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  • 1. UNIVERSITY OF BRISTOL ACCG 11900 INTRODUCTION TO ACCOUNTING A LECTURER: IAN CRAWFORD DEPARTMENT OF ECONOMICS LECTURE HANDOUTS AND EXAMPLES FOR AUTUMN AND SPRING TERMS 2003 AND 2004 1
  • 2. COURSE OUTLINE: Week Topic INTRODUCTION TO FINANCIAL ACCOUNTING 1 Background, introduction to the main financial statements 2 The three main financial statements 3 More on balance sheets and profit and loss accounts 4 More on cash flow statements 5 Accruals and prepayments, depreciation and sale of fixed assets, bad and doubtful debts 6 Incomplete records re debtors and creditors and cost of sales, introduction to trial balances and double entry 7 More on double entry, and more incomplete records 8 Test 9 Working capital management, bank reconciliations 10 Ratio analysis CHRISTMAS HOLIDAY 1 PROGRESS TEST 2 Tackling exam-style questions Attendance at the progress test in the first lecture of the spring term is compulsory – students failing to attend without provision of a medical note risk losing credit points for the course. The test is important as the material in Unit A is cumulative and it is vital that you revise as you go along. It is also regarded as an official progress test by many departments. Attendance at your weekly tutorials is also compulsory – your tutor is the best person to help you if you encounter difficulties. If you fail to attend a tutorial you must explain your absence to the economics department information office 1C4 (email econ- info@bristol.ac.uk, tel. 0117 928 8415). Tutorial exercises and appropriate reading for the course are detailed in the question pack. 2
  • 3. HEALTH WARNING I expect you to read (and abide by) the grey paragraph on the previous page regarding attendance requirements, especially at tutorials and the progress test. No-one is exempt from these requirements, not even civil engineers working on projects. I expect you to do your best to arrive at the lecture theatre on time. Arriving 5 minutes late on a regular basis will get you noticed! If you ever have trouble reading overhead slides, I expect you to put your hand up and tell me at the time, and/or sit nearer the front of the lecture theatre. I will do my best to ensure all lecture material is clearly legible. Please remember to bring your lecture handouts with you! I expect you to keep an eye on the economics department notice boards and my web pages for additional information about the course (this can be found at http://staff.bath.ac.uk/mnsipc/). Your tutorial groups will be notified to you via lists to be placed on the notice boards in D block of social sciences. Tutorials normally take place in E and F block, also in social sciences. Students sometimes complain about the amount of work this course involves. As it is a 20 credit point course, you can expect to spend 1/6th of your time working on this course. Based on a 40 hour working week, this would be almost 7 hours including the lecture and tutorial. This course is not designed specifically for first years and it is not an ‘easy ride’. Second, third and fourth years will also be taking this course and it may count towards their final degree classification. The level of the course is therefore set to take that into account, but don’t worry if you are not a mathematician or an engineer - it does also recognise that some students come from a non-mathematical background. You just need grade A mathematics at GCSE level (or equivalent). This is a 20 credit point course using the 12-12-6 system. There are therefore lectures every week of the autumn and spring terms, and for the first 4 weeks of the summer term, although where possible the lectures in the summer term will be revision lectures. There are exercises set every week which are important for you to do not only to receive credit points, but also to master the material (practice is the only way to get to grips with Unit A in particular). You may also need to look things up in either the recommended text, or another introductory level accounting text book. I would strongly advise you to use your tutor’s knowledge should you experience problems, or email me on mnsipc@bath.ac.uk The recommended text book for both units of this course is Accounting and Finance for Non-Specialists, 4th edition, by Atrill and McLaney, Prentice Hall. This course is assessed by is a single 3 hour examination in the summer which covers both Unit A and Unit B. Units A and B are co-requisites - you have to take them both. Past exam papers can be found in the social sciences library at any time, along with copies of the recommended texts (and a selection of alternative texts at a similar level). Past papers and solutions are usually available in the summer term for a small charge to cover photocopying. Finally, I hope you enjoy the course! 3
  • 4. LECTURE 1 ACCOUNTING INFORMATION What does it record and who is it for? Past events Future events External users Internal users Published Budgets Suppliers Managers Financial and Government Employees Statements Forecasts Investors Banks Shareholders Other Lenders FINANCIAL ACCOUNTING (Introduction to Accounting A) • External reporting/users • Legal requirements • Financial information • Produced annually • Past events ACCOUNTS • Paint a picture of a business • Three main statements: • The balance sheet shows the net worth = ASSETS – LIABILITIES ↓ ↓ OWNS OWES • The profit and loss account and cash flow statement explain how changes in the net worth came about, i.e. show (i) Profitability (ii) Liquidity An example of a set of actual company accounts is at the back of the handout 4
  • 5. FUNDAMENTAL ACCOUNTING CONCEPTS • Accruals (matching) • Consistency • Prudence • Going concern • Substance over form WHAT OTHER ‘RULES’ AFFECT ACCOUNTS? Companies: • Accounting Standards / Accountancy bodies • Companies Acts / Company Law • Stock Exchange Requirements • Audit Reports / Judgements Other types of business: • Taxation Requirements 5
  • 6. BUSINESSES Remember that we always account for the assets and transactions of a business separately from the assets and transactions of its owner(s). Three main types of business: • Sole Traders (single owner) • Partnerships (multiple owners) • Companies (single or multiple owners) New business form: • Limited Liability Partnerships (multiple owners) To become a company, must ‘incorporate’. DIFFERENCES DUE TO INCORPORATION • Liability of owners • Taxation differences • Succession and control • Financing opportunities • Costs of compliance and administration 6
  • 7. LECTURE 2 THREE FUNDAMENTAL FINANCIAL STATEMENTS 1. Balance Sheets Show: ‘A snapshot of a business at a point in time.’ The net worth of a business. Assets and liabilities, working capital, owners’ equity, sources of finance. Definitions: Net Worth = Total Assets (‘owned’) – Total Liabilities (‘owed’) Total Assets = Fixed Assets (to be used > 1 year) + Current Assets Total Liabilities = Long-Term Liabilities (to be repaid > 1 year) + Current Liabilities Working Capital = Net Current Assets = Current Assets – Current Liabilities Owners’ Equity = Capital (share capital if company) + Reserves (eg retained profits) The Balance Sheet Equation: Net Worth = Owners’ Equity This equation can be re-arranged or re-written to give us different formats for the balance sheet: Horizontal Format: Total Assets = Total Liabilities + Owners’ Equity Vertical Format #1: Fixed Assets + Working Capital – Long-Term Liabilities = Owners’ Equity Vertical Format #2: Fixed Assets + Working Capital = Long-Term Liabilities + Owners’ Equity 7
  • 8. Pictorial Representation This is a pictorial diagram of a balance sheet. It shows what happens to cash within a business. The area within the dotted line represents working capital (strictly speaking, cash is excluded from the definition of working capital, although ‘working capital’ is often used interchangeably with ‘net current assets’). This is a manufacturing business, so stock consists of raw materials and work-in-progress as well as finished goods. Stock is always valued at total cost for financial reporting purposes. In particular, the value of work-in-progress will include cost of raw materials, manufacturing overheads, and manufacturing labour. We will revisit stock costing in Unit B management accounting. CAPITAL SOURCES FROM WHICH CAPITAL HAS BEEN OBTAINED CASH FIXED DEBTORS ASSETS SA L E S FINISHED GOODS OR CREDITORS MATERIAL INVESTMENT SERVICES OVERHEADS LABOUR AREAS IN WHICH CAPITAL HAS BEEN INVESTED Note that the picture above is just another representation of the balance sheet equation - total cash from all sources of capital = total cash in all areas in which capital has been invested. 8
  • 9. EXAMPLE OF A SIMPLE BALANCE SHEET Bristol Industries : Balance Sheet as at 30.09.01 (Vertical Format #1) FIXED ASSETS £ £ Freehold Premises 50,000 Plant and machinery 20,000 Motor Vehicles 10,000 80,000 INVESTMENTS 24,900 CURRENT ASSETS Stocks 10,000 Trade debtors and prepayments 15,000 Cash 100 25,100 LESS: CURRENT LIABILITIES Trade creditors and accruals 15,000 Bank overdraft 10,000 25,000 NET CURRENT ASSETS 100 LESS: LONG-TERM LIABILITY Loan, secured by mortgage on Freehold Property (20,000) 85,000 REPRESENTING: CAPITAL AND RESERVES Proprietor's capital 50,000 Plus: Retained profits 35,000 85,000 Notes: If this was a company, ‘proprietor’s capital’ would be issued share capital. If this was a sole trader, ‘proprietor’s capital’ would be the owner’s investments in the business. ‘Retained profits’ in the balance sheet are the accumulated retained profits over the business’ life. Businesses may have other reserves, for example ‘share premium’ (if a company issues shares for consideration greater than their nominal value), and ‘revaluation reserve’ (if fixed assets are restated to a higher current value). 9
  • 10. INTRODUCTION TO ACCOUNTING PRO-FORMA ACCOUNTS Invented Ltd Balance Sheet as at X/X/XX (Vertical Format #2) £ £ Fixed assets x Current assets: stock x debtors and prepayments x cash in hand (petty cash) x __ x __ Current liabilities: creditors and accruals x proposed dividend x bank overdraft x tax owed x __ x __ Working capital (net current assets) x __ x __ FINANCED BY: Issued ordinary shares of £x x Reserves (balance b/f + x retained profit for this year from the P&L a/c) x __ x x% unsecured loan stock (= long-term liability) x __ x __ Notes: As this business is a company, it has share capital in the bottom of the balance sheet. Distributions to its owners (the shareholders) are called ‘dividends’ and appear at the bottom of the profit and loss account before arriving at retained profit for the period. If this business was a sole trader or partnership, distributions to its owners are called ‘drawings’ and may appear either as an expense at the bottom of the profit and loss account before arriving at retained profit for the period, or in the bottom of the balance sheet (deducted from ‘net profit’ for the period). See also the set of real company accounts reproduced at the back of the lecture handouts. 10
  • 11. Impact of Different Business Forms: Remember, in vertical format balance sheets the owners’ equity always appears at the bottom of the balance sheet, but this part of the balance sheet looks different depending on the form of the business: Sole Trader: £ £ Capital brought forward (at start of year) (note 1) XXX Add: Net Profit (earned in year) XXX Less: Drawings (note 2) (XXX) XXX Capital carried forward XXX Note 1: In the company’s first year of business, the owner will invest some money (‘capital’) in the business – include this here. Note 2: Drawings are cash or goods taken out of the business, by the owner, for personal use. If drawings are already deducted in the profit and loss account to arrive at ‘retained profit’, then use retained profit instead of net profit and do not deduct drawings here. Partnership: Partner: A B Total £ £ £ Capital brought forward XXX XXX XXX Add: Share of net profit (note 3) XXX XXX XXX Less: Drawings (XXX) (XXX) (XXX) Capital carried forward XXX XXX XXX Note 3: This is determined by the ‘partnership agreement’. Company: £ Issued Share Capital (note 4) Ordinary Shares (note 5) XXX Preference Shares (note 6) XXX Reserves Share Premium (note 7) XXX Profit and Loss Account (retained profits) XXX XXX Note 4: A company may issue any amount of shares up to its authorised limit. Note 5: Ordinary shareholders run the company and share the risk. Note 6: Preference shareholders may have guaranteed annual dividends and, if the company liquidates, will recover their investment before any money is paid out to ordinary shareholders. Note 7: Issued share capital is shown at its ‘nominal value’ – but shares may actually be sold for more than their nominal value when they are first issued. The difference is share premium. 11
  • 12. 2. Profit and Loss Accounts Show: A ‘history book’ or record of transactions over the past accounting period. The profitability of the business (difference between income and expenditure). Prepared on an ‘accruals’ basis (i.e. transactions recorded in the period to which they relate, regardless of the actual timing of the related cash flows). Explain changes in Net Worth from the previous to the current balance sheet. Definitions: Profit = Income - Expenditure Income = Sales Revenue + Other Income (eg interest receivable) Expenditure = Cost of Sales + Expenses (eg administration) Gross Profit = Sales Revenue – Cost of Sales Net Profit = Gross Profit + Other Income – Expenses Retained Profit = Net Profit – Dividends (if company – sometimes deduct drawings here if sole trader) Cost of Sales = Opening Stock + Purchases – Closing Stock (retail business) = Opening Stock + Purchases + Other Manufacturing Costs - Closing Stock (mnfing business) 3. Cash Flow Statements Show: A ‘history book’ or record of cash flows over the past accounting period. The liquidity of the business. Sources and applications of funds. Explain changes in cash from the previous to the current balance sheet. Note: Profit is NOT the same as cash – and cash is NOT the same as profit! Profit and loss accounts are produced on the ‘accruals’ basis: income and expenditure is ‘matched’ to the year it is earned or incurred. We need cash flow statements as well as profit and loss accounts because of the importance of cash to the survival of a business. 12
  • 13. INTRODUCTION TO ACCOUNTING PRO-FORMA ACCOUNTS Invented Ltd Profit and Loss Account for the year to X/X/XX £ £ Sales x } Less: cost of goods sold } opening stocks x } Add: purchases x } ____ } x } the Less: closing stocks (x) } ‘trading ____ } account’ (x) } ____ } Gross profit x } Less: expenses Rents x Wages x Depreciation x Directors' fees x Audit fees x Bank interest x ____ (x) ____ Net profit before finance charges x Interest on (long-term) loan stock (x) ____ Net profit before tax for the year x Tax payable (x) ____ Net profit after tax x Dividends (paid and proposed) (x) } ____ } the Retained profit for the year [≡ change in net worth of x }‘appropriation business] ____ } account’ Note: Remember that these figures have been calculated on an accruals basis, rather than being based on cash flows. This means that we have matched amounts earned against expenses owed, irrespective of whether or not the cash has actually been received or paid. Profit before finance charges is sometimes also called PBIT (profit before interest and tax) and sometimes also called operating profit. Note that bank interest paid on short- term borrowings (i.e. overdrafts) is treated as an ‘operating expense’ whereas interest on long-term borrowings (i.e. loans, debentures, mortgages) is a ‘finance charge’. 13
  • 14. INTRODUCTION TO ACCOUNTING PRO-FORMA ACCOUNTS Invented Ltd Cash Flow Statement for the year to X/X/XX £ £ Reconciliation of Operating Profit to Net Cash Flow from Operating Activities Operating Profit (= PBIT) X Depreciation charges X Profit on disposal of fixed assets (X) Increase in stocks (X) Increase in debtors (X) Increase in creditors X Net Cash Flow from Operating Activities X Cash Flow Statement Returns on Investments and Servicing of Finance Interest Received X Interest Paid (X) X Taxation (X) Capital Expenditure (X) X Equity Dividends Paid (X) X Management of Liquid Resources Purchase of Treasury Bills (X) Sales of Treasury Bills X X Financing Issuing of Ordinary Share Capital X Repurchase of Debenture Loan (X) Expenses Paid in Connection with Share Issues (X) X Increase in Cash X Note: ‘Capital Expenditure’ is expenditure on purchases of fixed assets. Cash received from sales of fixed assets is also included in this total. Note: ‘Taxation’ is tax paid in the year. Note: You do not need to know all the headings for the cash flow statement, but you do need to know what goes into the reconciliation of operating profit to net cash flow from operating activities, and what goes into the cash flow statement itself. 14
  • 15. LECTURE 3 Lecture example 1: Balance Sheets A. A Sole Trader Dr Seatham Rythe set up as a dentist on 1st January last. As of today he has: £ Surgery at cost 2,000 Equipment at cost 985 Cash in Bank 289 Amounts due to creditors 47 Petty cash on hand 4 You are required to arrange this information in a way that will show Dr Rythe's position as clearly as possible. B. A Partnership Fast and Furious started a grocery business on 1 March this year. They agreed to share profits and losses equally and each contributed £1,000 in cash, which was used to buy assets as follows: £ £ Furniture and Fittings 400 Stock 350 Motor van 180 Shop Premises, at cost 1,700 Less: secured loan (700) ______ 1,000 Cash 70 _____ 2,000 _____ Required: Draft a Balance Sheet to show the position of the partnership. C. A Limited Company Cosmetics Ltd is a company dealing wholesale in beauty preparations etc. The following are the balances shown in its ledger at 1 January of this year: £ Ordinary shares of £1 10,000 6% Preference shares of £1 5,000 Buildings 12,300 Stocks of cosmetics 5,040 Debtors 3,026 Creditors 2,900 Bank (overdraft) 1,615 Mortgage on buildings 3,000 Motor Lorry 500 Cash 9 Deposit with building Society 1,640 Required: Prepare a suitable Balance Sheet for the company. 15
  • 16. Lecture example 1: Solutions (A) A sole trader Dr Seatham Rythe - Balance Sheet at today's date Fixed Assets £ £ Surgery - at cost 2,000 Equipment - at cost 985 2,985 Current Assets Cash at bank 289 Petty Cash 4 ------- 293 Less Current Liabilities Creditors (47) Net Current Assets 246 ------- 3,231 Owner’s Equity 3,231 (B) A partnership Fast and Furious - Balance Sheet as at 1st March 2001 Fixed Assets £ £ £ Shop premises - at cost 1,700 Furniture and fittings - at cost 400 Motor van - at cost 180 ------- 2,280 Current Assets Stock - at cost 350 Cash 70 ------- 420 ------- Total Assets 2,700 Less: Long-term Liability Loan (secured on shop premises) (700) ------- 2,000 Fast Furious Total Owners’ Equity 1,000 1,000 2,000 16
  • 17. (C) A limited company Cosmetics Ltd: Balance Sheet as at 1st January 2001 Fixed Assets £ £ Buildings 12,300 Motor lorry 500 -------- 12,800 Current Assets Stocks of cosmetics 5,040 Debtors 3,026 Deposit with Building Society 1,640 Cash 9 ------- 9,715 DEDUCT Current Liabilities Creditors, due within one year (2,900) Bank overdraft (1,615) (4,515) Net Current Assets 5,200 Less: Long-term Liabilities Mortgage loan (secured on buildings) (3,000) 15,000 Capital and Reserves Ordinary shares of £1 each, fully paid 10,000 6% Preference shares of £1 each, fully paid 5,000 ---------- 15,000 NOTE: 1. There are many detailed format and disclosure requirements for company accounts, which will not be studied in this course. These requirements come from the Companies Acts and from Accounting Standards. 2. This particular example is a little artificial in that the net current assets, less long-term liabilities, just match the nominal value of share capital (the actual market value of shares may be different to this). Normally, there would also be a surplus or deficit reserve which would be the accumulated profit or loss attributable to ordinary shareholders. This may be a missing figure which you have to work out. 17
  • 18. Lecture example 2: The Ashton Company The Ashton Company has been manufacturing electrical switch gear for many years. In July 2001 the accountant of the company disappeared and with him disappeared the accounting records. You are approached by the owner of the business and asked to prepare a statement of the business assets and liabilities in the form of a Balance Sheet as at 31st August 2001. By checking with the bank, counting materials on hand, investigating the ownership of buildings and plant, circularising customers, etc., you establish the following information: £ Cash in hand 50 Balance at bank (overdrawn) 350 Stock of raw materials 17,500 Stock of finished goods 10,000 Amounts receivable from customers in respect of credit sales 30,000 Investments quoted on the Stock Exchange 2,500 Freehold Land 20,000 Buildings 35,000 Plant and Machinery 50,000 Bills received from suppliers indicate that £18,000 is owed to trade creditors. A mortgage of £12,500 (secured on the freehold land) is outstanding, and becomes repayable by the company in 2006. Ashton calculates, by referring to his own records, that he put £100,000 into the business as capital. Set out the balance sheet as at 31 August 2001 based on the information shown above. 18
  • 19. Lecture example 2: Suggested solution Balance sheet as at 31 August 2001 FIXED ASSETS £ £ Freehold land 20,000 Buildings 35,000 Plant and machinery 50,000 _______ 105,000 INVESTMENTS 2,500 CURRENT ASSETS Stock: raw material 17,500 finished goods 10,000 Debtors 30,000 Cash in hand 50 _______ 57,550 _______ LESS Current Liabilities Trade Creditors 18,000 Bank Overdraft 350 _______ 18,350 _______ NET CURRENT ASSETS 39,200 LESS: LONG TERM LIABILITIES Mortgage loan (12,500) _________ 134,200 _________ CAPITAL AND RESERVES Proprietor's capital 100,000 Retained profit* 34,200 ________ 134,200 ________ * This item is not supplied in the question but if the information in the question is complete, retained profits £34,200 must be the missing item required to balance the Balance Sheet. You must get used to dealing with ‘incomplete records’ like this. 19
  • 20. How transactions affect the Balance Sheet: an easy example Every business transaction has two effects. We can see how this works as follows: 1. A proprietor subscribes (invests) £1,000 cash to start up a new business. This is shown as follows: JOE SMITH BALANCE SHEET at T0 £ £ Current Assets Cash 1,000 Representing: Proprietor’s capital 1,000 2. £100 of the money is spent on stock. The balance sheet now becomes: JOE SMITH BALANCE SHEET at T1 £ £ Current Assets Stock 100 Cash 900 Net Assets 1,000 Representing: Proprietor’s capital 1,000 3. The stock is sold for £150, giving rise to a profit of £50. We now have: JOE SMITH BALANCE SHEET at T2 £ £ Current Assets Cash 1,050 Representing: Proprietor’s capital 1,000 Retained profits 50 1,050 The net worth of the business has increased to £1,050 as a result of this transaction. 20
  • 21. 4. A further £50 of stock is now bought on credit: JOE SMITH BALANCE SHEET at T3 £ £ Current Assets Stock 50 Cash 1,050 1,100 Current Liabilities Trade creditors 50 Net Current Assets 1,050 Representing: Proprietor’s capital 1,000 Retained profits 50 1,050 5. We can also construct a Profit and Loss Account as follows: £ Sales 150 Cost of Sales 100 Profit 50 This shows how the increase in the net worth of the business over the period in question has arisen, i.e. how much profit has been made and retained (kept) in the business. 21
  • 22. Lecture example 3: The Ashton Company again In the month of September, 2001, the Ashton Company makes the following transactions: £ Cash sales 14,800 Credit sales 35,270 Cash received from customers in respect of credit sales 29,500 Raw materials bought on credit 25,140 Cash paid to suppliers in respect of credit purchases 18,000 Manufacturing labour and overhead paid 20,000 Other non-manufacturing expenses paid 2,690 You also discover that at 30 September 2001, raw materials stocks are valued at £15,000, stocks of finished goods are valued at £11,000, and there are no stocks of work-in-progress. All cash movements go through the bank account. Set out the profit and loss account for the month of September, and show how the balance sheet as at 30 September would now look. Hint: As well as the cost of purchases of raw materials, ‘cost of goods sold’ in the trading account will include the other manufacturing expenses (labour and overhead). 22
  • 23. Lecture example 3: Solution The Ashton Company Profit and Loss Account for September 2001 £ £ Sales (14,800 + 35,270) 50,070 Less: Cost of Goods Sold Opening stock (17,500 + 10,000) 27,500 Purchases 25,140 Manufacturing expenses 20,000 Less: Closing stock (15,000 + 11,000) (26,000) (46,640) Gross Profit 3,430 Other expenses (2,690) Profit 740 The Ashton Company Balance Sheet as at 30 September 2001 £ £ Fixed Assets (no change) 105,000 Investments (no change) 2,500 Current Assets Stock (15,000 + 11,000) 26,000 Debtors (30,000 + 35,270 - 29,500) 35,770 Cash in hand (no change) 50 Cash at bank 3,260 (-350 + 14,800 + 29,500 - 18,000 - 20,000 - 2,690) 65,080 Current Liabilities Creditors (18,000 + 25,140 - 18,000) 25,140 Bank Overdraft - 25,140 Working Capital 39,940 Less: Long-Term Liabilities (no change) (12,500) Net Assets 134,940 Representing: Proprietor’s capital (no change) 100,000 Retained profit (34,200 b/f + 740) 34,940 134,940 Note: it was necessary to work out the new debtors and creditors figures using the old (b/f) figures and the information given in the question. The debtors and creditors figures were missing numbers due to incomplete records. We also had to work out the new cash figure. 23
  • 24. LECTURE 4 HOW TO PREPARE A CASH FLOW STATEMENT Summary balance sheets for a company for two years: 2001 2000 £'000 £'000 CHANGES FIXED ASSETS Cost 3,500 2,850 650 Accumulated depreciation (860) (540) (320) _________________ _________________ 2,640 2,310 CURRENT ASSETS Stocks 450 275 175 Debtors 250 100 150 Cash at bank 58 23 35 CURRENT LIABILITIES Creditors (415) (320) (95) LONG-TERM LIABILITIES Loan (280) – (280) _________________ _________________ 2,703 2,388 _________________ _________________ SHARE CAPITAL 1,900 1,600 300 RETAINED PROFIT 803 788 15 _________________ _________________ 2,703 2,388 _________________ _________________ SIMPLIFIED PROFIT AND LOSS ACCOUNT FOR THE YEAR £'000 Sales 2,255 Less: cost of sales (1,640) Annual depreciation charge (320) Other expenses (250) (2,210) _________________ _________________ Operating profit 45 Less: interest (30) _________________ Retained profit 15 _________________ Note: ‘Depreciation’ is a way of spreading the cost of a fixed asset over its useful economic life (>1 year, by definition of fixed assets). It is an application of the accruals concept. It is not a cash payment – that only happens at the time you buy the asset. We will see how we calculate depreciation next week. Note also that the balance sheet includes the accumulated depreciation (over the life of the asset) whereas the profit and loss account includes only the depreciation charge for the period in question (in this case, a year). 24
  • 25. SIMPLIFIED CASH FLOW STATEMENT FOR 2001 £000 Reconciliation of Operating Profit to Net Cash Flow from Operating Activities operating profit 45 Adjustments for non cash flow items depreciation 320 increase in stocks (175) increase in debtors (150) increase in creditors 95 ________________ Net cash flow from operating activities 135 Returns on investment and servicing of finance Interest paid (30) Capital expenditure purchase of fixed assets (650) Financing issue of new shares 300 new loan 280 580 __________ ________________ Increase in cash at bank 35 ________________ Note: We have added back the annual depreciation charge (from the profit and loss account) in the first part of the cash flow statement. In the balance sheet, depreciation that has accumulated over the life of the assets is deducted from the fixed asset cost to fixed asset net book value. But in the profit and loss account and cash flow statement we are only concerned about the depreciation charge for the period in question. 25
  • 26. Lecture example 4 - Nick’s Newsmart A friend of yours who owns a newsagents and confectionery business has asked for your help. He is very worried because he suspects that a shop assistant is stealing money from his till. He comments as follows: "For the year to 31 March 2001 my shop made a profit of £8,600 yet I have had to ask the bank for an overdraft", then adds "will you check the figures for me please?". You agree to help and he supplies the following information. Nick's Newsmart BALANCE SHEETS AS AT 31 MARCH 2000 2001 £ £ £ £ FIXED ASSETS Premises, at cost 16,000 16,000 Less acc. depreciation 3,600 12,400 3,900 12,100 _________________ _________________ Fixtures & fittings, at cost 3,000 8,200 Less acc. depreciation 1,000 1,300 _________________ _________________ 2,000 6,900 --------- --------- _ 14,400 19,000 CURRENT ASSETS Stocks: magazines, periodicals 5,400 8,060 sweets, tobacco 1,480 3,240 Debtors: trade 2,200 4,900 other 140 420 Bank 6,400 – Cash 280 500 _________________ _________________ 15,900 17,120 _________________ _________________ CURRENT LIABILITIES Creditors: trade 4,200 3,600 other 100 120 Bank overdraft – 4,000 _________________ _________________ 4,300 7,720 _________________ _________________ WORKING CAPITAL 11,600 9,400 --------- --------- NET ASSETS EMPLOYED £26,000 £28,400 --------- --------- Opening capital 24,600 26,000 Add net profit 6,800 8,600 _________________ _________________ 31,400 34,600 Less: drawings (5,400) (6,200) ______ ______ Closing capital £26,000 £28,400 --------- ---------- _ You confirm that he has not disposed of any fixed assets during the year. You are required to prepare a cash flow statement to show Nick where his profit has gone. 26
  • 27. NICK'S NEWSMART : SUGGESTED SOLUTION Cash Flow Statement for the year to 31 March 2001 £ Operating profit from accounts 8,600 Depreciation 600 Increase in stocks (4,420) Increase in debtors (2,980) Decrease in creditors (580) ____________________ Net cash from operating activities 1,220 Returns on investment and servicing of finance Drawings (6,200) Capital expenditure Payments to acquire fixtures and fittings (5,200) ____________________ Decrease in cash and cash equivalents (10,180) ____________________ Note: the depreciation charge for the year is calculated from the change in the accumulated depreciation in the balance sheets. This is easy to do as we are told that there are no disposals of fixed assets. We will see what the impact of disposals of fixed assets on the accumulated depreciation balances is next week, so that we can take account of it, if necessary, in future. 27
  • 28. LECTURE 5 ACCRUALS AND PREPAYMENTS The Balance Sheet sometimes contains ‘accruals’ in current liabilities, and ‘prepayments’ in current assets. This is because of the accruals, or ‘matching’ concept. Example: Bristol Industrial Company Ltd paid its annual buildings insurance of £4,000 on 30 June 2001. On 5th October 2001 it received an electricity bill for £560 for the quarter ended 30 September 2001. If the annual insurance paid on 30 June 2000 was £3,600 and other electricity costs for the year totalled £1,200, what are the amounts for insurance expense and electricity expense that should be included in the Profit and Loss Account for the year ended 30 September 2001? Operating expenses in the P&L: £ insurance (9/12*£2,700 + 3/12*4,000) 3,700 electricity (£1,200 + £560) 1,760 How should this information be reflected in the Balance Sheet as at 30 September 2001? £ Prepayment (current assets) insurance (9/12*4,000) 3,000 Accrual (current liability) electricity 560 OTHER EXAMPLES OF MATCHING ‘Depreciation’ is a way of spreading the cost of a fixed asset over its useful economic life (>1 year, by definition of fixed assets). It is not a cash payment itself – that happens at the time you buy the asset. Depreciation is a measure of the ‘consumption’ of the fixed asset - it matches the cost of using the fixed asset over a particular accounting period, with the benefits gained from using the asset in that period (accruals concept). 28
  • 29. DEPRECIATION Fixed assets are recorded in the balance sheet at ‘net book value’ (NBV), where NBV = cost - accumulated ‘depreciation’. When they are sold, the business makes a profit if the sales proceeds exceed the NBV. • Annual depreciation is charged to the profit and loss account. Two main methods used – ‘straight line’ and ‘reducing balance’. Suppose a lorry costing £40,000 was purchased by Bristol Industrial Company Ltd. The lorry is estimated to have a useful economic life of 4 years, after which it will have a scrap value of £4,000. Calculate the annual depreciation charge to the profit and loss account and the amount of accumulated depreciation for each year of the lorry’s life, under (1) Straight line depreciation; (2) Reducing balance depreciation at the rate of 50%. • Accumulated depreciation is deducted from the fixed asset cost in the balance sheet (to give net book value - NBV). This is the total depreciation charged to date. 29
  • 30. • When a fixed asset is sold we need to calculate the profit or loss on disposal. This is done by comparing the sale proceeds received with the asset's NBV at the date of sale. E.g. an asset was acquired 2 years ago for £100,000. It has an estimated scrap value of £20,000 and an estimated useful economic life of 4 years. Straight-line depreciation is charged for 2 years. Calculate the profit or loss on disposal in each case if in year 3 the asset is sold for: (1) £50,000; (2) £80,000. THE EFFECTS OF FIXED ASSET DISPOSALS ON CASH FLOW STATEMENTS When a fixed asset is sold, the business will make/receive: • a profit or a loss on disposal • cash proceeds from the sale In the reconciliation of operating profit to net cash flow from operating activities, we: • add back a loss on disposal • deduct a profit on disposal In the main body of the cash flow statement, we: • show the cash sales proceeds as a cash inflow (under ‘Capital expenditure’ if you want to use headings) 30
  • 31. NOTES ON METHODS OF DEPRECIATING FIXED ASSETS Accounting convention accepts that there are different ways in which the charge for depreciation can be calculated. Different methods will produce a different pattern of depreciation charges over the life of the fixed asset. This is considered essential as different assets will be consumed at varying rates or the fall in value of different assets will vary considerably. The most common methods of depreciation are given below: Key o = original cost of fixed asset s = scrap value of asset at the end of its useful life n = the useful life of the asset in years r = annual rate of depreciation d = annual charge for depreciation 1. Straight line method The annual depreciation charge is the same each year and is calculated as: o−s d= n 2. Reducing balance method An equal annual percentage of the undepreciated balance is charged as depreciation. Thus the amount of the annual charge diminishes each year. The rate of depreciation may be calculated as: s r = 1− n Note: A scrap value is required for this calculation and a small o scrap value must be assumed if none is considered likely. If you are asked to use the reducing balance method you will be given the appropriate rate to use: The annual depreciation charge in year 1 is equal to the rate multiplied by the asset’s original cost. In subsequent years, it is the rate multiplied by the asset’s NBV at the start of the year. 3. Sum-of-the-digits method This is a simplified variation of the reducing balance method. It is best explained by using an example. If n = 5, then the depreciation charge is: 5 Year 1 d= (o − s) 5 + 4 + 3+ 2 +1 4 Year 2 d= ( o − s ) etc. 5 + 4 + 3+ 2 +1 4. Physical usage method This method apportions the net cost of the asset (o – s) in accordance with the physical usage of the asset. Thus with a machine that is capable of making a certain number of units, or in a mine that contains a certain amount of deposit, this method is appropriate. Let x be the total physical number of units available from the fixed asset and z be the number of units used in the accounting period. z Then d= (o − s) x There are other methods of depreciation and the charge for depreciation can be made on the basis of any rational rule which allocates cost over useful life in accordance with the consumption of the asset. 31
  • 32. NOTES ON BAD DEBTS Write off if given up hope – this is a one-off event for a SPECIFIC debtor or receivable Charge to P/L expenses Reduce total debtors in B/S i.e. ELIMINATE ALTOGETHER Provisions for doubtful debts, carried forward in Balance Sheet - can be specific OR general Include increase or decrease from last year’s balance sheet in P/L expenses Deduct BALANCE c/f from debtors total on face of Balance Sheet. Example A company's debtors total £120,000 at 30.9.00. Of these, one customer who owes £20,000 is about to go into liquidation and it is not anticipated that any of this amount is to be recovered. The company makes a 2% provision for doubtful debts each year and the balance (provision) b/f from last year is £1,600. 1. Write-off the bad debts Charge P/L: Bad debts written off £20,000 Reduce B/S Debtors go down to £100,000 2. Make provision for doubtful debts Charge P/L with difference, i.e. need 2% x £100,000 = £2,000. Already have balance b/f of £1,600. So in P&L expenses we will have: Increase in provision for doubtful debts £400 In Balance Sheet we will see Current Assets Debtors 100,000 Less: provision for doubtful debts (2,000) ______ 98,000 What happens if the provision decreases from one year to the next? Note that we only need to provide for general doubtful debts against the balance of £100,000 (i.e. after writing off bad debts) as otherwise we would be accounting for the bad debts twice over. 32
  • 33. LECTURE 6 INCOMPLETE RECORDS SUMMARY OF CALCULATIONS OF DEBTORS AND CREDITORS/ CREDIT SALES AND PURCHASES • What number is missing? Opening debtors ("already owed") x + Credit sales in period ("extra sales") x ___ • Total owed "T" ___ Amounts received in the period x in respect of credit sales (from debtors) + Amounts written off x + Still owed (closing debtors) x ___ • Total owed "T" ___ 33
  • 34. N.B. Use this page to write out the similar summary for credit purchases. 34
  • 35. COST OF SALES Also known as cost of goods sold. £ Opening stock x from last year's balance sheet (current assets) or cost of sales (P&L) Add: Purchases x often needs to be calculated if credit purchases are involved ______ x Less: Closing stock (x) from this year's balance sheet (current assets) ______ COST OF SALES x ______ Missing Values Sometimes have just sales or cost of sales, and information about profits, and need to work out the missing number (cost of sales or sales). If profit percentage is a ‘margin’ it is based on sales. If profit percentage is a ‘mark-up’ it is based on cost of sales. e.g. Know sales are £1,000, at a mark-up of 25%. What is cost of sales? Cost of sales × 125% = sales = £1,000. So cost of sales = sales × 100 = £800 125 e.g. Know cost of sales is £500, profit margin on sales is 20%. What is sales? Sales × 20% = profit = sales – cost of sales Sales × 80% = cost of sales = £500 So sales = cost of sales × 100 = £625 80 Be prepared to combine elements of incomplete records! For example, you may need to use profit information to find the total sales figure, subtract cash sales to find credit sales, then use credit sales to find the closing debtors figure for your balance sheet. 35
  • 36. TRIAL BALANCES Before producing balance sheets and profit and loss accounts, a useful check on your figures is to produce a ‘trial balance’. Separate your balance sheet and profit and loss amounts into ‘debit’ (DR) and ‘credit’ (CR) balances as follows: Balance Sheet Items DR CR Asset Liability (Claim) Capital and Reserves Profit and Loss Account Items DR CR Expense Income (Revenue) Drawings/Dividends Profit The total of the list of debit balances should equal the total of the list of credit balances. If it doesn’t, there is a mistake or a missing number (incomplete record) somewhere! Example Trial Balance (balance sheet items only) DR CR £ £ Land and Buildings cost 50,000 Buildings accumulated depreciation 4,000 Machinery cost 12,000 Machinery accumulated depreciation 3,000 Stock 3,500 Trade debtors 5,000 Provision for doubtful debts 500 Cash in hand 45 Bank overdraft 2,000 Trade creditors 3,600 Mortgage 30,000 Capital 10,000 Reserves (incl. retained profit) 17,445 70,545 70,545 Sometimes, reserves may be a missing figure. Note that we do not need to show the profit and loss account balances separately, because they are already included in retained profit for the year (part of reserves). NB: All debit balances represent ASSETS or EXPENSES (or DRAWINGS). All credit balances are LIABILITIES or REVENUES (or CAPITAL). 36
  • 37. LECTURE 7 "DOUBLE ENTRY" - AN OVERVIEW Balance Sheet Accounts DR CR Asset + Liability (Claim) + Liability – Asset – Profit & Loss Accounts DR CR Expenses + Income + Income – Expenses – Remember: Profit for period ≡ ∆ net worth of the Business Every transaction has two effects - one is always a debit and one is always a credit. 37
  • 38. A SIMPLE BOOK-KEEPING EXAMPLE - JOE SMITH REVISITED ‘Journal’ Entries: £ Start business – invest £1,000 cash Dr cash 1,000 Cr capital 1,000 Purchase stock for cash Dr purchases 100 Cr cash 100 Sell stock for cash Dr cash 150 Cr sales 150 Purchase stock on credit Dr purchases 50 Cr trade creditors 50 ‘T’ Accounts Cash at Bank Capital Bal c/f _________________ _________________ ______________ _________________ _________________ _________________ ______________ _________________ Balance b/f Trade Creditors Stock Bal c/f Bal c/f _________________ ________________ ______________ _________________ _________________ ________________ ______________ _________________ Balance b/f Balance b/f Sales Purchases Trading Account Profit and Loss Account (Reserves) Bal c/f ______________ _________________ ______________ _________________ Balance b/f 38
  • 39. Note: we have a problem dealing with stock. Closing stock at the end of one period becomes the opening stock at the beginning of the next period. Opening stock affects the profit and loss account, while closing stock affects both the profit and loss account and the balance sheet. We do not account for stock as we go along during the year, but only at the year ends when we hold a stocktake. The book-keeping entries are summarised as follows: £ Enter the opening stock in the trading account: Dr trading account X Cr stock (balance sheet) X (note that in the example above there is no opening stock, but normally it would have been carried down as a debit balance in the stock ‘T’ account) Enter the closing stock in the trading account: Dr stock 50 Cr trading account 50 A SIMPLE EXAMPLE THE TRIAL BALANCE £ £ DR CR Cash 1,050 Stocks 50 Creditors 50 Capital 1,000 Profit and Loss Account 50 _________________ _________________ 1,100 1,100 _________________ _________________ Make sure that you could produce this without any help! Note that it amounts to a list of the balances brought down at the end of the period. It provides one in-built check of whether or not your calculations are numerically correct. (Note that unfortunately, accounts can still be incorrect even if they "balance"!) 39
  • 40. Lecture example 5: The Ashton Company revisited The trial balance at 31 August 2001 is as follows (see Lecture example 2): DR CR £ £ Land (NBV) 20,000 Buildings (NBV) 35,000 Plant and machinery (NBV) 50,000 Investments 2,500 Stock - raw material 17,500 Stock - finished goods 10,000 Debtors 30,000 Cash in hand 50 Trade creditors 18,000 Bank overdraft 350 Mortgage 12,500 Proprietor’s capital 100,000 Retained profit (reserves) 34,200 165,050 165,050 In the month of September 2001, the Ashton Company makes the following transactions (see Lecture example 3, page 21): £ Cash sales 14,800 Credit sales 35,270 Cash received from customers in respect of credit sales 29,500 Raw materials bought on credit 25,140 Cash paid to suppliers in respect of credit purchases 18,000 Manufacturing labour and overhead paid 20,000 Other non-manufacturing expenses paid 2,690 You also discover that at 30 September 2001, raw materials stocks are valued at £15,000, stocks of finished goods are valued at £11,000, and there are no stocks of work-in-progress. All cash movements go through the bank account. Show the journal entries and ‘T’ accounts reflecting the transactions for the month of September. Prepare the trial balance as at 30 September 2001. 40
  • 41. Lecture example 5: Suggested solution to ‘T’ accounts Cash at Bank Trade Creditors Bal b/f 350 Bal b/f 18,000 Bal c/f ______________ _________________ ______________ _________________ Balance b/f | | Stock - Raw Materials Bal b/f 17,500 Bal c/f _________________ _________________ ______________ _________________ _________________ _________________ ______________ _________________ Balance b/f Trade Debtors Stock - Finished Goods Bal b/f 30,000 Bal b/f 10,000 Bal c/f Bal c/f _________________ _________________ ______________ _________________ _________________ _________________ ______________ _________________ Balance b/f Balance b/f Sales Purchases Manufacturing Expenses Non-Manufacturing Expenses Trading Account Profit and Loss Account (Reserves) Bal b/f 34,200 Bal c/f ______________ _________________ ______________ _________________ Balance b/f 41
  • 42. Lecture example 5: Suggested solution trial balance as at 30 September 2001 You should check that your trial balance balances, and that you could use it to produce the balance sheet (on page 22, lecture example 3). DR CR £ £ Land (NBV) 20,000 Buildings (NBV) 35,000 Plant and machinery (NBV) 50,000 Investments 2,500 Stock - raw material Stock - finished goods Debtors Cash in hand 50 Trade creditors Bank overdraft Mortgage 12,500 Proprietor’s capital 100,000 Retained profit (reserves) 42
  • 43. Lecture example 6: George Square George Square had the following balances in his books as at 1.1.01: TRIAL BALANCE 1.1.01 Dr Cr £ £ Trade creditors 2,300 Stocks of raw materials 1,200 Work-in-progress 1,400 Stocks of finished goods 700 Machinery, at cost 2,500 Accumulated depreciation 500 Bank overdraft 1,250 Trade debtors 1,500 Proprietor's capital 3,250 7,300 7,300 His transactions during the year are shown below. All cash transactions are conducted by means of the bank account and all factory costs with the exception of depreciation are assumed to add to the value of cost of sales. All transactions are for cash unless stated otherwise. 1. Bought office premises by means of a long-term mortgage for £4,000. 2. Spent £3,000 on raw materials. He paid £2,200 by cheque and bought the remainder on credit. 3. Paid wages of £4,000 of which £1,500 was for office staff and the remainder for direct factory labour. 4. At the year end, stocks of raw materials were valued at £1,500, work-in-progress was valued at £4,850, and finished goods were valued at £1,200. 5. Rent on the factory premises of £300 was paid. 6. George Square took £400 as drawings during the course of the year. 7. Insurance on the office and factory machinery of £600 was paid (2/3 was for office premises). 8. £900 was paid for electricity and a further £100 was outstanding at the end of the year. 9. Finished goods costing £2,500 were sold on credit for £6,000. £7,000 was received from debtors during the year. 10. The machinery is to be depreciated at the rate of £250 p.a. and the office premises at the rate of £500 p.a. REQUIRED: 1. Write up George Square's ledger for the year, including separate accounts for the various expenses and sources of revenue. 2. As you write up the ledger, record in journal form how you would deal with each transaction. 3. Prove that your work balances by drawing up a Trial Balance at the end of the year. 4. Produce a Trading and Profit and Loss Account, Balance Sheet and Cash Flow Statement. 1. What is your assessment of the performance of George Square's business during the year? 43
  • 44. GEORGE SQUARE: SUGGESTED SOLUTION TO ‘T’-ACCOUNTS Capital Machinery - Cost Bal. b/f 3,250 Bal. b/f 2,500 Office Premises - Cost Mortgage loan Loan 4,000 Office Premises 4,000 Stock of Raw Materials Stock of Finished Goods Bal. b/f 1,200 Trading account 1,200 Bal. b/f 700 Trading account 700 Trading 1,500 c/f 1,500 Trading 1,200 c/f 1,200 account account 2,700 2,700 1,900 1,900 b/f 1,500 b/f 1,200 Stock of Work in Progress Purchases Bal. b/f 1,400 Trading account 1,400 Cash 2,200 Trading 4,850 c/f 4,850 Creditors 800 Trading account 3,000 account 6,250 6,250 b/f 4,850 44
  • 45. Cash at Bank Trading Account Debtors 7,000 Bal. b/f 1,250 Raw mat.s 1,200 Purchases 2,200 W.I.P. 1,400 Sales 6,000 Wages - factory 2,500 Fin. Goods 700 Wages - office 1,500 Raw mat.s 1,500 Rent 300 Purchases 3,000 W.I.P. 4,850 Drawings 400 Wages factory 2,500 Fin. Goods 1,200 Insurance 600 Rent 300 Bal. c/f 2,650 Electricity 900 Electricity 750 9,650 9,659 Insurance 200 P&L account 3,500 b/f 2,650 Insurance Electricity Bank 600 Bank 900 Trading account 200 Other Creditors 100 Trading account 750 P&L account 400 P&L account 250 Trade Creditors Debtors Bal. b/f 2,300 Bal. b/f 1,500 Bank 7,000 Sales 6,000 c/f 500 c/f 3,100 Purchases 800 3,100 3,100 7,500 7,500 b/f 3,100 b/f 500 45
  • 46. Accumulated depreciation P&L Depreciation Exp. Bal. b/f 500 Acc Depn (mach) 250 P&L Depn (mach) 250 Acc Depn (prem) 500 Bal c/f 1,250 P&L Depn (prem) 500 P&L account 750 1,250 1,250 Bal b/f 1,250 Wages - Office Sales Bank 1,500 Debtors 6,000 P&L account 1,500 Trading 6,000 Account Wages - Factory Rent Bank 2,500 Trading account 2,500 Bank 300 Trading account 300 Drawings Other Creditors Bank 1,500 P&L account 1,500 Electricity 100 46
  • 47. ACCG 11900: Introduction to Accounting A George Square Trial balance at end of the year Dr. Cr. £ £ Office premises 4,000 Acc. depreciation 500 Machinery 2,500 Acc. depreciation 750 Stocks of raw materials 1,500 WIP 4,850 Finished goods 1,200 Debtors 500 Creditors 3,200 Bank 2,650 Loan 4,000 Capital 3,250 EITHER Gross profit (from trading account) 3,500 Office Wages 1,500 Drawings 400 Insurance 400 Electricity 250 Depreciation expense 750 17,850 17,850 OR Retained profit for year (from P&L account, not 200 shown in suggested solution) 14,550 14,550 REMEMBER: Check that you can produce a balance sheet, profit and loss account and cash flow statement from the trial balance. How has the business performed during the year?? 47
  • 48. ACCG 11900: Introduction to Accounting A Missing Credit Sales/Purchases in double entry terms: Receivables/Sales/Debtors Balance b/f (opening X Cash received from x balance) – last year's debtors during the year – Balance Sheet bank a/c Credit sales for year (may X Bad debts written off in x be a missing figure!) year Returns inwards x Closing debtors x (receivables) – current asset in this year's __________ Balance Sheet __________ X __________ X __________ Payables/Creditors Payments made during the X Opening balance b/f at X year (Bank a/c) start of year – last year's Balance Sheet Credit purchases during X Returns outwards X the year (may be 'missing figure') Closing creditors – current X liability is this year's Balance Sheet __________ __________ X __________ X __________ NOTE for revision: it is not always the same figure that is missing from the above calculations and it is essential that you understand how the transactions fit together in order to: (i) work out what information you have not been given in a question and then (ii) calculate the missing number. 48
  • 49. ACCG 11900: Introduction to Accounting A Example: Bristol Industrial Company Ltd’s bank statements show that £25,600 cash was received from customers during the quarter ended 30 September 2000. At the beginning of the quarter their records show that there were debtors of £4,925. Unfortunately, a computer virus has destroyed all the subsequent accounting records. The credit controller can remember that debtors at the end of the quarter were £5,103 and that during the quarter bad debts of £260 had been written off. What were the credit sales for the quarter? Bristol Industrial Company Ltd makes all its sales at a mark-up of 20% and does not make any sales for cash. What was the cost of sales for the quarter? Stocks at the beginning of the quarter were valued at £3,100 and a stock- take at the end of the quarter valued stocks at £3,840. What were total purchases for the quarter? If all purchases are made on credit, creditors at the beginning of the quarter totalled £6,376, and the bank statement shows that payments to creditors during the quarter were £17,382, how much does Bristol Industrial Company Ltd owe its suppliers at the end of the quarter? 49
  • 50. ACCG 11900: Introduction to Accounting A Lecture example 7: Chippendale Chippendale is the owner of a furniture shop. On 31 December 1999 his book-keeper retired and the accounts of the business were subsequently kept by Chippendale's secretary. Her double-entry was completely accurate (i.e. debits = credits), and she produced the following trial balance at 31 December 2000. Dr Cr £ £ Capital – Chippendale 22,035 Drawings – Chippendale 22,600 Loan at 15%: interest 12,000 Freehold property 17,500 Vans – cost 20,800 Vans – accumulated depreciation 3,710 Shop fittings – cost 16,300 Shop fittings – accumulated depreciation 4,200 Stock at 31 December 1999 32,832 Trade debtors at 31 December 1999 7,817 Trade creditors at 31 December 1999 14,712 Purchases 185,298 General expenses 37,146 Wages 42,183 Cash sales 254,451 Credit sales 32,870 Provision for doubtful debts at 31 December 1999 367 Bank 3,431 Cash 300 __________________ 365,276 365,276 __________________ The following additional information is available: 1. When Chippendale acquired his present premises he also purchased an identical shop next door, the two freeholds costing £110,000. During 2000 the shop next door was sold for £127,500. 2. The secretary did not know how to deal with debtors so she ignored them entirely. The 'credit sales' account represents the cash received from debtors during 2000. By matching these receipts against the file of sales invoices, it appears that the amount due by debtors at 31 December 2000 was £14,898. Of this total, £832 represents bad debts and a further £437 is regarded as doubtful. 3. A similar situation existed with the creditors. The 'purchases' account debit is the total amount paid to suppliers during 2000; the total of unpaid invoices at 31 December 2000 was £18,002. 50
  • 51. ACCG 11900: Introduction to Accounting A 4. Stock at 31 December 2000 was valued at a cost of £49,451. Included in this figure were items of stock which had originally cost £9,270, but which were to be included in the January sale priced at £7,110. 5. Cash sales include £1,400 from the sale of Chippendale's private car which had been wrongly paid into the business bank account. 6. No entry had been made for part-time wages amounting to £3,650 paid out of the shop takings. 7. General expenses unpaid at 31 December 2000 amounted to £4,470. This amount included debits of £1,320 in respect of insurance, of which £408 relates to 2000. 8. The firm's bank statement shows an overdraft of £4,975; the discrepancy of £1,544 represents interest charged on 31 December 2000 which had been omitted in the firm's ledger. 9. The loan interest for 2000 had not been paid. 10. Vans are to be depreciated at 20% of cost, and shop fittings at 10% of net book value. REQUIRED: Financial statements for Chippendale's furniture shop for the year ended 31 December 2000, consisting of profit & loss account and balance sheet, using the trial balance and the additional information supplied. 51
  • 52. ACCG 11900: Introduction to Accounting A CHIPPENDALE FURNITURE SHOP : SUGGESTED SOLUTION There are a number of different approaches that can be adopted to answer this question; probably the most straightforward is to open up 'T' accounts to represent all the ledger accounts and then make the necessary adjustments. 1. The proceeds from the sale of the adjoining shop have been credited to the freehold property account. This error must be corrected by opening a 'profit on sale of fixed' asset account. So, cost of building still owned = £55,000. Profit on building sold = 127,500 – 55,000 = £72,500. 2. The trade debtors account must be reconstructed; the balancing figure will be the credit sales for the year, which will be credited to that account. 3. Similar procedure to above. 4. A trading account should be opened and the opening stock, purchases and closing entered. This will result in the stock account containing the stock at 31 December 2000. The closing stock value must be reduced by £2160, i.e. writing down the stock to NRV (£9,270 – £7,100). 5 & 6. These errors need to be corrected. 7. Note that there is an accrual and a prepayment for insurances. 8 – 10. These are 'year-end adjustments' which must be put through. (1) Calculation of Sales: Credit Sales Opening debtors 7,817  Cash received (32,870)  £39,951 : credit sales Closing debtors (14,898)  Cash sales 254,451 + 3,650 – 1,400 = £256,701 DR. CR. OR CR. Opening debtors 7,817 Cash received 32,870 Cash received 32,870 ∴ Credit sales Closing debtors 14,898 Bad debts w/off 832 (missing 39,951 Closing debtors 14,066 figure) ___________________ ___________________ ___________________ 47,768 47,768 47,768 ___________________ ___________________ ___________________ (2) Purchases Opening creditors (14,712)  Payments 185,298  £188,588 Closing creditors 18,002  COGS = 32,832 + 188,588 – [ 49,451 − 2,160 ( = 9,270 − 7,110) ] = £174,129 52
  • 53. ACCG 11900: Introduction to Accounting A CHIPPENDALE FURNITURE SHOP PROFIT AND LOSS ACCOUNT for the year ended 31 December 2000 £ £ Sales (£256,710 + £39,951) 296,652 Cost of sales (174,129) ________________________ Gross profit 122,523 Profit on sale of fixed assets (127,500 – 55,000) 72,500 ________________________ 195,023 Less expenses: General expenses 37,146 + 4,470 – 408 41,208 Wages 42,183 + 3,650 45,833 Depreciation 4,160 + 1,210 5,370 Bad debts 832 + (437 – 367) 902 Interest 1,800 + 1,544 3,344 ___________________ (96,657) ________________________ Profit for year 98,366 Capital brought forward 22,035 Drawings (21,200) ________________________ Capital carried forward 99,201 ________________________ BALANCE SHEET at 31 December 2000 £ £ £ FIXED ASSETS cost depreciation Freehold property 55,000 – Vans 20,800 7,870 Shop fittings 16,300 5,410 ___________________ ___________________ 92,100 13,280 78,820 CURRENT ASSETS Stocks 47,291 Debtors 14,066 Less provision for doubtful debtors (437) ___________________ 13,629 Prepayments 408 Cash 300 ___________________ 61,628 ___________________ CURRENT LIABILITIES Trade creditors 18,002 Accruals 6,270 Bank overdraft 4,975 ___________________ 29,247 ___________________ NET CURRENT ASSETS 32,381 LOAN (12,000) ___________________ 99,201 ___________________ 53
  • 54. ACCG 11900: Introduction to Accounting A CAPITAL ACCOUNT 99,201 ___________________ 54
  • 55. ACCG 11900: Introduction to Accounting A LECTURE 8 TEST 55
  • 56. ACCG 11900: Introduction to Accounting A LECTURE 9 WORKING CAPITAL CONTROL Why is it important? working capital is cash tied up in the day-to-day operations of the business the business cannot continue without working capital it has to be funded from somewhere if the business runs out of cash, it will fail Cash requirements need to be anticipated so that the business can arrange additional finance if necessary. Cash inflows and outflows are forecasted in a cash budget. Proforma cash flow budgets/forecasts: Jan Feb Mar Apr May Jun Total £ £ £ £ £ £ £ Inflows e.g. Capital Sales A Outflows e.g. Purchase of Fixed Assets Purchases of Stock Wages Rent etc. B Net cash flow A-B=C Cash b/f D E Cash c/f C+D=E To keep working capital to a minimum (and hence free up cash for other purposes, such as expansion of fixed assets or reducing debt), can: • keep stocks low (risk of stockouts causing business loss) • keep debtors low (encourage them to pay quickly with prompt payment discounts, run credit checks before selling on credit, risk of becoming uncompetitive) • delay payment to creditors (risk of losing supplier goodwill) BUT, if working capital is too low (or negative) then business may not be able to meet current liabilities as they fall due (risk of bankruptcy). 56
  • 57. ACCG 11900: Introduction to Accounting A Lecture example 8: Carruthers & Co. Ltd Carruthers & Co is formed with share capital £40,000 of which it invests £25,000 in fixed assets, plant and machinery, etc., and the remainder it leaves as cash £15,000. Its plans for the first 6 months are as follows and you are asked to produce: 1. a monthly cash flow forecast for the 6 months; 2. a profit and loss statement for the 6 months; and 3. a balance sheet as at the close of the 6 months period. Sales for 6 months £600,000 Materials in sales £240,000 Labour in sales £180,000 Other expenses including depreciation of £2,000 £140,000 Materials purchased for the period £260,000 Timing of cash receipts and payments for 6 months: Sales Payments Overheads Receipts Materials & Wages £ £ July 40,000 60,000 August 50,000 60,000 All paid September 50,000 20,000 evenly October 70,000 20,000 each November 120,000 20,000 month December 150,000 20,000 ___________________ __________________ 480,000 200,000 ___________________ __________________ 57
  • 58. ACCG 11900: Introduction to Accounting A CARRUTHERS & CO – SUGGESTED SOLUTION Opening Balance Sheet £ Fixed assets 25,000 Current assets Cash at bank 15,000 _______________ 40,000 _______________ £ Share capital 40,000 _______________ Cash Flow Budget Receipts July August September October November December £ £ £ £ £ £ Sales 40,000 50,000 50,000 70,000 120,000 150,000 Share capital 40,000 - - - - - Sub Total A 80,000 50,000 50,000 70,000 120,000 150,000 Payments Materials 60,000 60,000 20,000 20,000 20,000 20,000 Wages 30,000 30,000 30,000 30,000 30,000 30,000 Overheads 23,000 23,000 23,000 23,000 23,000 23,000 Fixed assets 25,000 – – – – – Sub Total B 138,000 113,000 73,000 73,000 73,000 73,000 Balance (A–B) (58,000) (63,000) (23,000) (3,000) 47,000 77,000 Balance b/fwd – (58,000) (121,000) (144,000) (147,000) (100,000) Balance c/fwd (58,000) (121,000) (144,000) (147,000) (100,000) (23,000) 58
  • 59. ACCG 11900: Introduction to Accounting A Profit & Loss Account for the 6 months to 31 December £ £ Sales 600,000 Less: Materials in sales 240,000 Labour 180,000 Overheads 140,000 ___________________ (560,000) ___________________ Retained profits 40,000 ___________________ Closing Balance Sheet as at 31 December £ £ Fixed assets (25,000 – 2,000) 23,000 Current assets Stocks (260 –240)000 20,000 Debtors (600 – 480)000 120,000 _________________ 140,000 _________________ Current liabilities Creditors (260 – 200)000 60,000 Overdraft 23,000 _________________ 83,000 _________________ Working capital 57,000 _________________ 80,000 _________________ Share capital 40,000 Retained profits 40,000 _________________ 80,000 _________________ 59
  • 60. ACCG 11900: Introduction to Accounting A BANK RECONCILIATIONS At the end of November the balance on your bank statement was £351.05. From the cash book you note that the last cheque issued was number 261 and that the balance shown at 30 November was £319.04. On examining your bank statement you find the following: (a) 3 cheques that had been issued have not yet appeared on the statement: 261 £16.51 259 £127.50 251 £96.60 (b) A deposit (banking) of £217.60 that was made on 29 November has not appeared on the statement. (c) A cheque for £323.50 has been banked but appears on the statement as £332.50. Bank reconciliation as at 30 November £ Balance per bank statement 351.05 Less: outstanding cheques 261 16.51 259 127.50 251 96.60 -------- (240.61) ---------- 110.44 Add: outstanding deposit 217.60 Less: error on statement (9.00) ---------- Balance per cash book 319.04 ---------- 60
  • 61. ACCG 11900: Introduction to Accounting A Lecture example 9: Daphne Ltd part (a) Daphne Ltd’s book-keeper has not yet reconciled the cash book balance of £1,405 at 30.6.X1 to the balance shown on the bank statement at that date, which is £4,020 in the company's favour. Investment income of £800 shown on the statement has not been entered in the company's books, neither have bank charges of £350 or a standing order for advertising of £415. Cheques outstanding at 30.6.X1 totalled £13,500 and lodgements (deposits) not yet credited on the statement amounted to £10,920. All of these items related to the year ended 30 June 20X1. Daphne Ltd: suggested solution part (a) (a) CASH BOOK Balance per TB 1,405 Bank charges 350 Investment income 800 Standing order 415 Amended balance 1,440 -------- -------- £2,205 £2,205 BANK RECONCILIATION £ Balance per statement (30.6.X1) 4,020 Add: deposits not yet credited 10,920 -------- 14,940 Less: cheques not yet presented (13,500) -------- Amended balance per cash book £ 1,440 61
  • 62. ACCG 11900: Introduction to Accounting A 62
  • 63. ACCG 11900: Introduction to Accounting A RATIOS Ratios are used for detailed analysis of the position and performance of a business, using the accounts of the business. Ratios should never be used by themselves – need to look at trends (comparisons over time) or compare to budget or external yardsticks (eg industry averages). There are four categories: 1. Profitability Ratios Allow examination and comparison of profitability trends. Gross Profit Ratio = Gross Profit × 100% Sales Net Profit Ratio = Net Profit Before Interest and Tax × 100% Sales Return on Capital Employed = Net Profit Before Interest and Tax × 100% (ROCE) Capital Employed Note: Capital Employed = Long-Term Liabilities + Capital + Reserves ROCE is very important, and can be split down further: ROCE = Net Profit Ratio × Capital Turnover Ratio Where the Capital Turnover Ratio = Sales . Capital Employed 63
  • 64. ACCG 11900: Introduction to Accounting A 2. Liquidity Ratios Identify short-term financial stability by analysing working capital. Stock Turnover Ratio = Cost of Sales (no. of times) Inventory Held OR Inventory Held × 365 days (no. of days) Cost of Sales Note: Inventory held could be the year end value of stock OR the average stock holding over the year (i.e. (opening stock + closing stock)/2). Quick Stock Turnover (high no. of times, low no. of days) ⇒ use Current Ratio; Slow Stock Turnover ⇒ use Quick Ratio: Current Ratio = Current Assets . Current Liabilities Quick Ratio (Acid Test) = Current Assets – Stock Current Liabilities Debtor Collection Period = Trade Debtors × 365 days Total Credit Sales Creditor Payment Period = Trade Creditors × 365 days Total Credit Purchases Note: Debtors and Creditors can be either the year end balances OR the average balance over the year. 3. Efficiency Ratios Examine the sales generated by the asstes employed in a business. We have already seen the Capital Turnover Ratio – other ratios include: Fixed Assets Turnover Ratio = Sales . Fixed Assets at Book Value 64
  • 65. ACCG 11900: Introduction to Accounting A 4. Investment Ratios Allow assessment of the business from the point of view of an investor (eg shareholder or lender). Gearing (Leverage) Ratios: Debt to Equity = Long-Term Liabilities Capital + Reserves Debt to Capital Employed = Long-Term Liabilities Capital Employed Investor Ratios: Dividend Yield = Dividend Per Share × 100% Market Price per Share Note: You need market price to calculate this – it may not be available. Dividend Cover = Net Profit Before Ordinary Dividends (no. of times) Ordinary Dividends paid and proposed Interest Cover = Earnings Before Interest (no. of times) Annual Interest Charge Earnings per Share = Earnings Before Ordinary Dividends Number of Ordinary Shares Issued Price Earnings Ratio= Market Price per Share (PE Ratio) Earnings per Share 65
  • 66. ACCG 11900: Introduction to Accounting A WRITING REPORTS The tutorial work on ratio analysis is required in the form of a report. You may not have prepared a ‘professional’ style report before, so here are a few pointers. The report should contain the following: 1. Title page (title of report, date, possibly the author) 2. Contents page (headings of the following sections, with page references) 3. Executive summary (brief summary of scope of report and main findings, imagine you are writing for a busy chief executive) 4. Terms of reference (restate the requirements for the report, possibly mention your methodology e.g. ‘using ratio analysis’) 5. Introduction (could contain background information on the company analysed, should split into several sub-sections if necessary) 6. Several separate sections for e.g. overview of financial performance and position (e.g. the company’s profits have grown at a rate of 5% over the past 5 years but the company has been losing cash, 50% of sales are made in Europe, etc.), discussion of profitability, working capital, etc. ratios. Refer to calculated ratio figures where appropriate, BUT DO NOT INCLUDE ACTUAL CALCULATIONS HERE. 7. Conclusion (of main findings - do NOT put anything new in your conclusion) 8. Appendices (containing your ratio - and any other - calculations) You should aim to calculate a couple of ratios in each category, but you need not be limited to this. ALWAYS CALCULATE RATIOS FOR MORE THAN ONE YEAR - it is important to be able to compare ratios against something! Do not be afraid of using sources like the financial times (searchable via CD-ROM in the library) or the internet to find out background information on the company to include in your report. Make sure you have a good read of the whole set of financial statements provided for you - if any pages are missing it is because the notes contained in those pages would probably confuse you and you shouldn’t need to be using them - including the directors’ report which often gives you useful background information. Use CONSOLIDATED figures where applicable - these are for the whole group of companies not just the individual parent holding company. YOU DO NOT NEED TO KNOW HOW TO CALCULATE THE CONSOLIDATED FIGURES YOURSELF. 66
  • 67. ACCG 11900: Introduction to Accounting A REVISION LECTURE - TACKLING EXAM-STYLE QUESTIONS DAPHNE LIMITED The book-keeper of Daphne Ltd, a manufacturing company, has prepared a profit and loss account for the year to 30 June 20X1. His trial balance shows the following items: £ Land and buildings (cost 1.7.X0) 60,000 Amortisation of leasehold property (1.7.X0) 45,000 Plant and machinery (cost 1.7.X0) 60,000 Depreciation on plant and machinery(1.7.X0) 24,000 Motor vehicles (cost 1.7.X0) 12,000 Depreciation on motor vehicles (1.7.X0) 10,000 Stocks (30.6.X1) 40,000 Debtors 22,500 Creditors and accruals 25,000 Cash at bank (per cash book) 1,405 Profit and loss account (1.7.X0) 32,500 Draft profit for the year 46,405 "Suspense account" 125,000 Ordinary shares of 50p (fully paid) 150,000 Investment (at cost) 12,000 You ascertain the following facts: 1. The book-keeper has not yet reconciled the cash book balance at 30.6.X1 to the balance shown on the bank statement at that date, which is £4,020 in the company's favour. Investment income of £800 shown on the statement has not been entered in the company's books, neither have bank charges of £350 or a standing order for advertising of £415. Cheques outstanding at 30.6.X1 totalled £13,500 and lodgements (deposits) not yet credited on the statement amounted to £10,920. All of these items related to the year ended 30 June 20X1. 2. The balance on the "suspense account" is made up thus: £ £ Purchase of freehold land Proceeds from sale of and buildings 100,000 motor vehicle 1,000 Purchase of motor vehicles 10,000 Purchase of new plant 15,000 Interim payment of employees' bonus 1,000 Balance c/d 125,000 ––––––––––––––––––––– –––––––––––––––––––– 126,000 126,000 ––––––––––––––––––––– ––––––––––––––––––––– All transactions took place in the year to 30.6.X1. 67
  • 68. ACCG 11900: Introduction to Accounting A 3. The value of the building bought during the year was £40,000 and it has an estimated useful life of 20 years. The company's other premises were acquired under a 20-year lease. 4. The plants uses a 'straight-line method' of depreciation. Plant and machinery are depreciated over ten years and no items are fully depreciated. 5. Motor vehicles are depreciated over four years. At the beginning of the year the company owned four vehicles, shown in the books as follows: Vehicle No: Cost Depreciation £ £ 1 2,000 2,000 2 2,000 2,000 3 4,000 4,000 4 4,000 2,000 ––––––––––––––––––– ––––––––––––––––––– 12,000 10,000 ––––––––––––––––––– ––––––––––––––––––– During the year vehicle no. 1 was sold for £1,000. 6. It is thought that debts totalling £500 are irrecoverable. A provision of 2% is to be made on the remaining debts. 7. The directors are recommending the payment of a dividend of 4p per share. 8. It is intended that the company's employees receive a total bonus of 5% of the net profit (before deduction of the bonus). 9. The draft profit was calculated before adjustments for the following payments: Electricity 1.4.01 – 30.6.X1 (paid July) £710 Rates 1.4.01 – 30.9.X1 (paid June) £420 You are required to: (a) make any necessary adjustments to the cash book balance as at 30.6.X1 and prepare a bank reconciliation as at that date; and (b) prepare an adjusted profit and loss account for the year ended 30.6.X1 and a balance sheet as at that date in vertical format. HINTS: This is a difficult and quite long question. DO NOT PANIC!! Deal with each of the adjustments separately and do not expect to get everything right. Start off with a trial balance and then do your bank reconciliation. Start your final accounts on new sheets of paper and write them out neatly, to make sure you get all of the "easier marks". 68
  • 69. ACCG 11900: Introduction to Accounting A DAPHNE LIMITED: SUGGESTED SOLUTION (a) CASH BOOK Balance per TB 1,405 Bank charges 350 Investment income 800 Standing order 415 Amended balance 1,440 -------- ---- £2,205 £2,205 BANK RECONCILIATION £ Balance per statement (30.6.X1) 4,020 Add: deposits not yet credited 10,920 -------- 14,940 Less: cheques not yet presented (13,500) -------- £ 1,440 69
  • 70. ACCG 11900: Introduction to Accounting A (b) DAPHNE LIMITED ADJUSTED PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30.6.X1 £ £ Draft profit 46,405 Add: Investment income 800 Profit on disposal of MV (W) 1,000 Prepayment of rates 210 _____ 2,010 -------- 48,415 Less: Depreciation (W) 16,000 Bad debt written off 500 Doubtful debts provision (W) 440 Advertising 415 Bank charges 350 Electricity accrual 710 _____ (18,415) --------- Net profit c/d £30,000 Less: Employees' bonus (W) (1,500) -------- 28,500 Less: Proposed dividend (W) (12,000) --------- Retained profit for the year £16,500 ===== 70
  • 71. ACCG 11900: Introduction to Accounting A DAPHNE LIMITED BALANCE SHEET AS AT 30.6.X1 £ £ £ Cost Depn NBV FIXED ASSETS Tangible assets Freehold land and buildings 100,000 2,000 98,000 Leasehold land and buildings 60,000 48,000 12,000 Plant and machinery 75,000 31,500 43,500 Motor vehicles 20,000 11,500 8,500 _____________________ ------- 255,000 93,000 162,000 Investments 12,000 ------ 174,000 CURRENT ASSETS Stock 40,000 Debtors and prepayments 22,210 Less provision (440) _______ 21,770 Cash at bank 1,440 ---------- 63,210 CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR Creditors and accruals 25,710 Proposed dividend 12,000 Employees' bonus 500 ---------- ---------- 38,210 NET CURRENT ASSETS 25,000 ---------- £199,000 ---------- CAPITAL AND RESERVES Share capital: Fully paid 50p shares 150,000 Profit and loss account 49,000 ---------- £199,000 ---------- 71
  • 72. ACCG 11900: Introduction to Accounting A DAPHNE: WORKINGS (i) Depreciation £ 40,000 Freehold building = 2,000 20 60,000 Leasehold building = 3,000 20 60,000 + 15,000 Plant and machinery = 7,500 10 4,000 + 10,000 Motor vehicles = 3,500 4 ` ______ (NB: Two of the remaining vehicles are already fully depreciated) £16,000 ______ (ii) Profit on disposal of MV £ Sale proceeds 1,000 Less: NBV (at 1.7.X0) nil _____ Profit on disposal £1,000 _____ (iii) Employees' bonus £ 5% x net profit £30,000 = 1,500 Less: Interim payment (suspense account) 1,000 _____ Accrued in final accounts £ 500 _____ (iv) Proposed dividend 4p x 300,000 shares £12,000 ______ (v) Provision for doubtful debts 2% x (22,500 – 500) = £ 440 72
  • 73. ACCG 11900: Introduction to Accounting A BASIL BRUSH Basil Brush is a sole trader who keeps a simple set of double entry accounting records. During the year ended 31 March 20X1 these records were kept correctly and a trial balance from the ledger balanced. Basil Brush has attempted to prepare a set of accounts from his ledger and the result is set out below; clearly the accounts are not correct! Profit & Loss Account for the year to 31 March 20X1 £ £ Stock, 31 March 20X0 1,500 Sales 35,150 Purchases 30,000 Discounts allowed 730 Rent paid 360 Less Discounts received 450 280 New motor vans, purchases Loan from A. Fox 490 1 January 2000 at cost 1,200 Wages 2,240 General expenses 320 Bad debts written off 420 Provision for bad debts, 31 March 20X0 100 Net loss for the year 220 £36.140 £36.140 Balance Sheet as at 31 March 20X1 £ £ Capital account, Freehold property 5,000 31 March 20X0 6,778 Furniture and fittings Trade creditors 3,080 cost at 31 March 20X0 1,020 Bank overdraft 1,870 Motor vans, cost at 31 March 20X0 600 Provision for depreciation Drawings 1,400 31 March 20X0: Trade debtors 3,350 Furniture & fittings 102 Motor vans 120 £11,950 £11.370 REQUIRED A redrafted Profit & Loss Account for the year to 31 March 20X1 and a Balance Sheet on that date, in the form in which they should, in your opinion, have been prepared. You should take into account the following additional information: (a) Depreciation charges for the year should be calculated as follows: Furniture and fittings 10 per cent of cost Motor vans at an annual rate of 20 per cent of cost. 73
  • 74. ACCG 11900: Introduction to Accounting A (b) The bad debts provision at the end of the year to 31 March 20X1 should represent 10 per cent of the Trade Debtors figure. (c) Interest on the loan from A. Fox should be provided at a rate of 10 per cent per annum. No interest for the year was paid in the period under review. The loan was raised on 1 April 20X0. (d) It is discovered that a credit sale for £300 made in February 20X1 has not been entered in Brush's books. (e) The closing stocks at 31 March 20X1 have been valued at £2,000. (f) Rent paid, as recorded in the ledger, relates to 9 months, thus one quarter's rent was owing at 31 March 20X1. 74
  • 75. ACCG 11900: Introduction to Accounting A BASIL BRUSH : SOLUTION NOTES Reconstructed Trial Balance - at 31 March 20X1 Dr Cr £ £ Stock, 1 April 20X0 1,500 Flurchases 30,000 Rent paid 360 New motor vans 1,200 Wages 2,240 General expenses 320 Bad debts written off 420 Provision for bad debts, 1 April 20X0 100 Sales 35,150 Discounts allowed 730 Discounts received 450 Loan from A. Fox 490 Capital account - B. Brush : 1 April 20X0 6,778 Trade creditors 3,080 Bank overdraft 1,870 Freehold property 5,000 Furniture & fittings, 1 April 20X0 1,020 Motor vehicles, 1 April 20X0 600 Drawings 1,400 Trade debtors 3,350 Provision for Depreciation - 31 March 20X0 - Furniture & fittings 102 - Motor vans 120 £48,140 £48,140 Adjustments (a) Depreciation: Furniture & fittings Dr Dep. exp. (P&L) 102 Cr F&F A/C (BS) 102 Motor vans – old Dr " " 120 Cr MV A/C (BS) 120 – new - ¼ yr Dr " " 60 Cr " " 60 (b) Bad Debts Provision Dr Bad Debts exp (P8L) (increase only) 265 Cr Prov A/C (BS) 265 (c) Interest on Loan Dr Interest (P&L) 49 Cr Creditors (BS) 49 (d) Credit Sale Adjustment Dr Trade Debtors (BS) 300 Cr Sales (P&L) 300 75
  • 76. ACCG 11900: Introduction to Accounting A (e) Closing Stocks Dr Stock AC (BS) 2,000 Cr Trading A/C (P8L) 2,000 (f) Rent accrual Dr Rent paid (P&L) 120 Cr Creditors (BS) 120 76
  • 77. ACCG 11900: Introduction to Accounting A BASIL BRUSH Profit & Loss Account for the year ended 31 March 20X1 £ £ Sales 35,450 Opening stock 1,500 Purchases 30,000 ________________ 35,000 Closing stock (2,000) ________________ Cost of Sales (29,500) ________________ Gross Profit 5,950 Other income - discounts receivable 450 Less expenses: Wages 2,240 Rent 480 General expenses 320 Bad debts 685 Depreciation:M.V. 180 F&F 102 Interest 49 Discounts allowed 730 ________________ (4,786) ________________ Net Profit for Year 1,614 ________________ 77
  • 78. ACCG 11900: Introduction to Accounting A Balance Sheet as at 31 March 20X1 Cost Depn. £ £ £ Fixed Assets Freehold property 5,000 – 5,000 Furniture & fittings 1,020 204 816 Motor vans 1,800 300 1,500 _____________ 7,316 Current Assets Stocks 2,000 Trade debtors less provision 3,285 _____________ 5,285 _____________ Creditors: amounts due within one year Trade creditors 3,080 Other creditors 169 Bank overdraft 1,870 _____________ 5,119 _____________ Net Current Assets 166 Creditors: amounts due after more than one year Loan (490) _____________ 6,992 _____________ Capital Account Opening balance 6,778 Profit for year 1,614 Less Drawings (1,400) 214 _____________ _____________ Closing Balance 6,992 _____________ 78