoS) calculated CP of inventory sold (CoS) calculated
by elimination after every sales transaction and sales
Op. Inv. + Purchases + Costs – return
Abnormal losses – Closing Inv. = CoS Debit: CoS and Credit: Inv. – Sales
Debit: Inv. And Credit: CoS – SR
Balance on inventory account does not Balance on inventory account always
equal physical inventory on hand, equals physical inventory on hand
except on the first and last day

4. Cost formulas
 A method to allocate the cost of all purchases between inventories on hand at
the end of the financial period (asset) and the inventories sold during the year
(expense)
 For different types of product, different methods are used:

4.1 Specific identification

 Easily identifiable goods
 The actual cost price of the good is allocated
 Specific cost price is linked to a specific unit over the course of time

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4.2 First-In-First-Out (FIFO) method

 Not easily identifiable product
o Trading stock
 The assumption is that inventory purchased first will also be sold first

4.3 Weighted average

 CP is recalculated after each new purchase or on a regular basis
 Used for consumable goods
 Average cost = total cost of units on the present date / total quantity of units

 Inventory is measures at the lowest of CP or NRV

 Perpetual: CoS is calculated as the event occurs
 Periodic: All purchases are added together and all sales are added together,
then CoS is calculated at the end

4.4 Retail method

 Used by smaller entities where inventories include large quantities of small
items with a high turnover, that all have the same profit margin
 The inventory count indicates the inventory at sales price
 CP is calculated by applying the gross profit percentage on the SP
o Inventory that has been marked down must be taken into consideration
 How to use:
o Whatever the margin is on is equated to 100
o SP is always higher than CP, therefore the margin plus the CP is equal
to the SP

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 Example:

5. Standard Cost Method

 For manufacturing businesses (used to calculate value of inventory)
 Standard costs are determined for each input necessary to manufacture the
item
 These costs are updated during the year if needed
 All purchases during the year are then recorded in the records at these prices
 If the goods are purchased at a price higher than the standard cost, then:
o Debit Purchases (at standard price)
o Debit Variance Account (difference between purchase and standard
price)
o Credit Bank (the money decreasing)
 At the end of the year, inventories on hand are valued by multiplying the
number of units left over the standard cost per unit
o If the standard price is more or less close to the cost price, then the
standard cost can be used to value inventory
 CoS is calculated by multiplying the number of units sold by the standard cost
 The Variance Account is written off in the Income Statement against Cost of
Sales in order to calculate the actual cost of sales

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FIFO and Weighted Average systems

under periodic and perpetual systems
Date Transaction Type Unit Price # of units Total amount
1st March Opening balance 50 100 5 000
5th Purchase 51 20 1 020
10th Purchase 52 30 1 560
12th Sale ? 15 ?
18th Purchase 55 50 2 750
25th Sales ? 100 ?

1. Perpetual
1.1 FIFO
Inventory
1st March Op. Inv. (100 x 50) 5 000 12th Cost of Sales 750
(15 x 50)
5th Purchases (20 x 51) 1 020 25th Cost of Sales 5 015
(85 x 50)
10th Purchases (30 x 52) 1 560
18th Purchases (50 x 55) 2 750 Balance c/f 4 565
10 330 10 330
Balance b/d 4 565

 Cost of Sales = 750 + 5 015 = 5 765

1.2 Weighted Average

Inventory
1st March Op. Inv. 5 000 12th Cost of Sales 758
(see next pg.)
5th Purchases 1 020 25th Cost of Sales 5 147
(see next pg.)
10th Purchases 1 560
18th Purchases 2 750 Balance c/f 4 398
10 330 10 330
Balance b/d 4 398

 Cost of sales = 758 + 5 174 = 5 932

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 Calculation of 12th March CoS:

(5000 + 1020 + 150) / 150 = 50.53
50.53 x 15 = 758
 Calculation of 25th March CoS:
(50.53 x 135) + 2750 = 9 572
9 572 / (135 + 50) = 51.74

2. Perpetual
 Closing inventory includes 85 units
Opening Inventory 100
Purchases 20
Purchases 20
Sales (15)
Purchases 50
Sales (100)
Closing balance 85

2.1 FIFO
 Closing inventory is inventory that has been purchased last
 85 closing inventory units
o 50 @ R55 (18th) = R2 750 [Last purchase]
th
o 30 @ R52 (10 ) = R1 560 [2nd last purchase]
o 5 @ R51 (5th) = R255 [Remaining inventory]
o Closing inventory = R4 565
 CoS = Opening Inventory + Purchases – Closing Inventory
 CoS = 5 000 + 5 330 – 4 565
 CoS = 5 765
 If the FIFO method is used, the values for the closing inventory and CoS is
the same regardless if perpetual or periodic systems are used

2.2 Weighted Average

 Unit price = R51.65
o Calculation: (5 000 + 1 020 + 1 560 + 2 750) / (100 + 20 + 30 + 50)
 Closing Inventory = R4 390.25
o Calculation: 80 x 51.65
 Cost of Sales = Opening Inventory + Purchases – Closing Inventory
 Cost of Sales = 5 000 + 5 330 – 4 390.25
 Cost of Sales = 5 939.75
 In the case of weighted average, the Cost of Sales amount will differ between
periodic and perpetual

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Inventory losses and Insurance Claims

 Abnormal losses and losses incurred that don’t form part of the entity’s normal
business activities
o Losses due to fires, floods or natural disasters
 These are regarded as an irregular expense and therefore doesn’t form part
of Cost of Sales
 Business can take out insurance to protect themselves against these
expenses
 Formula to calculate the value of an insurance claim:
𝑆𝑢𝑚 𝐼𝑛𝑠𝑢𝑟𝑒𝑑
𝐼𝑛𝑠𝑢𝑟𝑎𝑛𝑐𝑒 = × 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑑𝑒𝑠𝑡𝑟𝑜𝑦𝑒𝑑
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑎𝑡 𝑡𝑖𝑚𝑒 𝑜𝑓 𝑙𝑜𝑠𝑠

 At times, the value of the inventory is unknown

o The amount of the loss can be calculated by drawing up an estimated
trade account for the period from when the last final accounts were
drawn up
o The following steps must be followed
1. By making an estimation of the gross profit figure, cost of sales
can be calculated (Sales – GP)
2. Estimated closing stock can be calculated (Op. Inv. +
Purchases – CoS)
3. If all closing stock is lost, the full estimated closing stock is the
amount that can be claimed from the insurance company
4. If certain stock is not damaged, the undamaged stock is
subtracted from the estimated closing stock to calculate the
inventory loss

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Financial Accounting 188

Chapter 12: PPE

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Introduction
 Asset: A resource that is controlled by the entity as a result of events in the
past and from which economic benefits will flow to the entity
 Current asset: asset that will be sold or used within 12 months
 Non-current asset: used for longer than 12 months in order to generate
income
Tangible Assets Intangible Assets Financial Assets
Property Goodwill Investments
 Land & Buildings Computer software
Plant Patents
 Machinery & Trademark & Copyright
Production lines
Equipment (generic)
 Office equipment
 Computer equip.
 Motor vehicles
 Furniture

Cost Price and Depreciable Amount

 Depreciable amount: the cost price of an asset less residual amount
 Cost price: The cost price plus any direct costs incurred to bring the asset in
working condition for its intended use (ready for sale)
o Includes improvements (since it will add economic benefits)
o Excludes repairs (since this is an expense)
 Residual value: This is the amount expected at the sale/trade-in of the asset
at the end of its useful life, AFTER deduction of estimated sale and selling
costs
 All costs that are incurred after the item is ready for its intended use (ready for
sale) are seen as expenses and therefore do NOT form part of the Cost Price
 The carrying amount is the cost price of an asset minus the accumulated
depreciation

Depreciation & accumulated depreciation

 Depreciation is the decrease in the value of an asset over its useful lifetime
o It is the apportionment of the depreciable amount of an depreciable
asset over its estimated useful life
o Depreciation is written off from the date the asset is ready to use
o Depreciation will only cease once the asset is derecognised OR if the
asset can no longer be used to generate income
 Depreciation will NOT cease if the item is just lying around and
not being used

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 Depreciation is an expense and is therefore debited

 At the same time, accumulated depreciation (since it is a negative asset) is
credited
Dt. Depreciation
Cr. Accumulated depreciation

1. Straight line method

 The Residual Value is taken into account
 Depreciation is written off as a fixed amount based on a fixed percentage of
the depreciable amount
Depreciation = (Cost price – residual value) x Depreciation Percentage x Months/12
 Example: CP = 13 000; Rate = 20%; RV = 3 000, Time = 30 months
o Year 1: (13 000 – 3 000) x 20% x 12/12 = 2 000
o Year 2: (13 000 – 3 000) x 20% x 12/12 = 2 000
o Year 3: (13 000 – 3 000) x 20% x 6/12 = 1 000

2. Diminishing balance method

 Depreciation is calculated on the carrying amount of the asset, at a fixed
percentage from the date ready to use
Depreciation = (CP – Acc. Depreciation) x Depreciation Percentage x Months/12
 Example: CP = 10 000; Rate = 20%, Time = 3 years
o Year 1: Depreciation= 10 000 x 20% = 2 000
o Year 2: Depreciation = (10 000 – 2 000) x 20% = 1 600
o Year 3: Depreciation = (10 000 – 2 000 – 1 600) x 20% = 1 280

3. Production unit method

 When purchasing certain assets, their expected economic life will be based
on the number of production units that can be manufactured by the asset
(budgeted total production units)
 The depreciation percentage is calculated by taking the total number of units
manufactured in the year as a percentage of the total budgeted units
o This percentage is multiplied by the depreciable amount to determine
the depreciation
 When the asset has only been used for part of the year, depreciation is NOT
apportioned
 This method is the exception to the standard that depreciation must be written
off from the date that the asset is ready for use
 No depreciation is written off if asset is not used
 Example: CP = R53 000, RV = R3 000, Total budgeted = 100 000 units
o Year 1: 10 000 manufactured: 10k/100 000 x (53 000 – 3 000) = 5 000
o Year 2: 15 000 manufactured: 15k/100 000 x (53 000 – 3 000) = 7 500
o When 100 000 units in total have been produced, then the asset will be
written off

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 Example: Depreciation in ledger accounts

 Information:
o CP of vehicles on July 2016 = R600 000
o Vehicles purchases on 30 June 2017 = R150 000
o Accumulated depreciation on 1 July 2016 = R240 000
o Depreciation = R10 000 per month
a) Show the appropriate ledger accounts closed on 30 June 2017
Vehicles
01/07/16 Balance b/d 600 000 30/06/17 Balance c/f 750 000
30/06/17 PJ 150 000
750 000 750 000
01/07/17 Balance b/d 750 000

Depreciation
30/06/17 Acc. Depr. 120 000 30/06/17 Profit & Loss 120 000

Accumulated Depreciation
30/06/17 Balance c/f 360 000 01/07/16 Balance b/d 240 000
30/06/17 Depreciation 120 000
360 000 360 000
01/07/17 Balance b/d 360 000

b) Show the disclosure in the balance sheet on June 2017

Balance sheet on 30 June 2017
PPE
Vehicles at CP 750 000
Less: Accumulated Depreciation (360 000)
Carrying amount 390 000

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Fixed asset register

 Used to record information on all the different assets, regarding depreciation
 Serves as the individual ledger account for each asset with corresponding
control accounts in the general ledger
o The control accounts will include all amounts recorded in the fixed
asset register, but only the combined totals
 Example:
Description Date CP RV Depr. Depr. Yr. 1 Yr. 2
purchased Method Amount
Machine A 01/04/17 500k - PU 5% 500k 5 000 7 000
Machine B 01/06/18 100k 10k DB 10% 90k 9 000 8 100
Furniture A 01/03/19 100k - SL 20% 100k 20 000 20 000

 Administrative detail of each individual asset plus information regarding

transactions related to these assets
 It is updated after each transaction or event regarding each individual asset
and corresponding control accounts adjusted with totals

Derecognition of PPE
 The carrying amount of PPE is derecognised:
o On disposal (when the asset is sold)
o When no further economic benefits are expected from its use or
disposal
 When it doesn’t meet the definition of an asset anymore

1. Sale or trade-in of PPE

 When PPE is sold, the CP and accumulated depreciation of the asset must be
taken out of the accounting records
 Profit: When the asset is sold for more than its carrying value
 Loss: When the asset is sold for less than the carrying amount
 Realisation account: Used to compare the proceeds of a sale/trade-in of the
asset with its carrying value to calculate the profit/loss
 Steps when derecognising PPE
o Write depreciation off on the assets up to the date of sale/trade-in
 Dt Depreciation
 Cr Accumulated depreciation
o Transfer the CP of the asset to the realisation account
 Dt Realisation
 Cr Asset at CP
o Transfer the accumulated depreciation of the asset to the realisation
account
 Dt Accumulated Depreciation
 Cr Realisation
o Record the proceeds of the sale/trade-in in the realisation account

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 Dt Bank/Debtors
 Cr Realisation
o Close off the realisation account and transfer the profit or loss to the
P/L Account on sale of PPE
o Take the information relating to the assets out of the fixed asset
register
 Example:
o CP of vehicles on 1 July 2006: R60 000
o Accumulated depreciation on 1 July 2006: R24 000
o Depreciation: 20% Straight Line
o A vehicle with a CP of R15 000 and a carrying amount of R9 000 on 1
July 2006 was sold on 1 April 2007 for R7 500 cash

Depreciation = (15 000) x 20% x 9/12

Depreciation = R2 250
Carrying amount = CP – Accumulated Depreciation
9 000 = 15 000 – Accumulated Depreciation
Accumulated Depreciation = R6 000
Carrying amount – Depreciation = 9 000 – 2250 = 6 750
6 750 < 7 500, therefore made a R750 profit on the sale of the vehicle

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Compensation received from insurer

 If an asset is destroyed, damaged or stolen and an insurance claim is
instituted against the insurer, the asset will be derecognised
 The compensation received from the insurer is recognised as a separate
income item in the Income Statement and a separate ledger account is
opened
o The compensation received is therefore not accounted for as proceeds
in the realisation account and the carrying amount of the asset is
written off as a loss in the realisation account
 Only when compensation is receivable from the insurer will a debtor be
created and the amount be recognised in the Profit & Loss Account for the
year
 Recognise compensation from the insurer:
Dt Debtor
Cr Compensation from Insurer
 On the day the cash is received
Dt Bank
Cr Debtor

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Financial Accounting 188

Chapter 13: Adjustments and Closing

Procedures

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Adjustments of Ledger Accounts

 Transactions are recorded during the year in the financial records as they
occur and payments have been made and received
 At the end of the financial period, the transactions must be faithful
representations of the financial position of the entity
 Adjustments of income statement items at the end of the financial year is
necessary to comply with the accrual basis
 The most common adjustments are as follows:

1. Bad Debt
1.1 Adjustment of debtors
 Bad debt written off:
o Bad debts are specific debtor that are written off as proof exists that the
debtors, most likely, will not be able to pay their debts
o Various steps can be taken before debtors are written off
 Various accounts are sent to the client
 Client will be contacted and requested to settle their account
 Debt collector can attempt to collect money on behalf of the
entity
 Attorney can be appointed to collect the debt
o When the debtor is written off, an adjustment will have to be made in
the debtors’ ledger
o Bad debt is written off continuously throughout the year, irrespective of
the steps followed

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 The bad debt is written off in the Income Statement and the debtors will
decrease
o The debtors control account and debtors’ ledger will also decrease

 Bad debts recouped/recovered

o Occurs when the debt that is originally written off as bad debt is
collected later on
o However, the debtor is non-existent as it has already been written-off,
therefore the entry will not affect debtors
Two possibilities exist:
o Debts that have been written off as bad debt in the current year and
are collected in the same year
 It was written off as an expense in the income statement,
therefore collecting the debt will decrease the expense
 Dt Bank
 Cr Bad Debts Written Off
o Debts that have been written off as bad debt in the previous year and
are collected in the same year
 As it can’t be offset against the previous year’s bad debt, the
debt recovered is recognised as an income
 Dt Bank
 Cr Bad Debts Recovered/Recouped

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 Later in the same year, the debtor pays a portion and the entity collects
R1 500
Dt Bank 1 500
Cr Bad debts 1 500
o The debtors’ control account and the debtors ledger are not affected as
the debtor has already been written off
o The expense for bad debt is now R8 500 (10 000 – 1 500)
 The following year, the debtor pays out a portion and the entity collects
R1 500
Dt Bank 1 500
Cr Bad debt recovered 1 500
o The debt recovered will be an income in the Income Statement

2. Allowance for credit losses of debtors

 Debtors that are not written off must be tested for impairment if there is doubt
whether you will recover some of the debt from them
 The basis for the impairment is only an estimate, however, it is not random
o All debtors are reviewed and all doubtful ones are identified and an
amount, specifically based on these debtors, is provided
 The accounting entry, even though based on specific debtors, is made
overhead all debtors
 The allowance only indicates a possibility that an account owed will not be
collected and is not written off against any debtor
o Therefore, no entry is made in the debtors ledger
 The allowance for credit losses is deducted from the value of the debtors and
the net amount is presented in the balance sheet
 Allowance is revised annually

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 Example:

 Net movement in allowance for credit losses of debtors is a R1 000 increase

and will be recognised as an expense in the Income Statement
 The total allowance for credit losses of debtors will be netted off against
debtors for disclosure purposes
 Debtors will thus be presented as R104 500 (110 000 – 5 500) in the balance
sheet

3. Accrued expenses
 An expense that is applicable to a specific financial period, but has not been
paid at year end
o Expense is thus in arrear
 Although the expense will be paid in the next financial period, it is accrued in
the current period and must be recognised in the current period as a current
liability
Example:
 Year end – 31 Jan 2016
 Telephone per month = R850
 Telephone account regarding the telephone cost for December 2016 has not
been received at end of year
o R850 is outstanding
 At year end, the expense and the current liability, which will be paid in
January 2017, must be recognised:
Dt Telephone cost 850
Cr Accrued expense 850
 The telephone cost for 12 months, which is applicable in the current period,
has now been recognised

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 If the telephone costs for December 2016 is received in January 2017 and a
payment is made, it is recorded as:
Dt Accrued expense 850
Cr Bank 850

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4. Prepaid expense
 An expense paid in the current period, but is only applicable to a future
financial period
 Expense applicable to following period must be classified as a current asset at
year end
Example:
 Annual insurance premiums of R12 000 paid on 1 April 2017
o Only R9 000 of the current expense is applicable in the current period
 The R3 000 of the expense, applicable to 2018, will be reclassified as a
current asset:
Dt Prepaid expense 3 000
Cr Insurance 3 000
 In January 2008, the prepaid expense will be written back to ensure that the
R3 000 regarding insurance is recognised in the applicable period
Dt Insurance 3 000
Cr Prepaid expense 3 000

6. Income receivable/Accrued income

 Income received in the current period is only accrued in the following period
(services/products are not yet delivered)
 Income is applicable to following period must be classified as a current liability
in the current year at year end
Example:
 Year-end = 31st December 2007
 Rent is received and recorded at the beginning of the month
 Monthly rent amounts to R4 500
 On 28th December 2007, as receipt was issued for rent received of R4 500
regarding January 2008
o This means that rent for 13 months have been recorded (R58 000),
when only 12 months were due (R54 000)
o The R4 500 is applicable to 2008
Dt Rent Received 4 500
Cr Income in advance 4 500
 In January 2008, the income received in advance will be written back to
ensure that the R4 500 rent income is recognised in the applicable period
Dt Income in advance 4 500
Cr Rent received 4 500

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7. Consumable inventory on hand

 Expenses are incurred during the year for consumable inventory
 Some may be unused and available for the future period
 The portion of the expense regarding consumable inventory that will be used
in the future period must be reclassified as consumable inventory at year-end
Example
 Year-end = 31st December 2017
 During the year, cleaning materials amounting to R750 was purchased and
recorded as an expense
o Only R600 of the materials were used in the current period
Dt Consumable Inventory 150
Cr Cleaning materials 150
 In January 2018, the consumable inventory will be written back as follows to
ensure that the expense regarding stationary is recognised in the period of
use
Dt Cleaning materials 150
Cr Consumable inventory 150

8. Suspense accounts
 When the accountant is unsure of one of the elements of the transaction, the
element will be posted to a suspense account until the certainty is cleared up
 Once the uncertainty has been cleared up, the suspense account is closed off
with a General Journal entry

The Closing Procedure

 At the end of the financial period, the ledger accounts concerning Income
Statement items are merged into convenience accounts to calculate profit/loss
as well as an increase or decrease in equity as well
 Most general convenience accounts:
o Cost of Sales
o Trade Account
o Profit and Loss Account

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1. Purchases

 Purchase returns and discount received have credit balances

o To close them off, they are debited and moved to the credit side of the
Purchases account (which is an expense account)
o The difference between the credit and debit side of the purchases is
closed off to Cost of Sales

Sales

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 Both Sales Returns and Discount Allowed have net debit balances, so their
accounts are credited to close them off
o The debit is weighed against the credit side to work out what must be
closed off to the Trade Account

Cost of Sales:

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 The balance at the beginning of the year is on the debit side

o The opening balance is then closed off to Cost of Sales
o Once all transactions have occurred, the final inventory is on the credit
side and closed off to Cost of Sales
o The balance for the next year is on the debit side

 All debit entries are recorded on the debit side of Cost of Sales, which are
weighed against the closing inventory
o The difference between the two is taken to the trade account (credit
balance)

Trade account:

 Sales and Cost of Sales are compared to one another to determine whether a
profit or loss was made
o If a profit is made, the trade account will be closed off on the debit side
and the credit side of the Trade Account will be added to
o If a loss occurred, the account will be closed off on the credit side and
the debit side of the Profit and Loss account will be added to

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Profit and Loss

 Operating income
o All income has a credit balance, so it is closed off on the debit side and
put back on the credit side in the profit and loss account
o Things like “income received in advance” and “income receivable” will
be weighed against the income before it is transferred
 Operating expenses
o All expenses have a net debit balance, so it is closed off on the credit
side and put back on the debit side of the Profit and Loss account
o Things like consumable inventory, prepaid expenses, and accrued
expenses are weighed against expenses before being put into the
Profit and Loss account

 All expenses are on the debit side and all incomes are on the credit side
o If the credit side is larger, a profit has been made and the balance will
be on the debit side
o If a loss has been made, the debit side will be larger and the balance
will be on the credit side
o The balance for the following year will be put on the side that was
bigger

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Compiling Income Statements and

Balance Sheet
1. Income statement

 The income statement consists of all things related to the movement of money
o Sales minus Cost of Sales gives the Gross Income for the business
o Adding income and subtracting all other expenses gives the net profit
for the year

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2. Balance sheet

3. Closing off: Periodic inventory system

 Step 1
o Purchase returns and Discount received = Purchases (Credit)
o Sales returns and Discount Allowed = Sales (Debit)
 Step 2
o Purchases = Cost of Sales (Debit)
o Other expenses = Cost of Sales (Debit)
o Opening and closing inventory = Cost of Sales
 Step 3
o Cost of Sales = Trade Account (Debit)
o Sales = Trade Account (Credit)

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 Step 4
o Trade account = Profit and Loss account
o Operating income and expenses = Profit and Loss account
 Step 5
o Profit and Loss = Capital
o Capital contributions/withdrawals = Capital

4. Closing off: Perpetual inventory system

 Step 1
o Purchase returns = Inventory (Credit)
o Sales returns = Sales (Debit)
o Discount allowed = Sales (Debit)
 Step 2
o Discount received = Cost of Sales (Credit)
 Step 3
o Cost of Sales = Trade Account (Debit)
o Sales = Trade Account (Credit)
 Step 4
o Trade account = Profit and Loss account
o Operating income and expenses = Profit and Loss account
 Step 5
o Profit and Loss = Capital
o Capital contributions/withdrawals = Capital

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Financial Accounting 188

Chapter 14: Correction of error

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The Nature of Accounting Errors

 The financial statements of an entity must be a faithful representation of an
entity’s financial position
 Entities will design internal control measures to minimise errors

Identifying accounting errors

 Review the amounts in the trial balance
 Review the entity’s internal sources (trial balance and control accounts)
 Review the entity’s external sources (creditors and banks monthly
statements)
 General errors include
o Summation errors
o Incorrect cross casting
o Transposition errors
o Incorrect recording
o Omission of events

Internal sources
1. Trial balance
 A list of all the balances in the accounts in the general ledger
 If the trial balance does not balance it may indicate:
o The debit and credit sides are not in agreement
o Summation/transposition errors
o Incorrect posting from journals to the ledger
o Balance of ledger accounts are incorrectly calculated or recorded
incorrectly in the trial balance
Example
 Totals
o Debit: 90 047
o Credit: 89 036

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No. Details Debit Credit

3 Wages 25
4 Interest received 31
5 Bank account 36
Debtors’ control 36
6 Bad debts recovered 191
7 Bank account 300
8 Discount received 209
9 Discount allowed 63

2. Control accounts
 Convenience accounts like the debtors’ and creditors’ control accounts are
opened in the general ledger to support internal control
 The control accounts involve the total of the entries in the individual debtor’s
and creditor’s ledgers
 The control account is therefore a duplicate of the individual accounts
 General errors
o Source documents incorrectly recorded in the journals
o Summation/transposition errors
o Incorrect posting
o Balances calculated incorrectly

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 Correction steps
o The debtors’ and creditors’ control accounts will be corrected with the
appropriate amount
o The correction will be recorded in the general journal with a complete
narration
o Update the debtors and creditors lists with the appropriate corrections
Question 14.2
 The following ledger accounts appeared in the ledger of Cosmo traders:

 Look in the green file for the additional info

 Additional info that only has info about the credit/debit side of a creditor or
debtor and not the reason for the difference will not appear in the
supplementary ledger, but will appear in the supplementary debtors and
creditors lists
 Part A is on the next page

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Part B

External sources
 The process of comparing an entity’s records with external sources from third
parties such as creditor monthly statements and bank statements

1. Creditor monthly statement

 Creditors are involved in every transaction that occurs on credit, examples are
o Purchase of goods
o Cancellation of a purchases
o Interest levied by a creditor on outstanding amounts
o Payment of the creditor
o Cash discount received from creditors
 Entries in the creditor’s books will be mirror images
 If the entry is on behalf of the entity = recorded in the creditor’s ledger account
 If the error is on behalf of the creditor = recorded in the settlement statement
 Steps
1. Check if previous month’s corrections were made on the monthly
statement
2. Recalculate the balance of the monthly statement
3. Recalculate the balance of the creditor’s ledger accounts
4. Correct obvious errors on the monthly statement + Creditors ledger
account
5. Compare monthly statement + Creditors ledger account for errors and
omissions
6. Correct errors from additional information
7. Reconcile closing balances
8. Subtract cash discount of payment was made within specific period

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Example of creditor statement versus entity’s records

 Information:
o Entity purchased goods worth R5 000 from the supplier
o Entity returns damaged goods to the value of R500 to the entity
o Entity pays a portion of the outstanding debt to the value of R3 000 to
the supplier and receives a R300 discount
o Supplier levies interest of R150 on outstanding debt
 Accounting records of the entity:

 Accounting statement:

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Question 14.3
 Sampo Cycles purchases products from Vastrap Ltd. on the following basis
o Trade discount of 25% on all purchases
o A cash discount of 10% is allowed on all payments received within a
month after the end of the month during which the particular purchase
was made
o Interest of 1% is levied on all payments received after more than one
month after the end of the month during which the particular purchase
was made
 Sampo received the following monthly statement on 17 July from Vastrap Ltd.

o Adding up the credit side and subtracting it from the debit side shows
that the credit side is larger by 10 = therefore it must be subtracted
o Credit note 26 is incorrectly shown on the debit side, it must be added
to the credit side twice in order to correct this mistake
 The ledger account for Vastrap Ltd. in the creditors’ ledger of Sampo Cycles
for June 2005 was as follows:

 Green highlight – wrong side

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 Blue highlight – different from monthly statement

 Yellow highlight – has not been put on other ledger/statement
 Credit minus debit = 1 139, therefore R40 larger than the balance given so the
credit side must increase by R40

 You are required to:

o Compile a supplementary ledger account for Vastrap Ltd. for June
2005 in the records of Sampo Cycles to rectify the account (commence
with balance of R1 099)

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o Prepare settlement statement to Vastrap Ltd. showing the amount that

Sampo Cycles will pay on 31 July 2005 in respect of the amount due
on 30th June 2005 (Commence with balance of R1 445)

o Any amount that will result in the entity (Sampo Cycles) owning the
creditor (Vastrap Ltd.) less will be deducted from the settlement
statement
o Only amounts that have not yet been recorded, or incorrectly recorded,
will appear on the statement
Balance 1 157
Less: 10% Cash discount (115.70)
Amount payable 1 041.30

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2. Bank statements
 The relationship between the bank and the entity
o Entity deposits money at the bank
o Bank makes payments on behalf of the entity
o Customers of the entity make deposits directly into the entity’s bank
account
o Bank provides credit facilities
o Entity earns interest on amounts due by the bank
o Bank levies interest on amounts due by the entity
o Bank levies bank charges, commissions, fees for services rendered
 Bank statement is same as creditors statement, a mirror image if the entity
 The bank statement and the entity’s records will usually be different though
 Reasons
o Time
 Outstanding cheques
 Still needs to come off of bank account/must be deducted
from bank recon. Statement
 Outstanding deposits
 Still needs to be added to the bank account/must be
added to the bank recon. statement
o Information not yet known to the entity
 Charges for services
 Interest received/levied
 Unpaid cheques
 Stop orders/debit orders
 Direct payments made or received
o Errors made by the entity
 Steps
1. Check the bank statement – ensure that the previous month’s errors
have been corrected
2. Check bank statement for errors
3. Compare own records with bank statement – mark the differences
4. Make the necessary entries in the bank ledger account and calculate
the new bank balance
5. Compile the bank reconciliation statement
6. Inform the bank of any errors
 Rules
o Error in own records – make corrections in bank account
o Information unknown – make correction in bank account
o Error on bank statement – make correction on bank recon statement
o Time difference – make correction on bank recon statement
 Any money going into the entity’s bank account = Debit on bank statement +
credit on entity’s own records
o Opening balance (if positive)
o Deposits
o Interest earned

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o Other receipts such as capital deposits or direct payments from a

debtor
 Any money leaving the entity’s bank account = Credit on bank statement +
Debit on the entity’s records
o Opening balance (if negative)
o Cheque payments
o Debit orders
o Stop orders
o Interest paid
o Bank charges
o Other payments such as capital withdrawals or EFTs of
creditors/expenses
Question 14.4

o Outstanding cheques and incorrect deposits must be deducted from the

statement, whilst outstanding deposits must be added

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o Unreconciled difference is not added at all to the statement

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 Anything highlighted in blue will affect the bank recon statement

 Anything highlighted in green will affect the bank account
 Anything not highlighted will either affect both, or just adds necessary info

You are required to:

 Prepare the correct bank reconciliation statement on 28th February 2003

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 Prepare the bank account in the general ledger that will show all the entries
for the month ended 31 March 2003

 Prepare the bank recon statement for 31st March 2003

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Financial Accounting 188

Chapter 15: Partnerships

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Definition and Characteristics

 Legal relationship between two or more people
 Each owner must make a contribution to the partnership
 It is not a separate legal entity which means that it doesn’t pay income tax
 Assets are jointly owned by all of the partners
 Liabilities are shared jointly and separately

Advantages
 Simple to establish or dissolve
 Changes in owner composition or capital structure can be introduced by
mutual agreement
 A larger capital amount can jointly be brought together by partners
 Technical competency and knowledge can be used to partners’ advantages
 Collective decision making can decrease risk

Disadvantage
 Partners are jointly and separately liable for obligations/liabilities
 The continuity of the partnership as a going concern is directly dependent on
the personal relationships and life expectancy of the partners
 Transferability of ownership is limited
 Conduct of one partner has power to bind the relationship

Partnership agreement
 Can be in writing or verbally communicated
 The following must be addressed:
o Rights and obligations of each partner
o Contributions
o Management
o Profit sharing
o How to dissolve
o Insurance policies
o Procedure when partner retires/dies
o Procedure when partnership dissolves

Accounting for Partnerships

1. Capital Accounts
 The funds invested by the owner of an entity is shown in the capital account
 The balance of this account represents the interest of the owner in the entity
 In a partnership, a capital account for each of the partners needs to be
opened
 Capital contributions can be in the form of cash or other assets

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 Contributions as capital usually stay in the entity permanently

o Contribution = Dt Cash / Cr Capital
o Withdrawal = Dt Capital / Credit Cash
 The capital accounts remain unchanged unless partners contribute or
withdraw during the year
 Capital accounts will always have a credit balance
 Capital is shown as equity in the partnership’s balance sheet
Contributions in the form of cash:

Contributions in the form of assets:

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2. Current accounts
 All transactions excluding capital contributions, capital withdrawals, loans and
advances which the partner incurred with the partnership are recorded in the
current account
 It includes funds invested by the owner on a short term basis
 Like capital, it is grouped with equity in the balance sheet
 What’s included?
o Profit shares of partners
o Salaries and bonuses paid to partners
o Withdrawals by partners
o Interest on capital and current accounts granted to partners
o Interest on withdrawals charged from partners
 The current account can have either a credit or a debit balance
o Credit balance = the amount due to the partner by the partnership
 The partner’s withdrawals have been less than the total of his
profit share + any salary/bonus they received
o Debit balance = the amount due to the partnership by the partner
 The partner’s withdrawals have exceeded the total of his profit
share + any salary/bonus they received
 Current accounts are shown as equity in the partnerships balance sheet
Withdrawals
 The following withdrawals can be made
o Capital withdrawals
 Dt Capital
 Cr Bank
o Cash withdrawals
 Dt Withdrawals
 Cr Bank

 Dt Current account
 Withdrawals

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o Withdrawals of goods at cash price (Periodic)

 Dt Withdrawals
 Cr Cost of Sales

 Dt Current Account
 Cr Withdrawals
o Withdrawals of goods at Cost Price
 Dt Withdrawals
 Cr Inventory

 Dt Current account
 Cr Withdrawals
Loans and advances
 When a loan/advance is made by a partner to the partnership in their own
capacity, they are regarded as a creditor and does not form part of the
partner’s capital contribution
o This is because over a specific period and at a specific interest rate the
loan is repayable, whereas capital contributions are not
o The interest repayable is regarded as an expense to the partnership,
not distribution of profit
 The loan/advance can be turned into capital at a later date
Distribution of profits
 Net profit is calculated in the same way as in a sole proprietor, but in a sole
proprietor profit is transferred to the capital account
 In a partnership, profit is transferred to the distribution account
 Profit is distributed according to the partnership agreement
o If there is no formal agreement, profit is distributed in relation to long
term capital
 Profit and losses are distributed after the interest on capital, interest on
current accounts, and interest on withdrawals have been taken into account
 How it is distributed
o Either in a fixed ratio (5:3)
o Or in relation to long term capital
 Any form of distribution of profits, even those traditionally classified as
expenses must be treated as distribution of profits and not as an expense in
the process of calculating profit
 Payments to partners can be expenses such as an interest on the loan and
salaries to partners
Process
 Profit is calculated in P&L account
 Closed off to distribution account
 Final distribution to partners depends on the distribution account and the
current account

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 Withdrawals/interest on loans
o Cr Distribution account
o Dt Current account
 At the end of the year, the withdrawal and distribution accounts are closed off
to the current accounts of the partners
 In a current account
o Withdrawal > Profit = Current Account Debit Balance
o Withdrawal < Profit = Current Account Credit Balance
Example:

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Goodwill
 Non-current asset
 Assets pits the entity into a position to generate more income than they
normally would
 It is not reflected in the financial statement since it has not been paid for
 When a business is purchases or a new partner is brought in, it is then shown
in financial statements as it was purchases at a certain price
o Only bought goodwill is shown in financial statements
 In partnerships, goodwill is valued as the part of the partnership that will be
used to determine the purchase price when the new partner is admitted
 How the value of the old partnership is determined before the new partner is
admitted:
o Dt Goodwill
o Cr Capital A (old profit sharing ratio)
o Cr Capital B (old profit sharing ratio)
 The journal entry to write back the goodwill if it should not be shown in the
new partnership’s records (after the admittance of a new partner)
o Dt Capital A
o Dt Capital B
o Dt Capital C
o Cr Goodwill

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 A new partner can also bring goodwill in with them

o In this case, the value of the goodwill should be agreed upon, and it will
be debited together with the other assets which are brought in, with a
credit to the partner’s current account
Reserves
 An entity’s goal is to grow and improve performance
o To expand, the entity needs additional capital
 There are multiple ways capital can be obtained
o The partners can contribute more capital
o Money can be borrowed from a third party or partner
o Reserves can provide finance
 There are two types of reserves
o General reserve
 Profits are not distributed, but kept in equity as a reserve, which
can be used later to finance expansion or can be distributed to
partners to increase their capital
 This generally occurs with a change in capital structure
 Journal entry
 Dt Distribution account
 Cr General reserve
o Unrealised profits
 With a change in the capital structure of a partnership, all assets
of a partnership are revalued to determine the actual value of
the partnership
 The unrealised profits/losses that result from the revaluation of
the assets are distributed to the capital accounts of the partners,
in accordance to their old profit sharing ratios
 Journal entry for unrealised profits
 Dt Assets
 Cr Capital A
 Cr Capital B
 Unrealised profits will be the opposite

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Financial Statements of a Partnership

 Income statement same as a sole proprietor
 The balance sheet is the same, except for the composition of equity
 The partnership has a statement of changes in equity, which includes the
distribution account
Example
 Information regarding AB Traders for year ending 30 June 2007

 Depreciation of R100 000 must still be written off for the year ending 30 June
2007
 A and B distribute profits and losses in the ratio 3:2
 B is entitled to a salary of R50 000, no entry has been made in respect of the
salary
 Interest on capital is 5% and interest on current accounts is 10%, both p.a.
 Interest on withdrawals:
o A: R920 + B: R580

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Current Account A
01/07/06 Balance 50 000 Interest on Cap 7 500
30/06/07 Interest on CA 5 000 Prof Share 35 700
Withdrawals 15 000
Interest on W 920 Balance b/f 27 720
70 920 70 920
Balance b/f 27 720

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Balance sheet of AB Traders

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Change in Owner Composition

 Capital structure can be changed by mutual agreement
 Possible because the partnership is not a separate legal entity
o It is, however, a separate accounting entity
 Only the interest of the remaining/new partners will change with the
admittance, retirement, or death of a partner
 When a change is made, the existing partnership is dissolved and the new
partnership is formed, taking over the assets/liabilities as a going concern
Steps:

 Assets minus liabilities = book value of the partnership = net assets

 The right to share in profits extends to unrealised profits
o An example would be to buy an asset for R10 000 and you can sell it
for R25 000
 The R15 000 is unrealised profit because the asset has not
been sold yet
Admittance of a new partner
 As soon as a new partner has been admitted, the old partnership does not
legally exist anymore
 The partnership is still in existence as a going concern though
 It is necessary to do the entries to give the effect to the change in capital
structure with the admittance of the new partner

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 There are two ways a new partner can be admitted

o The direct purchase of the interest on one or more partners
 Dt Capital A (Partner selling)
 Cr Capital B (New partner)
 When a partner is admitted in this way, no entry in the asset and
liability accounts of the partnership is necessary
 An adjustment must be made to the capital accounts

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o Acquisition of interest by contributing to the capital of the

partnership
 If a new partner brings cash and/or other assets into the
partnership
 Dt Assets
 Cr New partner’s capital account
 The actual value of the partnership should be calculated
 The assets should be revalued to calculate unrealised
profits/losses
 Where goodwill is involved, it must first be determined and
credited to the “old” partners in the “old” profit sharing ratio as
the intangible asset forms part of their capital in the entity
 The three steps of admittance must thus be followed

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Question 15.3
 A and B are partners in an enterprise and share profits and losses in the ratio
3:2
 The following balances appeared in the ledger of the enterprise on 31st
December 2001:
Capital/Current Account for A: 40 000
Capital/Current Account for B: 30 000
General reserve: 5 000
Fixed Property 75 000
 C was allowed to join the enterprise on 1st Jan 2002 on the following
conditions
o C will share in 20% of the profits/losses, while A and B will continue to
share in the ratio 3:2
o The fixed property will be valued at R100 000 for the purposes of C’s
entry as a partner and must be shown at that amount in the records of
the partnership
o C must pay an amount of R35 000 into the bank account of the
enterprise on that date, which will represent 25% of the interest in the
net assets of the enterprise

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o The general reserve and goodwill must not be shown in the records of
the partnership
 You are required to:
o Calculate the new profit sharing ratio

o Show the capital/current accounts for the partners, in column format,

for the period 31 December 2001 to just after C joins as partner

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Retirement/death of a partner
 At the retirement/death of a partner, the accounting procedure is basically the
same as in the case of the admittance of a partner
 The partner’s interest in the equity is valuated and if goodwill is present, it is
credited to the partners’ capital accounts
 The interest of the retiring or late partner must be compensated to him in one
way or another agreed way
 If it is not paid out in cash, it will be transferred to a loan account and paid
back according to the agreement
 The remaining partners’ profit sharing ratios stays in the same mutual ratio as
it was before the death/retirement of a partners agree on another profit
sharing ratio
Example 15.8

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Example 15.9

Simultaneous retirement of an old partner and entry of a new one

 At simultaneous retirement and admission of partners, the accounting
procedure stays the same as at the single retirement or single admission
o But is preferable to first process the old partner’s matters separately
and then to make the entries for the new partnership

Treatment of policies
 If a partner dies, the remaining partners may have cash flow problems as they
will have to pay the dead partner’s capital account to his estate
 Partners thus take out policies on their own lives and cede it to the other
partners, so that cash is available for the remaining partners
 Important concepts
o Joint life policy
 Taken out on the lives of all the partners
 One policy is jointly taken out on the lives of all the partners and
if one of them dies, the policy is paid out
 Only one premium is paid as there is only one policy
o Separate life policies
 Taken out on the life of each of the partners
 Each partner has their own policy and a separate premium is
paid on each of the partners’ policies
o Pay-out/endowment value
 Amount that the insurer pays out at the death of a partner to the
deceased partner's estate
 It is the value that the deceased partner’s estate will increase by
o Surrender value
 Amount that the insurer pays out if a policy is cancelled before
the death of a partner
 It is equal to: Total premiums + Interest earned – Admin costs
 When a partner dies, this is the value that the remaining
partners’ policies will increase by
o Carrying amount
 If premiums are treated as expense: carrying value of policy
account is zero
 If premiums are treated as an asset: carrying amount of policy
account is the total of all the premiums paid up to date

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o Premium
 Yearly/monthly payment for the policy
 Can be treated as an expense or an asset
 Premiums are paid by the partnership

1. Treatment of premiums as an expense

 Premiums will be treated as normal expenses and will annually be written off
to profits
 The expense will appear on the Income statement
o Dt Premium expense
o Cr Bank/Creditors
 With any changes in partners, the policies (and other assets) will have to be
revalued by bringing in the value of the policies into the books of the partners
o Dt Policy Assets (one for each partner)
o Cr Capital accounts (of the old profit sharing ratio)
 Policies will increase by the full amount of the endowment or surrender
values
 If a partner died, the value of their policy must be taken out of the books as
the policy has already, or will soon be, paid out and does not exist anymore
o Dt Bank/Insurance debtor
o Cr Policy Asset (of the late partner)
 The remaining partner’s policy assets can be affected in one of three ways
o Keep at surrender value
 Nothing has to be done as the policies are already shown at
surrender values
o Shown at carrying value or original value
 Assets must be taken out of the books as the policies are
treated as an expense again and the carrying amount is equal to
zero
o Policy assets should be treated as an asset
 The policy assets should be revalued with the difference
between the surrender value and the premiums paid to date

2. Treatment as an expense
 Premiums are debited to a policy asset account annually and the premiums
don’t decrease the net profits of the partners
o Dt Policy Assets
o Cr Bank/Debtors
 Policies will increase by the surrender value or endowment value, minus
the current value of the policy asset
 Therefore, a policy asset can be revalued downward if the surrender value is
less than the current value of the policy asset
 Upward revaluation
o Dt Policy Assets
o Cr Capital Accounts of partners (old profit sharing ratio)

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 Downward valuation
o Dt Capital Accounts of partners (old profit sharing ratio)
o Cr Policy Assets
 If a partner died, the value of their policy asset must be taken out of the policy
asset account since the policy has already been paid out and does not exist
anymore
o Dt Bank/Insurance debtor
o Cr Policy Asset
 The remaining partners’ policy accounts can be affected in one of three ways:
o Policies to be shown at surrender value
 Nothing should be done as they are already shown at surrender
value
o Policies to be shown at carrying amount in the books or original
value
 The assets will be revalued at the original carrying amount in the
books
o Policy assets should be shown as an expense
 Assets should be revalued from the surrender value to zero

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Financial Accounting 188

Chapter 16: Companies

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Characteristics
 Differs from other entities because a company is a separate legal entity
o This means that it can continue to exist separately from its
shareholders
o It has ownership of its own assets and is liable for its own liabilities
 The number of shareholders can range between 1 – unlimited
 It has an indefinite existence
 Ownership is transferable without any changes to the capital structure of the
company
 Natural persons, trusts, and other entities can be shareholders

1. Advantages
 Separate legal entity
 Exists independent of its shareholders
 Shareholders have limited liability in respect of the company’s actions
 Easy to change ownership by selling shares
 Company tax rate (28%) is lower than the tax return of a natural person

2. Disadvantages
 Separation between ownership and management may be problematic
 Comprehensive regulations
 Complex to create or dissolve

Foundation of a company
 A company originates when a notice of incorporation, together with the fees
and a copy of the memorandum of incorporation is filled at the Companies
and Intellectual Properties Commission (CIPC)
 The commission will then
o Approve the company’s name
o Allocate a registration number and register the company as a legal
person
o Endorse Notice of Incorporation & Memorandum of Incorporation
o Issue a registration certificate
 Costs incurred during foundation include
o Printing and stationary
o Professional fees for the preparation and submission of the company
documents
 Foundation costs incurred are written-off against equity
o Dt Retained earnings
o Cr Bank/Creditor

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Managing a company
 The shareholders elect directors to manage the company on their behalf
 The company must be managed in accordance with
o The Companies Act
o The Memorandum of Incorporation (MoI)
o Additional rules as determined by the board
 At the annual general meeting
o Presentation of the directors’ report, audited financial statement, and
report of the audit committee
o Election of directors
o Appointment of auditor and audit committee
o Any matters raised by shareholders

Types of Companies

 Companies without share capital

o Are not established for gain, an example would be welfare
organisations
o Do not obtain capital by investment of shareholders, but finance their
capital through foreign capital
 Companies with share capital

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Share capital
 The capital of a company originates when investors are invited by means of a
prospectus to apply to purchase shares of a company
 Foreign capital can also be used to finance a company
 Shares are allocated to successful investors, known as shareholders
 The interest of each investor is represented by the amount of shares he holds
in the company
 A shareholder’s shares grant the following rights
o To vote on the annual general meeting of the company
o To information of the company
o To share in profits distributed by means of dividends
o To share in the final distribution of net assets at liquidation of a
company
 Shares:
o Authorised = the maximum number of share capital according to the
MoI
o Issued = the actual number of shares issued
o The difference between the two is the reserve capital
Classification of shares
 There are two different types (preference and ordinary)
o Different rights are attached to each
o A company can only issue a type, class and number of shares that
have been authorised in the MoI
 Preference shares
o Preference rights on dividends (profits) above ordinary shareholders if
profits are distributed
o The amount of dividend is calculated according to a fixed price per
share
 It also takes into account the time that the share has been held
 Cumulative vs non-cumulative
o Redeemable preference shares can be repurchased and redeemed
in a way and at a price predetermined by the company
o Convertible preference shares have rights with regard to conversion
of ordinary shares
o Profit sharing preference shares are entitled to a fixed percentage as
well as a portion of the remaining reserves as dividends
 Ordinary shares
o Right to have a minimum of one vote
o Rights to receive a dividend (if declared)
 Is calculated as a fixed amount per share without allowing for
the term the share was held
o Only distributed after preference dividends have been paid or provided
 Share value = the number of shares x price per share

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Issue of shares
 The board of directors of a company can pass a resolution to issue unissued
shares, as long as it has been authorised in the MoI
 The costs incurred in the issuing of the new shares will be written-off against
retained earnings
o Dt Retained Earnings
o Cr Bank/Creditor
 Public company
o Shares will be presented with a prospectus
o Investors can analyse investment opportunities
o An application form will be attached to the prospectus
 Private company
o Potential investors are approached in person
o No prospectus or application form
o Private agreement between the company and investor
Example 16.1
 Recording of the issue of shares
o 50 000 ordinary shares offered to the public
o R2.20 per share
o Applications for 60 000 shares were received
 Step 1 – application for the 60 000 shares
o Interested investors return the application form with the cheque
payment directly to the company’s attorneys
o These cheques are deposited into the company’s bank account, known
as the Trust account
o Because no shares have been issued, the company has a liability
toward these interested investors, known as the application account
Dt Trust Account 138 000 (60k x 2.30)
Cr Application Account 138 000
 Step 2 – 50 000 shares allocated
o Management compare the number of shares offered for sales and the
number of shares applied for
o Shares are then allocated to successful investors and payment for
these shares are transferred from the trust account into the company’s
bank account
Dt Bank 115 000 (50k x 2.30)
Cr Trust Account 115 000

Dt Application Account 115 000

Cr Ordinary share account 115 000

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 Step 3 – refunding of successful applications

o Money is refunded to unsuccessful investors, if any, from the trust
account
o If applications received exceed the amount offered for the sale, the
share issue is said to be oversubscribed
o If fewer subscriptions are received than were offered for sale, the share
issue is said to be undersubscribed
Dt Application Account 23 000 (138k - 115k)
Cr Ordinary share capital 23 000

Reserves
 Reserves form part of the equity of the company
 Includes profits not yet distributed to shareholders
 Reserves may be raised out of realised and unrealised profits
o Realised profits – generated through past transactions
o Unrealised profits – generated when a valuation is done
 Realised and unrealised profits are available for distribution

1. Retained earnings
 Created from realised and unrealised profits/losses
 It is the profit arising from a past event
 These profits are not distributed as dividends in the current year, but held in
reserve from which future dividends may be declared
 Available for distribution at any time
 Profit for the year is calculated in the Profit and Loss Account, which is then
closed off to the retained earnings account
o Dt Profit and Loss Account
o Cr Retained Earnings
 Retained earnings are distributed in the following order:
1. Transfer to other reserves (not in FinAcc 188)
2. Dividends to preference shareholders (if declared)
3. Dividends to ordinary shareholders (if declared)
4. Foundation and share issue cost also closed-off to retained earnings

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2. Other reserves
 Other reserves created from realised and unrealised profits
 These reserves are also available for distribution
 A reserve that was created from unrealised profits should adhere to certain
liquidity and solvency requirements, as set out in the Companies Act, before
the reserves can be distributed
 Example
o The property was revalued during the year and the value was
increased with R25 000
o Journal entry:
 Dt Fixed property 25 000
 Cr Revaluation reserve 25 000

Dividends
 The portion of profits paid out to the shareholders
 They are only due/owed when they are declared by the board of directors
o Therefore there is no obligation before they are announced for the
company to pay
 No accounting entry is made in the current year for dividends declared after
year end

1. Requirements with declaration and payment of dividends

 The dividend must be authorised by the board of the director
 The company must satisfy and liquidity tests immediately after distribution
o Solvency: Fair value asset > Fair value liabilities
o Liquidity: pay debts in ordinary course of business
 Ordinary dividends may only be declared if provision has been made for
current and arrears dividends on cumulative and non-cumulative preference
share
 Date of dividend declaration
o Dt Dividends
o Cr Dividends payable
 Date of dividend payment
o Dt Dividends payable
o Cr Bank
 Closing-off of the dividend account to retained earnings
o Dt Retained earnings
o Cr Dividends

2. Ordinary dividends
 Expressed as a fixed amount per share
 Term for which the shares are held is not taken into account
 Each ordinary shareholder receives an amount equal to the fixed dividend per
share multiplied by the number of shares they own

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 Journal entry
o Declared
 Dt Ordinary dividends xxx
 Cr Dividends payable xxx
o On date of release
 Dt Dividends payable xxx
 Cr Bank xxx

3. Preference dividend
 Preference shares are normally calculated according to a fixed amount per
share
 The term for which the shares were held are taken into account when
calculating the preference dividend
o The term of cumulative preference dividend stretches from the last date
of dividend declaration to the date of the new declaration
o The right to the cumulative preference dividend does not expire every
accounting date
 Example:

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4. Non-cumulative (cannot be more than one year)

 Calculate on date of declaration
 Term stretches from the start of the financial period or last declaration
 The right expires every accounting date

Income tax of companies

 A company is a legal entity and thus taxable in terms of the Income Tax Act
 Income tax is an expense
 Tax expense is closed off to the Profit & Loss Account
 Tax is calculated at 28% of net profit
 Tax is calculated after net profit is calculated, net profit serves as the basis
o Taxable income is not necessarily the same as profit before tax
 The actual tax payable for the tax year is not known until the profit and taxable
income are calculated at financial year end, the company estimates what the
actual tax will be and starts paying SARS at 6 month intervals
o First payments: 6 months after the beginning of the financial year
o Second payment: last day of the financial year
 These payments are generally never exactly what is owned, so these
payments will decrease bank and are recognised as prepayments to SARS
o Dt SARS/Income tax expense
o Cr Bank
 At the end of the financial year, the tax estimate is recognised as an expense,
and a corresponding liability to SARS is recognised
o Dt Income tax expense
o Cr SARS/Income tax payable

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 Example:

1. Under- and over-provision

 At the end of the financial year, the company will submit tax returns to SARS
 SARS recalculates tax and sends the assessment back to the company
 The company must check if its final obligation is equal to their estimate
 Let’s say a company paid R28 000 provisional
o If only R25 000 is required, then too much tax is provided
 Therefore it is an overprovision
 Dt SARS 3 000
 Cr Income tax expense 3 000
o If R30 000 was needed, then too little tax was paid
 Therefore is was an under provision
 Dt Income tax expense 2 000
 Cr SARS 2 000
 If the company takes too long to repay their debt, then they will be fined:
o Dt Fines/Interest xxx
o Cr SARS xxx

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Financial Accounting 188

Chapter 17: Financial statements of

Companies

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Accounting Policy
 All financial statements are prepared in accordance with the International
Financial Reporting Standards (IFRS)
 The financial statements are prepared on the historical cost basis, except for
o Certain PPE is recorded at revaluated amounts
o Financial assets are measured at fair value
 IT IS EXTREMELY IMPORTANT TO KNOW THE LAYOUT OF THE NOTES
ON EACH OF THE FOLLOWING TOPICS
o IT WILL BE ASKED IN THE EXAM, EITHER THE FIRST OR THE
SECOND OPPORTUNITY

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Notes to the Statement of Financial

Position

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PPE
 Initially recognised at cost price
 Land is subsequently measured at re-valued amounts
 All other PPE is measured at carrying value
 Gains or losses upon revaluation of PPE are recognised in Other
Comprehensive Income and accumulated in the Revaluation Reserve in
the Statement of Changes in Equity
 Land is never depreciated
 Depreciation of vehicles is written-off according to the straight line method
 Depreciation of equipment is written-off as x% per year according to the
diminishing balance method
 Asset’s residual values are reviewed, and adjusted if needed
 Gains and losses on disposal are recognised a part of Profit and Loss in the
Statement of Comprehensive Income (SCI)
 The note will be as follows:
Property Plant Equipment Total
Gross Carrying amount (CP) 80 000 58 500 42 500 181 000
Accumulated Depreciation - (10 500) (7 500) (18 000)
Carrying amount @ start of 80 000 48 000 35 000 163 000
year
Additions - 24 500 20 000 44 500
Revaluations 20 000 - - 20 000
Improvements 5 000 - - 5 000
Depreciation - (7 500) (5 000) (12 500)
Disposals - (15 000) (10 000) (25 000)
Carrying amount @ end of 105 000 50 000 40 000 195 000
year
Gross carrying amount (CP) 105 000 65 000 50 000 220 000
Accumulated depreciation - (15 000) (10 000) (25 000)

Investment in subsidiaries
 A company is considered a subsidiary if another company owns more than
50% of the company’s shares
 Investments in subsidiaries are shown at cost price
 The note will be as follows
Company name Nature of Place of business % shareholding Amount
business
ABC Ltd. Trade Gauteng 70 55 000
XYZ Ltd. Service Cape Town 55 40 000
LT Loan to ABC 5 000
100 000

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Financial assets
 Financial assets are initially recorded at fair value
 Any adjustments to fair value are shown as part of Profit and Loss in the SCI
 The note will look as follows
Listed shares
X ordinary shares in Yuppie Ltd. 30 000
Unlisted shares
XX preference shares in Lela Ltd. 15 000
45 000

Inventory
 Inventory is measured at the lowest of cost price or NRV
 Cost price is calculated with the FIFO or weighted average method
 Any write-down to NRV is recognised in the Profit and Loss
 The note for inventory is set out below:
Inventory on hand consists of
- Finished goods (@ NRV) 15 200
- Raw materials 5 000
- Work-in-progress 7 000
- Consumer goods 800
28 000

Share capital
 The note will include be as follows:
Authorised R
- XXX ordinary shares
- XXX cumulative shares
Issued
- XXX ordinary shares 40 000
- XXX cumulative shares 33 000
73 000
Reconciliation of amount of shares Ordinary shares Cumulative pref.
Balance – beginning xxx Xxx
Issued xxx Xx
Redeemed (xxx)
Converted Xxx
Balance - end xxx xxx

Other reserves
 Just list the type of reserve and the description of necessary

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Long-term loans
 An example of the note will look as follows:
Secured
 10% mortgage loan 50 000
Unsecured
 Bank loan 10 000
60 000
Less: Short-term portion shown under current liabilities (5 000)
55 000

Notes to the Statement of Profit or Loss

and Other Comprehensive Income
Note R
Revenue 9 550 000
Cost of Sales (137 500)
Gross profit 412 500
Other income 7 000
Other expenses (309 500)
Distribution cost (4 750)
Administrative expenses (19 250)
Finance charges (6 500)
Finance income 11 20 500
Profit before tax 10 100 000
Income tax expense 12 (30 000)
Profit for the year 70 000
Other comprehensive income
Profit on revaluation of property 20 000
Other comprehensive income for the year, net of tax 20 000
Total comprehensive income for the year 90 000

Revenue
 Revenue can come from sales, rendering of services, interest, royalties,
dividends and rent income

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Other income and expenses

 The note will look as follows
Income
- Dividends received from subs 1 500
- Profit on disposal of equipment 3 000
- Compensation from insurer from loss of equip. 9 000
- Profit iro fair value adjustment of financial assets 800

Expenses
- Employee benefits (salaries/wages) 6 300
- Loss of sale of asset 1 500
- Depreciation
- plant 7 500
- equipment 5 000
- Operating lease payments
- vehicles 5 750
- computer equipment 8 000
- Director’s remuneration
- for services 33 000
- for other services (salary) 165 000
- Abnormal inventory losses 1 500
- Write-down of inventory to NRV 200

Finance income

Interest from subsidiaries 4 000

Other interest income 16 500
20 500

Income taxation
SA normal tax – current year 28 000
- prior year 2 000
30 000

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Notes for Statement of Changes in Equity

Ordinary Pref. Reval. Retained
Total
SC SC Reserve earnings
Balance @ beginning 25 000 20 000 30 000 137 000 212 000
Ordinary shares issued 15 000 - - - 15 000
Preference shares issued - 13 000 - - 13 000
Total compr. Income for the
- - 20 000 70 000 90 000
year
- PAT - 70 000 70 000
- Other compr income 20 000 20 000
Ordinary dividend (12 000) (12 000)
Preference dividend (4 000) (4 000)
Share issue cost (2 000) (2 000)
Balance @ end 40 000 33 000 50 000 189 000 312 000

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Financial Accounting 188

Chapter 18: Close Corporations

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Statement of net investments

 This will be asked in the exam, again either in the first or the second
opportunity
 This contains the same info as the statement of changes in equity of
companies
 But it includes other items such as
o Loans to and from members
 Members have a choice whether they want to invest in the CC
through loans or through contributions
 They also have the option of withdrawing with interest,
distributions or loans from the CC
 The statement will look as follows
Members’ Retained Loan from Loan to Total
contribution earnings member member
Opening balance xxx xxx xxx (xxx) Xxx
Net Profit Xxx
Distributions (xxx) (xxx)
Contributions made Xxx
Contributions paid (xxx)
Loan from member Xxx Xxx
Loan to member (xxx) (xxx)
Repayment of loan xxx Xxx
Closing balance xxx xxx xxx (xxx) xxx

Note – transactions with members

 An example is as follows:
Transactions with members
Net profit is shown after the following transactions with members have been taken
into account:
Member 1 Member 2 Member 3 Total
Rent Xxx Xxx
Interest paid xxx xxx Xxx
Salaries Xxx Xxx Xxx Xxx
Xxx Xxx Xxx Xxx
Interest
(xxx)
received
xxx xxx xxx Xxx

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Financial Accounting 188

Chapter 19: Value-Added Tax

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The Mechanics of VAT

 VAT is levied at 14% on the majority of goods/services but not money
 VAT payable/refundable = output VAT – input VAT
 Output tax = tax on sales
o This is tax charged by the vendor in respect of delivery
 Input tax = tax on sales
o This is the tax paid by the vendor in respect of delivery
 To calculate the VAT payable if you bought something:
o 14/114 * price
 VAT is levied at each point in the production and distribution channels
Transactions VAT Return VAT Owing to
SARS
1. Manufacturer
Sales 100 Tax on Sales (sales * 14%) 14
VAT 14 (Output tax)
114 Less Tax on Purchases
(Input Tax) (0)
VAT Payable 14 14
2. Wholesaler
Sales 400 Tax on Sales (sales * 14%) 56
VAT 56 (Output tax)
456 Less Tax on Purchases
(Input Tax) (14)
VAT Payable 42 42
3. Retailer
Sales 600 Tax on Sales (sales * 14%) 85
VAT 84 (Output tax)
684 Less Tax on Purchases
(Input Tax) (56)
VAT Payable 28 28
4. Shop
Sales 850 Tax on Sales (sales * 14%) 119
VAT 119 (Output tax)
969 Less Tax on Purchases
(Input Tax) (84)
VAT Payable 35 35
119

 Therefore, the output tax for the previous member is the input tax for the
current member
 The numbers and transactions of the illustration above can be found on pages
5 – 6, but this is arbitrary

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Accounting treatment
Purchases
 The total purchase price (with VAT) is recorded in the total column of the PJ
o The purchase price (minus VAT) goes to the asset/expense column
o VAT then goes to the VAT column
 Journal entry for purchases:
Dt Expense/Asset with purchase price 100
Dt VAT-control 14
Cr Creditors’ control 114
 For knowing when to multiply with 14% or with 14/114
o If you have the price, multiply with 14/114
o If you have the net price (without VAT), multiply with 14%
 Journal entry for purchase returns transactions
Dt Creditors’ control 114
Cr Expense/Asset 100
Cr VAT-control 14
 Journal entry for redemption of a legal claim of creditor
Dt Creditors’ control 114
Cr Bank 114
 Remember, that no VAT is levied on the payment of money to creditors

Sales
 The total sales price, including VAT, is included in the total column
o The sales price (minus VAT) goes into the sales column
o The VAT goes into the VAT column
 Journal entry for sales transactions
Dt Debtors 114
Cr Income with selling price 100
Cr VAT-control 14
 Journal entry for sales returns transactions
Dt Income 100
Dt VAT control 14
Cr Debtors 114

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VAT-control account
 VAT-control has a debit balance, then it is an input tax
o it is a current asset
o VAT is therefore receivable
o We can claim VAT back (refundable)
 If VAT-control has a credit-balance, then it is an output tax
o It is a current liability
o This is VAT that we owe to SARS (payable)

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