ACCOUNTING FOR ASSETS

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Mount Kenya University
DEPARTMENT OF BUSINESS AND
SOCIAL STUDIES
COURSE CODE: BAF3101
COURSE TITLE: ACCOUNTING FOR ASSETS

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CHAPTER ONE
FINANCIAL ACCOUNTIG ENVIRONMENT
Learning Objectives
By the end of this topic the learner should be able to:
i) Outline the elements of a financial statement
ii) Understand the conceptual frame of accounting
iii) Outline qualitative characteristics of financial information
iv) Differentiate between principles and assumptions in accounting
v) Appreciate the need for accounting ethics
1.1 Introduction
Within a company, the board and various other units and divisional managers need
accounting information to enable them understand and control the business on a regular
basis. In most medium-sized and large businesses, budgets and subsequently monthly
management accounts are prepared for this purpose. Managers will want to know about
various financial indicators such as growth in sales, margins, level of costs, amount of funds
tied up in stock and debtors and so on. All of this has the overall objective of seeking to
ensure that the company achieves its profit objectives. If the management accounting
information shows that budgets are not being achieved, decisions will be taken relating to
matters such as pricing, level of overheads such as marketing expenditure and staff numbers
or levels of capital expenditure, to try to steer the company back on course to achieving the
sales, profit and other measures set out in the budget. External reporting also has an
important decision making focus, as well as a compliance focus.
In a narrow, traditional sense, a board of directors presents to shareholders an annual report
that gives an account of stewardship of the company’s assets during the year. But even
implicit in that is an assumption that the shareholders will consider whether they and the

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performance to be acceptable. If they do not, that might lead to their refusing to reappoint
some directors. So even here there is a notion of decision making.
But in a modern context, the decision making role is more explicit. Certainly for companies
listed on a stock exchange the board is reporting to “the market” the analyst and fund
manager community in general and not just to those who happen to be shareholders at the
present. The market has expectations about earnings, and if the earnings reported disappoint
the market, the share price, and sometimes the director’s career will suffer. The fundamental
decisions taking place here, of course, are concerned with whether to hold, buy or sell the
company’s shares.
1.2 The components of company’s annual report
An annual report especially of a listed company is now very substantial document. The
following are currently its main components:
i) Chairman report. This is given by listed companies and some other public interest entities,
but not generally otherwise.
ii) Operating and financial review (OFR). This is recommended for listed and some other
public interest companies by an accounting standards board (ASB) statement of the same
name. It is now becoming a statutory requirement for listed companies.
ii) Director’s remuneration report. Certain disclosures relating to directors remuneration are
required by all companies but in the case of listed companies these are more extensive and
are presented as a separate report.
1.3 The conceptual frame work
Conceptual frame work was developed to guide the FASB in developing financial
accounting standards. It consists of a series of Statements of financial Accounting
Concepts which will be discussed below:
SFAC #1 “Objectives of Financial Reporting by Business Enterprises” The objectives of
the conceptual frame work is to provide information
i) Useful for decision making.
ii) That helps predict cash flows.
iii) About economic resources, claims to resources and changes in resources and claims.
SFAC#2 “Qualitative Characteristics of Accounting Information”
The qualitative characteristics of accounting information
include:-

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1. User –Specific Quality – Understandability, users must be able to understand the
financial statements in the context of making investment and/or credit decisions. Users are
expected to have some degree of knowledge and be willing to study the financial
statements.
2. Overriding objectives – Decision Usefulness requires that the financial statements
are useful in making investment and/or credit decisions.
3. Primary Qualities
A. Relevance – the accounting information must make a difference in the decision
making process. The components of relevance are:-
i) Predictive value, the information should be useful in predicting future cash flows.
ii) Feedback value, the information should confirm investor expectations but future cash flows
based on net income.
iii) Timeliness, the information must be available in time to make investment and / or credit
decisions.
B.Reliability – the accounting information must be verifiable, representationally faithful
and neutral.
i) Verifiability, the accounting information is objectively obtained.
ii) Representational Faithfulness, there is agreement between the measure and what users
would assume that the measure represents.
iii) Neutrality, the information does not favor one particular group over other interested
parties.
4. Secondary qualities
i) Comparability – The information can be compared for similarities and differences
among events and conditions.
ii) Consistency – The information allows comparisons between different time periods.
5. Constraints
i) Cost Effectiveness, the costs of providing accounting information must not exceed the
benefits at the public level.
ii) Materiality, a subjective judgment as to whether an item would effect the decision of
financial statements users.
SFAC#6 “Elements of financial statements”
The FASB identified 10 elements that comprise the classes of items reported in the financial

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statements.
1. Assets, probable future economic benefits.
2. Liabilities, obligations to other entities
3. Equity, residual owners’ interest in the net assets of the business
4. Investments by owners, transactions describing owner contributions
5. Distributions to owners, transactions describing withdrawals by owners.
6. Revenues, gross outflows resulting from providing goods or services to customers
7. Gains, inflows from transactions not related to sales to customers
8. Expenses, gross outflows incurred generating revenues
9. Losses, outflows from transactions not related to operating activities.
10. Comprehensive income, all changes in equity except those with owners
SFAC#5 “Recognition and measurement in Financial Statements of Business
Enterprises”
Recognition, the process of including data in the accounting information system and
therefore the financial statements. The four criteria for recognition are:-
Definition: the item meets the definition of an element
i).Measurability: the item has a relevant attribute measurable with sufficient reliability
ii) Relevance: the information is capable of making a difference in the decision making
process
iii) Reliability: the information is representationally faithful, verifiable, and neutral.
2. Measurement,-the process of assigning numerical amounts to the elements.
1. Unit of measurement: money without adjustments
2. Attributes:
a) Historical costs
b) Net realizable value
c) Present value of future cash inflows
3. Assumptions
i). Economic Entity Assumption
Financial information is reported about a unique economic entity and not the activities of
the owners or of an entire industry.
ii).Going Concern Assumption
Financial information is based on the assumption that the business will continue to operate

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and therefore the accruals and deferrals that are an integral part of accrual accounting will
remain relevant.
iii).Periodicity Assumption
Third party users need financial information in order to make investment and/or credit
decisions. In order to provide timely information the activities of the 2. Environmental and
Theoretical Structure of Financial Accounting business enterprise is broken into accounting
periods so that investors and creditors can asses the progress of the organization.
iv). Monetary Unit Assumption: KShs. is the unit of measurement in reporting financial
information in the Kenya
5 Principles
i). Historical cost principle
GAAP requires that assets and liabilities be measured at their original transaction value.
This provides useful cash flow information and arms length exchanges between entities are
both objective and verifiable.
ii) Realization Principle
For revenue to be recognized two criteria must be satisfied:
a) The earnings process must be complete
b) Collection is reasonably assured
iii). Matching principle
Expenses are recognized in the period of in which related revenues are generated. There are
four approaches to recognizing expenses depending on the type of expense involved:
i) Based on a direct relationship between the expense and related avenue
ii) Based on the type period in which the expense is used
iii) Based on a systematic and rational allocation to specific time periods,
iv) Based on the period incurred without reference to the revenue
generated.
iv) Full - Disclosure principle: The full - disclosure principle specifies that
information should be provided that would effect the investment and / or
credit decisions of third party financial statements users.
1.4 Ethics in Accounting
In a professional setting, ethics involves the ability to distinguish between right and wrong.
Professional accountants are faced with complex situations in which the appropriate decision

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is not always clear. Through membership in professional organizations the conduct of
professional accountants is governed by a code of professional ethics. In addition, with the
passage of the Public Company Accounting Reform and Investor Protection ACT of 2002, the
SEC has jurisdiction over the behavior of professional accountants who work for publicly
traded companies.
1.5 Aicpa Code of Ethics
Preamble
A certified public accountant assumes an obligation of self - discipline above and beyond the
requirements of laws and regulations.
Article I - Responsibilities
In carrying out their responsibilities as professionals, members should exercise
sensitive professional and moral judgments in all their activities.
Article II - The Public Interest
Members should accept the obligation to act in a way that will serve the public interest, honor
the public trust, and demonstrate commitment to professionalism.
Article III - Integrity
To maintain and broaden public confidence, members should perform all
professional responsibilities with the highest sense of integrity.
Article IV - Objectivity and Independence
A member should maintain objectivity and be free of conflicts of interest in discharging
professional responsibilities. A member in public practice should be independent in fact
and appearance when providing auditing and other attest services.
Article V - Due Care
A member should observe the profession's technical and ethical standards strive continually to
improve competence and the quality of services, and discharge professional responsibility to
the best of the member's ability.
Article VI - Scope and Nature of services
A member in public practice should observe the Principles of the Code of Professional
Conduct in determining the scope and the nature of services to be provided.
1.6 Guidance in Identifying and Managing Ethical Dilemmas
Analytical Model for Ethical Decisions
1. Determine the facts of the situation.

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2. Identify the ethical issues and the stake holders.
3. Identify the values related to the situation.
4. Specify the alternative courses of action.

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5. Evaluate the alternative courses of action in terms of their consistency with the
values identified above.
6. Identify the consequences of each possible course of action.
7. Make your decisions and take any indicated action.
? Review Questions
1. Accounting principles can be classified into two categories: - (a) Accounting concepts
(b) Accounting conventions
Explain each of the two
2. Write brief notes on accounting concepts.
3. Write brief notes on accounting conventions
4. What are accounting policies? Give examples of them
5. Outline some of the advantages that might rise from using a conceptual frame work of accounting.
6. Explain each of the elements of a financial statement.
7. Define the following terms as used in accounting.
(a) Initial recognition
(b) Subsequent recognition
(c) Measurement
8. When is each of the elements of financial statements recognized?
9. Write short notes on bases of measurement in accounting.

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CHAPTER TWO
REVIEW OF THE ACCOUNTING CYCLE:
Learning Objectives
i) Briefly explain the accounting cycle
ii) Explain and account for adjusting entries
iii) Explain and account for reversing entries
iv) Measure and recognize assets, income and expenses
2.1 Definition
This is a complete sequence of accounting procedures which are repeated in the same order
during each accounting period .Accounting period is one year, beginning on any given day and
ending in 12 months later. A calendar – year accounting period is an accounting year which
starts on 1st
/Jan and ends on 31st
/Dec.
All other 12-months accounting periods are known as fiscal year accounting period.e.g from 1st
July to 30th
/June, The accounting cycle when manual or electronic includes:
1. Identification and measurement of transactions and other events.
2. Recording transactions in the books of original entry:-journals.
3. Classifying data by posting from the journals to the ledger.

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4. Summarizing data from the ledger on a trial balance.
5. Adjusting, Correcting, and Updating recorded data after due consideration of all pertinent
facts.
6. Summary adjusted in the form of financial statements.
7. Closing the accounts to summarize the activities of the period.

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8. Reversing certain adjusting entries to facilitate the recording process in subsequent
periods.
When the steps are completed, the cycle begins again for the next period.
2.2 Analysis of each step of the Accounting Cycle:
Step 1: The first step in the accounting cycle is the analysis of transactions and selected
other events. Not all events are recorded. Generally; two criteria are applied in
determining whether an event or item should be recorded. These are:-
(i) The event or item should be measurable objectively in financial terms.
(ii) The event or item should be able to affect the financial position of the company. For
example, most accountants agree that changes in personnel, changes in managerial
policies and the value of human resources are important, but none of those items are
recorded in the accounts. On the other hand, when the company makes a cash sale-no
matter how small- we have no reservations about recording these transactions. Events
are of two types:-
(i) External events – Events which involve interactions between an entity and its
environment. Example: - a change in the price of a good or service that an entity buys
or sells, a flood or earthquake or an improvement in technology by a computer.
(ii) Internal events – events which occur within an entity, such as building and
machinery in its operation or transferring or consuming raw materials in production
processes.
STEP 2. Recording transactions in books of original entry.
Also called book of original entry - when the business undertakes a business transaction.
The information written in the journal comes from business papers – receipts, vouchers, LPO,
cheques etc. The business paper is also called source documents.
That information from the business paper is recorded in chronological order in the appropriate

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journals.
Hence, a journal is organized chronologically by transaction – i.e. thus the units/elements of a
journal are the individual business transaction.

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Depending on the size of the business, a business can maintain one or more journals.
In large, business enterprises, transactions with common attributes may be clarified and recorded
in a single journal. As a result, the result is several special journals.
The accounting language, entering the records in the journal is called Journalizing.
Such accounts which are affected include: -
(i) Assets Account
(ii) Liabilities Account
(iii) Owner’s equity Account
(iv) Revenue Account
(v) Expenses Account
GENERATE JOURNAL
The books of original entry where most transactions are entered include: -
(a) Cash book
(b) Sales journal
(c) Purchases journal
(d) Return inwards journal
(e) Return outwards journal
These books have grouped together similar things e.g. all credit sales are in the sales
journal.
To trace any of them would be relatively easy, as we know exactly which book would

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contain the item.
The main book of original Entry.
There are other transactions (items) which do not pass through the books of original
entry.
These items/transactions are much less common, and sometimes much more
complicated.

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It would be easy for a bookkeeper to forget the details of these transactions. What is
needed is a form of diary. To record such transactions, before the entries are made in
the double entry accounts. The diary to record these is called The Journal/General
journal/Journal proper.
Advantages of the Journal paper
(i) Makes fraud more difficult
(ii) Reduces the risk of entering the item once only instead of having double
entry.
(iii) Incase the bookkeeper leaves the firm, the journal enables understanding of
bookkeeping entries.
Typical uses of the journal
 To record the purchase of fixed assets on credit.
 To record the sale of fixed assets on credit.
 To record opening entries.
 To record closing entries.
 To write off bad debts.
 To record issue of shares and debentures.
 To correct errors.
Format of journal

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General Journal Page Number
Date Details Folio Debit Credit
Date – When the transaction take place.
Detail – Name of the account to be debited.
_ Name of the account to be credited.
_ Narration of the transaction.

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Folio – Ledger page where the transactions is recorded.
Debit – To record the amount to be debited.
Credit – To record the amount to be credited
A simpler formal normally used in exams is
The Journal
Date Dr Cr
Name of the account to be debited
Name of the account to be credited
Shs.
xx
Shs.
xx
The records in the general journal are posted to the relevant ledgers.
Example 1: Purchase of fixed assets on Credit/Sale of fixed assets on credit.
Bora traders made the following transaction in the month of may 2010
3rd
May: Import equipment worth Shs. 70,000 on credit from Bidii merchants.
17th
May: Sold motor car to Moko traders worth shs.150, 000 on credit.
29th
May: Sold fittings worth shs.60, 000 to Juma traders on credit for shs.80, 000.
30th
May: Sold old portable kiosk worth shs.300, 000 to Nyabera stores on credit for
shs.250, and 000.

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Required:
Record the above transactions, in the Journal paper/the Journal or General journal.
BORA TRADERS
THE JOURNAL

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Date Description Dr
Shs.
Cr
Shs.
3rd
May Equipment A/C
Bidii A/C
To record the purchase of
equipment (Asset) on credit
170,000
170,000
17th
May Disposal A/C
Motor vehicle A/C
Transfer the motorcar from
the motor car A/C to
disposal A/C
150,000
150,000
17th
May Motor Traders A/C
Disposal A/C
To record the disposal of the
150,000
150,000
29th
May Disposal A/C
Fitting A/C
To transfer fittings
60,000
60,000
Juma traders A/C
Disposal A/C
Disposal A/C
Income statement A/C
To record profit
recognized to the sale of
fittings
80,000
20,000
80,000
20,000
30th
May Disposal A/C
Kiosk A/C
300,000
300,000

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disposal A/C
30th
May Nyabera A/C
Disposal A/C
Disposal A/C
Income Statement A/C
To record for lose
recognized to the sale of
kiosk to Nyabera
250,000
50,000
250,000
50,000
Example 2: To record opening entries
The opening journal entries are made for the following reasons:-
1. If a business wants to start keeping complete Account.
2. When a business has been acquired as a going concern.
3. A business may open new set of books of Account as the old ones are closed.
John Mbabu, after being in business for some years without keeping proper
records has consulted you in order to assist to keep proper book of A/C.
On 1st
July, 2009 you established that assets and liabilities were as below:-
Assets
Motor van Shs. 840,000
Fixtures Shs. 700,000

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Stock shs.390, 000
Debtors - Maru shs.95, 000
- Bago shs.45, 000
Bank shs.80, 000
Cash shs.20, 000
Liabilities

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Mango shs.129, 000
Lao shs.41, 000
Required
Record the above items in the journal
Solution
Assets are entered first and continuous.
Creditors are entered second and continuous.
Remember: Assets = Capital + Liabilities.
JOHN BABU
THE JOURNAL
Description Dr. Shs. Cr.shs.
Motor van A/C 840,000
Fixtures A/C 700,000
Stock A/C 390,000
Debtors A/C 140,000
Bank A/C 80,000
Cash A/C 20,000
Creditors A/C 170,000

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Capital A/C 2000,000
Example 3:

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On issue of shares and debentures
On 31st
Dec, 2010 Bidka ltd issued 20,000 ordinary shares at a price of sh.60 per share. The
nominal price per share is sh.40.All shares were fully paid for.
Required:
Prepare Bidka ltd’s journal entries for this
Solution
The Journal
Dr. Cr.
Sh. Sh.
31st
Dec, 2011 Bank A/C (2,000 X sh.60) 120,000
Ordinary share capital A/C 80,000
Share Premium A/C 40,000
To record ordinary shares issued at a premium
STEP 3: Posting from the journals to the ledgers
After journaling the next step is transferring the journal information to A/Cs in the ledger and

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this is called Posting.
Under posting each debit and credit amount in the journal is listed in the appropriate a/c in the
ledger.
A ledger is a book and its pages consists of a/c.Each a/c represents stored information about a
particular kind of asset, liability owners, equity, revenue or expenses.

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Classification of ledgers
(a) Nominal ledger – for incomes and expenses
(b) Real ledgers A/C – for assets and liabilities.
_always have a balance.
Nominal Ledgers
Also called temporary accounts.
Always closed at the end of the accounting by transferring their balance to others.
Examples of such accounts include:-
Revenue account
Expense account etc
Real account ledger
Also called permanent account
They are balance sheet account which remains open and normally show a balanced after
accounting is closed.
They include asset a/c, creditors’
a/c.
Step.4: Trial balance preparation

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At the end of each period a trial balance of the general ledgers is prepared. This is to determine
that a mechanism of the recording and posting operations have been carried accurately.
Trial balance consists of all accounts and their balance. The account balances are the used as a
base for preparing financial statements. However; some adjusting entries should be done.
Step 5: Adjusting entries
Financial statements are prepared a specific year, however, some transactions which are entered
in the books of accounts will lead to more than one account again. The reason for this is that the
businesses normally follow accrual basis of accounting.

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As a result of this in order to cater for a single year as relating to financial statements, year end
adjustments are necessary. Adjusting entries are entries made at the year end in order to achieve
proper matching of revenues and expenses in the determination of the net income for the current
period and to achieve an accurate statement of assets and equities existing at the end of the
period.
Each adjusting entry will affect both real accounts and nominal accounts.
Items which needs adjustments
(1) Prepaid expenses
(2) Unearned revenues
(3) Accrued liabilities or expenses
(4) Estimated items
(5) Accrued assets or revenue
(6) Opening and closing stock
1. Prepaid expenses
This is an item paid and recorded in advance or before is used or consumption
A part of it represents expense for the current year and the other part represents the asset on hand
at the end of the year.
Examples:-
Prepaid water bills prepaid
electricity bill
Prepaid insurance premiums
Example 1

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In January 2011, M.K.U rented a building in Eldoret. The agreement provided the payment of
shs.100, 000 per year payable in advance. The financial accountant wrote a cheque on 1st
January, 2011 for three years rent.
Required:-
(a) Show ledger entries in relation to the transaction
(b) Show adjusting entries necessary as at 31st
Dec, 2011
Solution
Bank/Cash a/c

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2011 sh. 2011 sh.
1st
Jan Unexpired Rent a/c 300,000
Unexpired Rent a/c
2011 sh. 2011 sh.
1st
Jan Bank 300,000 31st
Dec Rent Expense a/c 100,000
(Adj entry)
(b) At the end of the year M.K.U will have consumed the service hence a part of unexpired rent
will become rent expense
The journal entries needed to be :-
Dr. Rent expense A/c 100,000
Cr. Unexpired rent A/C 100,000
Rent expense a/c
20011 sh. 2011 sh.
31st
Dec, unearned rent a/c 100,000
(Adj entry)
2. Unearned revenue
This is the revenue received and recorded as a liability are as revenue before the revenue as been
earned by providing goods or services to customers. Thus the customers have paid the company in

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advance e.g rent paid in advance, commission paid in advance, service paid in advance.
Example 2
A computer expert charges his clients on annual basis, the annual charge for a computer service
are shs.60, 000.On 1st January, 2010 he received a cheque from a client for two years future
service.
Required:-
a) Ledger entries showing how the transactions should be reflected
b)Show appropriate adjustments at the end of the year.
Solution
Unearned service fee a/c
2010 shs 2010 shs
31st
Dec earned 60,000 1st
Jan Bank 120,000
(adj entry)
Bank a/c
2011 shs 2010 shs
1st
Jan Unearned service
Fee a/c 120,000
(b) Earned Service fee a/c

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2010 shs. 2010 shs.
31st
Dec Unearned
Service fee a/c 60,000
(adj entry)
3. Accrued liabilities or expenses
These are items or expenses that have been incurred during the period but have not yet been
recorded or paid as they represent liabilities at the end of the year.
The rated items for such item are included in the income statement as expenses.
Examples include
Accrued wages / salaries
Accrued miscellaneous expenses
Accrued water bills
Accrued security expenses
Example 3.
The payroll of M.K.U in relation to casual laborers is 3m per year. The casual laborers are paid in
accrual basis after a period of 5months.
Required
Open appropriate ledger accounts in relation to year ended 31st
Dec 2020.
(a) Show appropriate adjusting entries at the end of the year.
Solution

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Annual payroll bill = sh.3, 000,000
Monthly payroll bill = sh.3m = 0.25
12
5 months payroll bill = sh. 0.25 x5 = sh.1.25
2 months payroll bill = sh.0.25 x2 = sh.0.5
Salary expense a/c
2010 sh (m) sh (m)
31st
May Bank A/C 1.25
31st
Oct Bank A/C 1.25
31st
Dec Salary payable A/C 0.5
(adj entry)
Bank A/C
2010 sh (m) 2010 sh(m)
31st
May salary/expense a/c 1.25
31st
Oct salary/expense a/c 1.25
(B) They are two months remaining for the year to end. He has got a service of two months, but not

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yet paid at year and hence salaries payable account for adjusting purpose.
Salary payable a/c
2010 sh (m) 2010 sh (m)
31st
Dec salary expense a/ c0.5
(adj entry)
(4) Accrued assets or revenue
These are items of revenue that have been earned during the period but that have not been
collected or paid by the client also called accrued assets, accrued revenue or revenue receivable.
e.g Fee balances in the books of M.K.U as at 31st
Dec 2010.
Example 4
Bidco Kenya ltd rented down ago at Thika town, the monthly payments is 500,000,the lessee was
able to pay for only 9months as at 31st
Dec 2010.
Required:-
(a) Open appropriate ledger a/c to show the transactions.
(b) Show journal entries necessary for the year and adjustments.
(c) Show the adjusting of the appropriate ledger accounts.
Solution

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(a)
Rent revenue
2010 sh. 2010 sh.
30th
Sep Bank 450,000
31st
Dec rent receivable a/c 50, 000

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Bank A/C
2010 sh. 2010 sh.
30th
Sep Rent revenue a/c 450,000
(b) Dr Rent Receivable a/c 150,000
Cr Rent Revenue a/c 150,000
Rent receivable a/c
2010 sh. 2010 sh.
31st
Dec Rent revenue a/c 150,000
(5) Estimated Items
Uncollectible accounts and depreciations of fixed assets are called estimated items because
the amounts are not exactly determinable.

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An estimated item is a function of unknown future events and
developments. Examples of the items include:
i. Adjusting entries for bad debts and provision for doubtful
debts.
ii. Adjusting entries for depreciation-provision for bad debts.
Adjustment for Provision for Doubtful Debts
Example 5.
At the year ended 31st
Dec 2010,the outstanding debtors in the books of Kayak Oil Kenya
Limited stood at shs 450,000 .The experience indicates that 2% of the outstanding debtors
may turn to be bad hence need for provision.
Required
a. Amount of provision to be provided.
b. Open the appropriate ledger accounts to show the adjustments.
c. Extract of financial statement to show the adjustment.
Solution
a. Amount of provision=2%*450,000
=9,00
0.
b. Remember that a provision for doubtful debts does not affect the debtors account but
Provision for Doubtful Debts Account

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Current Assets Shs Shs
Debtors 450 000
Provision for doubtful Debts (9000) 441 0
2010 sh 2010 sh
31st
Dec Income Statement 9000
c. Extract of Financial Statement.
i) Cap well (k) Limited
Statement of Comprehensive Income for
The Year Ended 31st
Dec
2010(Extract) Operating Expenses
Shs.
Provision for Doubtful Debts
(9000
)
ii). Cap well (K) Limited
Statement of Financial Position as at
31st
December 2010(Extract).
00
(6) Adjusting for Opening and Closing Stock.

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The two can be said to be adjusting entries or year end closing entries. They are adjusted in
order to determine the cost of sales/goods sold because they relate to purchases. We also
involve the closing entries which assist in determining the cost of sales, they include:
1) Purchase discount.
2) Purchase allowance.
3) Purchases.
4) Carriage inwards.
5) Return outwards
Example 6.
The following information were got form the books of KBL
Shs
Opening stock 30 000
Purchases 200 000
Transportation 6 000 000
Returns outwards 1 200 000
Purchases allowances 800 000
Purchase discount 2 000 000
Closing stock 26 000 000
Required
a) Show the journal accounts necessary to transfer the amounts to the cost of goods sold
account.

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b) Open appropriate ledger accounts to show the adjusting entries as well as closing
entries.
*All revenues are credited
*Remember the closing stock is not in the books of account.

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Journal Entries
Dr Cr
(Shs)(m) (Shs)
1) Cost of goods sold 30
Opening Stock 30
2) Cost of goods sold 200
Purchase account 200
3) Cost of goods 6
Transportation 6
4) Return outward 1.2
Cost of goods sold 1.2
5) Purchase allowance 0.8
Cost of goods sold 0.8
6) Purchase discount 2
Cost of goods sold 2
7) Closing stock 26
Cost of goods sold 26

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STEP 7 Closing of Accounts
Normally, nominal accounts should be closed after adjustments.
The accounts normally included are:
i. Purchase related accounts excluding opening stock accounts and closing stock
accounts.
ii. Expenses accounts.
iii. Sales related accounts.
We charge them by posting their entries to a special suspense account called Trading ,Profit and
Loss ,currently statement of comprehensive income.
STEP 8 Reversing Entries
After the financial statements have been prepared and the books closed, it is frequently helpful to
reverse some of the adjusting entries before entering the regular transactions of the entire period.
Such entries are called reversing entries-not all adjusting entries are reversed.
The entries which are normally reversed are
a) Prepaid items which have been entered originally in the nominal accounts (revenues and
expenses accounts).
b) All accrued items.
The following items should not be accrued:
i. Prepaid items which have been originally entered in the real accounts.
ii. Estimated items are never accrued.
Example 7: Prepaid Items
Assume that all insurance premiums are debited initially in the insurance expense account
instead of an expired insurance account.
-Insurance premium for 3 years -60 000

32
i. Amount paid for 3years-60 000
ii. An account initially affected -insurance expense account.
Required
a) Show appropriate adjusting entries in appropriate ledger account.
b) Show appropriate reversing entries in appropriate ledger accounts.
Solution
a) Insurance Expense Account
2010 shs 2010 shs
1st
Jan Bank a/c 60 000 31st
Dec Income Statement 20 000
(Adjusting Entry)
31st
Dec Insurance expense a/c 40000
60 000 60 000
Bank a/c
2010 shs shs
1st
Jan Insurance expense a/c 60 000
At year end, an amount equal to 60 000/3=sh 20 000 should be charged in the income statement
for the year ended 31st
Dec 2010.

33
Income Statement (Extract)
2010 shs 2010 shs
31st
Dec insurance exp a/c 20 000
Insurance expense account is a nominal account .It should have a zero balance at year end.
The balance of shs 40 000 should be taken to an expired insurance account.
Un expired Insurance Account
2010 shs 2010 shs
31st
Dec Insurance Expense a/c 40 000 1st
Jan Insurance Expense a/c 40 000
(Reversing)
T he start of the year, the unexpired insurance account should be reversed to insurance expense
account.
All accrued items should be reversed.
Example 8
The casual laborers in Thika Motor limited are paid after a period of 5 months. The payroll bill
in relation to casual laborers is shs 150 000.As at 31st
Dec 2010 the payroll bill of 2 months had
not been paid.

34
Required
a) Show appropriate adjusting entries in appropriate ledger accounts
b) Show appropriate reversing entries in appropriate ledger accounts.
Workings
Payroll bill for 1month=150 00/12 =125 000.
Payroll bill for 5 months = 12 500*5=62 500.
Payroll bill for 2 months not yet paid =12 500*2=25 000.
.
Casual Wages Account
2010 shs 2010 shs
31ST
May bank c/k 62500 31st
Dec income statement a/c 150000
31st
Oct bank a/c 62500
31st
Dec 2010 Wages payable a/c25 000
(Reversing)
At the start of the new Year, a reversing entry should be done to casual wages payable account.
Thus we open a new casual wages account.
Wages payable a/c
2011 sh. 2011 Sh
1st
Jan Casual wages a/c 25000 31 Dec Casual wages a/c 25000
At the start of the new year, a reversing entry should be done to casual age’s payable account.
Thus we open a new casual wages account.

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2.2 Recognition of Elements of Financial Statements
2.2.1 Assets – the resources controlled by an entity as a result of a past event in respect to which
its probable that the embedded future economic benefit will flow in to the entity.
The resources have a value that can be reliably estimated or measured objectively. Before any
transactions or event is recognized as an asset, it must conform to the assets recognition
criterions which are -:
Control – this is the ability of the entity to determine the usage of the asset which is mainly
indicated by the risks and rewards of ownership and not the legal title (substance over form).
Probable- future economic benefit – this refers to the ability to use or sell the resource.
Based on the high degree of certainty (more likely than not).
Measurable objectively – initial amount is recognized al cost.
Where there is no initial cost the fair value at the point control is transferred.
Assets are classified depending on the nature, usage and other characteristics.
The following basis of classification is possible –:
Tangible
Intangible
Tangible fixed assets have physical form and can be verified while intangible assets cannot be
touched.
Goodwill as an intangible asset is non identifiable separately and attaches to all the other assets
when they are working as a going concern.
Other intangible assets like trade marks, patents, development cost, and computer software are
separately identifiable and can be sold on their own.

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Non current and current assets
Non – current assets are available in the business over more than one accounting period and they
may have definite or indefinite useful life.
The following categories of non current assets should be identified and disclosed separately.
 Property/plant and equipment
 Investment property
 Biological assets
 Financial assets (other investments)
 Investments in associates
 Identifiable intangible assets
Current assets are held for trade in the ordinary course of the business of they can easily be
transferred into cash on cash equivalents within one accounting period.
The following categories of current assets can be identified separately.
 Inventory
 Fixed assets held for sale
 Receivables
 Monetary and non – monetary assets
Monetary assets are contractual and provide a specific amount in the future.eg receivables, cash
and cash equivalents and marketable investments.
Non – monetary do not guarantee a specific amount in future and there recognition is based on
probable future economic benefits (non - contractual) e.g. stock, equity investments, plant,
machinery etc
2.2.2 Revenue and Expense Recognition
Income –it is recognized in the income statement when an increase in future economic benefits
related to an increase in an asset or a decrease of a liability has arisen that can be measured.

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Expense-it is recognized in the income statement when decrease in future economic benefits
related to a decrease in an increase of a liability has arisen that can be measured reliably.
Expenses are recognized in the statement on the basis of the association between the costs
incurred and the earnings of specific items of income.-this process is commonly known as
matching of costs with revenues.
2.3 .Measurements of the elements of financial statements
Measurement is the process of determining the monetary amounts at which the elements of the
financial statements are to be recognized and in the balance sheet and income statement .this will
involve the selection of the particular basis of measurement.
Measurement bases include.
i) Historical cost: assets are recorded at the amount of cash or cash equivalent paid
or the fair value of the consideration given to acquire them at the time of their
acquisition.
ii) Currents cost. assets are carried at the amount of cash or cash equivalent that
would have to be paid if the same or an equivalent asset was acquired currently
iii) Realizable (settlement) :assets are carried at the amount of cash or cash
equivalent that could currently be obtained by selling the asset in an orderly
disposal
iv) Present value: assets are carried at the present discounted value of the net cash
inflows that the assets is expected to generate in the normal course of business
Historical cost base is the most common measurement basis adopted by enterprises
when preparing their financial statements. This is usually combined with other
measurement bases. For example, inventories are carried at lower of cost and net
realizable value, marketable securities and pension liabilities are carried at their present
value.

38
? Review Questions
1. Define the term an accounting cycle.
2. Briefly, outline and explain each of the steps of the accounting cycle.
3. Explain the following terms
(i) Journalization
(ii) Posting
(iii) Adjusting an entry
(iv) Reversing an entry
4. What is the difference between nominal ledger and a real ledger.
5. On 1st
Jan, 2010 KBLD Ltd rated a go down in industrial area. The agreement provided the
payment of sh.500, 000 per year for 3years, payable in advance.
Required:-
(a) Show ledger entries when the transaction was effected.
(b) Show adjusting entries necessary as at 31st
Dec, 2 010 and as 31st Dec 2011.
6. Omo dry cleaners offers cleaning services to Starehe Group of Hotels. On 1st
Jan, 2010 Omo
Dry cleaners received a cheque of sh.60, 000 for two years future services starting from 1st
July,
2010.
Required:-
(a) Show ledger entries showing amounts that should be reflected in the ledger books, i.e in the
books of Omo dry cleaners.
(b) Show appropriate adjusting entries for the years ended 31st
Dec, 2011 and 2011.
7. (a) Which items are normally reversed?
(c) The casual laborers in Del mo (k) ltd are paid after a period of 7months having been employed
as at 1st
July, 2010.
The payroll bill in relation to casual laborers is sh.200, 000 per year.
Required;-
(a) Show appropriate adjusting entries in appropriate ledger accounts.
(b) Show appropriate reversing entries in appropriate ledger accounts.

39
CHAPTER THREE
ACCOUNTING FOR CURRENT ASSETS
Learning Objectives
i) Give examples of current assets
ii) account and prepare financial extracts in relation to account receivables
iii) understand the need for cash flow statement
iv) prepare cash flow statement
3.1 Accounting for receivables
Accounts receivable are asset of a business. When accounting for receivable the aspects to
consider include:
Bad debts are written off.
Bad debts recovered.
Provision for doubtful debts
Provision for discount on debtors.
We have to show how these items affect financial statements
3.1.1Bad Debts
In most businesses, most sales are credit. The business bears the risk that some customers may
never pay for the goods sold to them on credit. Thus normal business risk and therefore bad debts
as they occur are treated as normal business expense and must be charged as such manner.

40
Calculating the profit or loss when the debt is found to be bad, the assets are shown by the
debtors account is worthless and must be eliminated as an asset account.
Procedure
First show the asset in the appropriate account.
To eliminate the worthless asset, debit bad debts account and credit debtor’s account.
To charge the bad debt to income statement, debit income statement account and credit bad
debts account.
Example1
On 5th
May 2010, Sungura traders sold goods worth shs 50 000 to Bora Enterprise on credit
terms. On 31st
Dec 2010, Bora enterprise was declared bankrupt hence could not settle its
debts.
Required
a) Bora account
b) Bad debts account.
c) Income statement extracts showing the charge of bad debts written off.
Solution
a) Debtors A/C - Bora Enterprises
2010 sh 2010 sh
5th
May 31st
Dec
Sales a/c 5000 bad debts a/c 50000

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b) When Bora enterprise becomes bankrupt
Bad Debts A/C.
2010 shs 2010 shs
31st
Dec Debtors 50 000 31st
Dec income Stt a/c 50000
a) To charge Bora Enterprise limited to income statement,
Bora Traders
Statement of Compressive Income
For the year ended 31st
Dec 2010 (Extract)
Operating expenses
Bad debts shs (50 000)
3.1.2 Bad Debts Recovered
It is not uncommon for bad debts written off in the previous year to be recorded in the later
years. When this occurs, the accounting procedures are as follows
1. Promise to recover.
Reinstates the debtor who was written off by
Dr-debtors account
Cr-bad debtors recovered account.
2. When the cash or cheque is later received from the reinstated debtor in full or in part,
Dr-bank/cash
Cr- debtors account.

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3. To balance off bad debts recovered account,
Dr. Bad debts recovered account
Cr. Profit and loss (income statement) debit bad debts account.
Example 2
Assume that Bora enterprises who had been written off by Sungura traders promised to pay his
expected amount and he paid the amount as at 30th
Jan 2011
Required.
Show the appropriate ledger account to effects the promise and the payment
Solution
Bad Debts Recovered A/c
2011 shs 2011 sh
1st
Jan Bora Entp. a/c 50000
Bora enterp a/c
2011 shs 2011 shs
30th
Jan bad debts recovered a/c 50 000 30th
Jan Bank 50 000

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Bank Account
2011 shs 2011 shs
30th
Jan Bora Enterprise a/c 50000
Sungura Traders income Statement (extract)
For the year ended 31st
Dec 2011
Other Incomes shs
Bad Debts Recovered 50 000
3.1.3 Provision for doubtful debts
In addition to accounts for bad debts which are actually unrecoverable it is prudent to be
psychologically prepared that debt owing at the end of accounting period will turn to be bad
debts. The total of debtors appears in the balance sheet as an asset. If they are all paid, then, this
will mean the debtors figure was a correct. If some of the debtors do not, pay the figure of the
debtors has been corrected in the balance sheet.
To get an accurate figure as possible for the debtors the firm will make the best estimates
of the number of debtors who will not pay their account. This is what we call provision for bad
debts. The estimate can be made in the following ways:
1) By looking at each debt and estimating which one will be bad debt.
2) By estimating on the basis of experience what percentage of the debts which
prove to be bad normally, the experience and the attachment of a percentage is
used.

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3.1.4 Accounting for Provision for doubtful debts
The following procedure is used:
1) When the decision has been taken as to the amount of provision is to be made
Dr.Income Statement account with the amount of provision.
Cr: provision for bad debts account.
2) To reflect total debtor accurately, this is done in the statement of financial position and In
the debtors account
Thus
ABC Limited
Statement of Financial Position
As at 31st
Dec 200x
shs shs
Current Assets
Debtors a/c xx
Less provision for bad debts (xx) xx
Note that provision for doubtful debts is worked after the bad debts are written off.
Increasing or reducing the provision
a. After providing for the first, the provision for the following year is cumulative or
deductive.
b. It is cumulative if total for the next year is bigger than total for the previous year.
In this case the amount recharged in the income is a difference of the two.

45
c. It is a deductive if the total of the following is lesser than the total for the present
year.
d. The difference of the two is treated as income and will fall under other incomes
stated as under provision for bad debts.
Example 3
For the year ended as at 31st
June 2007,the total debtors after bad debts were written off were
shs 60 00 .For the year ended at 31st
June 2008/09 the total debts after bad debts were written off
were increased to shs 80 000 and 120 000 respectively. The company utilizes 2% as provision
for bad debts.
Required
a) Show a provision for bad debts.
b) Prepare extract of financial settlement for the year ended 30th
June 70, 08 and 09.
Solution
Amount of provision for the year ended 30th
June 2007=2%*shs 60 000= shs.
Charge to income statement=shs 1200.
20008= 2%*shs 80 000 =shs 160 000.
Charge in income statement =shs 1600-1200 =shs 400.
June 09 =2%*120 000 =2400.
Charge in income statement =240 000-160 000 =shs 80 000.

46
Solution
Provision for Bad Debts Account
2007
30th
June Bal c/d
shs
1200 30th
June income statement 2008
30th
June Bal c/d 1600 1st
July bal c/d 1200
30th
June income c/f 400
1600
2009 2008
30th
June Bal c/d 2400 1st
July bal c/d 1600
2009 800
2400 30th
June income statement 2400
XYZ Limited
Income statement (Extract) for the year Ended 30th
June
07 08 09
Shs shs shs
Other expenses
Provision for bad debts (1200) (400) (800)

47
XYZ Ltd
Statement of Financial Position (extract)
As at 30th
June.
07 08 09
Shs shs shs
Current Assets
Debtors 60 000 80 000 120 000
(5200) (1600) 2400
58 800 78 400 117 600
3.2 Accounting for cash.
Accounting for cash will involve:
I. Control systems relation to cash.
II. Preparing bank reconciliation
III. Preparing cash flow statement
3.2.1 Preparing Cash flow statement
A business enterprise monthly prepares two major financial statements
i. Income Statements which finds out Profit or Loss made result of operation of the
company over a specified period.
ii. Financial position statement which reflects the state of assets or liabilities of company at
a particular date.
Another required financial statement is cash flow statement. This is a requirement of IAS.

48
3.2.2 Need for Cash flow Statement
1) The users are required to understand how the business generated cash and how the
current cash was used.
2) Unlike the income statement where profit reported i.e. influenced by account policies and
statement of the cash flow does not follow any policies and statements as it will indicate
the performance of the firm without such influence and therefore provide a better
perspective to establishing performance.
3)
Remember a business enterprise can be making profits while at the same time suffering
from cash crisis. This can lead to business enterprise close-up.
3.2.3 Components of cash flow statement.
Cash low statement summarizes the cash flow by reconciling the opening and closing balances
with cash and cash equivalent.
3.2.4 Cash equivalence-refers to liquid assets which can be easily transformed to cash. at no
or minimum cost
1) Demand deposits in bank
2) Short-term investments
3) Bank overdraft.
3.2.5 Cash flow Movement/Activities.
Can be classified into three categories:
1. Operating cash movement/activities.
2. Investing cash movement/activities.
3. Financing cash movement /activities.
3.2.6 Operating cash movement/Activities

49
These are the core activities of a business They refer to main or ordinally business activities.
They indicate net amounts generated form business customers after meeting necessary expenses
to raise those revenues
Operating cash flows are most important because they indicate the ability of the business to
sustain itself.
Operating cash flows are determined in two ways:
I. Directly
II. Indirectly.
Directly- Requirement IAS7 (International Accounting Standard 7)
a) Cash received is compared with cash paid in ordinary activities of the business.
b) This can be determined from cash flow or from control ledger.
The format is as below-
Cash received from customer’s xx
Cash received form other operations xx
Cash paid to suppliers (xx)
Cash paid to employees (xx)
Cash paid for operating expenses (xx)
Net cash flow Operating expenses xx

50
Indirectly
Under this method, operating profits reconciled with operating cash flow. Operating profit is
profit before interest (EBIT)
and tax which is adjusted with non-cash items such as:
Non-cash expenses.
Non –cash income
Prepayment
Accruals.
Non –cash expenses
These are items subtracted from the income statement but do not involve payment. For
example: Depreciation, Impairment, Losses on disposal of an asset etc
Non –Cash Income
These are gains recognized in the income statement but do not involve accessing of cash
as a result they should be subtracted from profit. They include profit on disposal of an
asset and reversal of impairment losses.
Prepayments.
Refers to any cash paid in expenses before it is recognized in the income statement
a) They entail use of each but in effect on profits.
b) They should be subtracted, and they include
 Decrease in creditors
 Increase in bills receivable
 Decrease in bills payable
Accruals
Refers to revenues or expenses recognized in the income statement without necessarily receiving
cash or paying cash.

51
They should be added back and they include
 Receiving or paying cash.
 Decrease in debtors.
 Decrease in bills receivable.
 Increase in creditors
 Decrease in bills payable.
3.2.7 Investing Activities
Refers to cash generated or used in relation to fixed assets Fixed assets investments define
capacity to generate income.
The capacity should be continually enhanced and where necessary removed.
3.2.8 Financing Activities
This is cash generated or used in relation to long-term sources of capital such as
 Sale of shares.
 Repayment of loan and
 Debentures among others.
3.2.9 Format of cash flow
ABC Limited
Cash flow Statement for the Year Ended 31 Dec 2011.
shs shs
Net Cash flow from operating activities xx
Interest paid or received xx
Dividends paid or received xx

52
Net Cash flow from investing Activities
Sales of fixed assets xx
Purchases of fixed assets (xx) xx
Net Cash flow from financing Activities
Issue of Shares xx
Issue of debentures xx
Payment of loans (xx) xx
Increase in cash and cash equipments XX
The working for net cash from operating activities is as follows shs
EBIT XX
Add back non-cash expenses
Depreciation xx
Impairment xx
Amortization xx
Loss on disposal (fixed assets) xx
Less non-cash incomes
Profit on disposal of fixed assets (xx)
Changes in working capital
Decrease in debtor’s xx

53
Increase in creditor’s xx
Decrease in creditors (xx)
Etc
Net Cash flow from operating Activities xx
After preparing the cash flow reconciliation between the opening cash or bank balances, increase
in cash and cash equivalence and closing cash /bank balance should be done thus:
Reconciliation
Opening cash or bank balance xx
Add increase in cash and cash equipment xx
Closing bank and cash balance xxx

54
Example 4:
From the following balance sheet prepare the cash flow statement of Bidco Kenya
Limited for the year ended 31st
Dec 2009.
31st
Dec 2008 1st
Dec 2009
Shs shs
Issued capital 18 000 3 000
Retained profit 7500 9200
10% Debentures 6000 7500
Taxation payable until 1st
Jan 2900 3200
Trade and expenses creditors 3200 3400
Proposed dividends 500 600
38100 46900
Fixed assets cost 23000 25 000
Depreciation (5650) ( 6200)
17 350 18 800
Stock 12000 14695
Debtors 4200 4150
Balance at bank 4550 9255
38100 46900

55
Additional information during the year
Fixed assets were purchased at a cost of shy 5600Fixed assets which cost 3600 were disposed for
shsh2500, the book value of these assets was shs 1500 and the profit has been included in
retained profit.
Required
a) Fixed assets account
b) Provision for bad debts
c) Disposal account
d) Cash flow statement as at 31st
Dec 09
Solution
a) Fixed assets account
Fixed assets account
2009 shs 2009 shs
1st
Jan bal b/d 23 000 Disposal account 3600
Cash at bank 5600 31st
Dec b/d 25 000
28 600 28600

56
b) Provision for depreciation account
Accumulated Depreciation Account
2009 shs 2009 shs
Disposal account 2100 Jan bal b/d 5650
31st
Dec Income statement 650
31st
Dec bal c/d 6200
8300 8300
After preparing the cash flow reconciliation between the opening cash or bank balances, increase
in cash and cash equivalence and closing cash /bank balance should be done thus:
c) Disposal of fixed assets account
Fixed Assets Disposal Account
Shs shs
Fixed assets 3600 Cash/bank 2500
Profit on disposal 1000 Depreciation account 2100
4600 4600

57
The accumulated depreciation of the asset being disposed should be transferred from the
accumulated deprecation account to fixed assts disposal account.
Accumulated depreciation of disposed asset = Cost-book value
=3600-1500
=shs 1500.
Bidco Limited
Cash flow Statement for the year ended 31st
Dec 2009
Shs shs
Net cash flow from operating activities 4705
Interest -
Tax (08) (2900)
Dividend (08)(500)
Net cash from investing Activities
Purchases of fixed Assets 5600
Disposal of Fixed Assets 2500 (3100)
Net Cash flow from Financing Activities
Issues of Shares 5000
Issue of Debentures 1500
6500
Increase in cash and cash equivalent 4705

58
2009
Dividends
shs
600
2009
Jan bal c/d
shs
7500
Tax 3200
Interest EBIT (Bal fig) 5500
Bal c/d 9200
13000 13000
ii) Net operating cash flow shs
EBIT
Add back non –cash expenses
5500
Depreciation 2650
Less Non-Cash incomes
Profit on Disposal (100
Changes in Working Capital
Increase in Stock 14695-12000 (
Workings
i.) For EBIT using retained earnings account.
Retained Earnings Account
0)
2625)

59
Decrease in Debtors 4250-4150 50
Increase in Creditors 3400-3200 200
Net cash Flow from O.P 4705
Reconciliation
Shs
Opening cash /bank balance 4550
Add increase in cash and cash equivalent 4750
Changing bank/cash balance 9255

60
? Review questions
1. What do we mean by short term marketable securities? Give examples.
2. Differentiate between the following
(a) Bad debts and provision for bad debts
(b) Under provision for bad debts and over provision for bad debts.
3. Outline the accounting procedure for bad debts recovered.
4. For the year ended 31st
Dec,2007,2008 and 2009,the outstanding debtors after bad debts were
written off were sh.240,000, sh.180,000 and sh.300,000 respectively. The company utilizes 5%
as a provision for doubtful debts.
Required:-
(a) Provision for doubtful debts A/C
(b) Extracts of financial statements for the years ended 31st
Dec, 2007, 2008, and 2009.
5. Assume that in question 4 above, the debtors were before bad debts were written off. The bad
debts to be written off were sh.10, 000, sh.20, 000 and sh.30, 000 for each of the years. The
other information remains the same.
Required:-
(a) Bad debts account.
(b) Provision for doubtful debts
(c) Extracts of financial statements for the years ended 31st
Dec, 2007, 2008 and 2009.
6. (a) What do we mean by cash and cash equivalence?
(c) Outline the 3 categories of cash flow measurements/activities.
7. Write short notes on
(a) Non – cash expenses
(b) Non – cash incomes
(c) Prepayments in relation to cash flow
(d) Accruals in relation to cash flow.

61
CHAPTER FOUR
ACCOUNTING FOR NON-CURRENT ASSETS
Learning Objectives
i) Give examples of non-current assets
ii) Account and prepare financial extracts in relation to PPE
iii) Account and prepare financial extracts in relation to goodwill
iv) Account and prepare financial extracts in relation to financial instruments assets
4.1 Accounting for Property, Plant and Equipment (IAS 16)
Tangible non – current assets used by the business in its day to day operation to generate
revenue.
4.1.1 Initial recognition
PPE should initially be recognized at cost when the transaction or events meet the asset
recognition criteria.
Cost
This is the total amount incurred to bring the asset in place and in condition ready for intended
use.
It comprises of the following elements:-
Purchase price less any amount
1) Initial handling cost e.g. fright, insurance, loading and offloading etc.

62
2) The entire non – recoverable taxes e.g. duty, non – refundable vat.
3) Site preparation cost e.g. cost of escavation, site of modification
4) Installation cost e.g. cost of prototype
5) Pre – production testing e.g. labor and material cost.
6) Site restoration cost e.g. provision based on estimated cost discounted to reflect time
value of money.
7) Borrowing cost
8) Grants
9) Other qualifying cost.
NB: Where an asset is a self construction, initial cost = contract price or the cumulative cost of
labor, material and reasonable overhead collection.
In an exchange transaction (trade in) the cost = the fair value of the asset given up. Unless it
cannot be reliably determined, in which case the value of the asset recovered is considered.
Costs that should not be included in the initial cost include:
1) Abnormal losses – these are material unexpected losses that arise due to human error or
omission. This can be minimized or controlled if reasonable care is taken. They should therefore
be written off in the period they arises and not included as cost of another asset.
2) Cost incurred after the asset is in a condition ready for its intended use – these are operating
expenses which should be written off in the period they are incurred.
However, where subsequent cost are material and are expected to enhance the attribute future
economic benefit relating to the asset, they can be capitalized as an asset.
3) Initial asset operating losses (under capacity) should not be capitalized.
4) General overheads – these are common costs that cannot be attributed directly to the PPE.
They should also be written off in the period they are incurred.

63
4.1.2 Subsequent measurement
Some items of PPE have indefinite useful life and therefore non – depreciable e.g land.
PPE with limited or definite useful lifes are depreciable. Depreciation is a systematic allocation
of the depreciable amount of all assets over its useful life. Depreciable amount = initial cost –
estimated residual value.
Through depreciation the cost of the asset is attributed to the benefit the entity derive d from the
continued use of the asset. Therefore the pattern of dep.should reflect how the business utilizes
the embedded economic benefit. (Value in use).
The depreciation pattern may be based on the time frame or usage, methods such as straight line,
sum of years digits, reducing balance method reflect the time frame.
While units of outputs, hours of usage or revaluation method reflects the usage. Some PPE have
different components, each with unique characteristic such as components should be accounted
for separately.
Major items of spares should also be treated as part of the PPE (General spares and consumables
are treated as inventory IAS 2).
N.B:
The useful life of an asset, the residual value and the pattern of depreciation are judged estimates
based on the information available at the year end. They must be regularly reviewed, any change
being accounted for on the period of change and in any other subsequent period (change in
accounting the estimates applied prospectively).
Example:1
ABC ltd is a media developer. On 1st
Jan, 04, the co – imported specialized electronic
equipment from the United States. The following costs were incurred:-
Purchase price (list price) –sh 800,000 (trade discount of sh.5% granted)
Insurance and freight – sh.250, 000

64
Duty (include claimable vat sh.36000) – sh.146, 000
Pre – production testing include (abnormal losses sh.64, 000) - sh.129, 000
Installation cost -sh.480, 000
The equipment was put in to use on 1st
July, 04 and was estimated to have a useful life of 5 years
and a residual value of sh.150, 000.
On 31st
Dec, 06 the equipment was estimated to have a remaining useful life of 2years and
residual value of a nil.
Accounts are prepared on 31st
Dec, and depreciation provided on a straight line with
proportionate change in the year of acquisition.
Required:-
(a) Compute the initial cost of the equipment.
(b) Depreciation charge for each of the year end 31st
Dec, 04 05, 06, 07.
(c) Prepare extracts of the income statement and balance sheet.

65
Solution
Initial cost = (800,000 x 95%) + 250,000 + (146,000 – 36,000) + (129,000 – 64,000) + 480,000
= 760,000 + 250,000 + 110,000 + 65,000 +480, 000
= 1,665,000.
Depreciation. Dec 04 – Depreciable cost = (1, 665, 000 – 150,000) x 6/12 = 151,500
5
Dec 05 = 1,665,000 – 150,000 = 303,000
5
Dec 06 = 1, 665,000 -150,000 = 303,000
5 757500
Dec 07 = 1,665,000 – 757,500 = 453,750
2

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ABC LIMITED
Income statement for the year ended 31st
Dec
Operating expenses 04 05 06 07
Depreciation 151,500 303,000 303,000 453,750
Abnormal loss 64,000 - - -
ABC LIMITED
Statement of financial position as at 31st
Dec
As at 04 05 06 07
PPE
Machine on cost 1,665,000 1,665,000 1,665,000 1,665,000
Depreciation (151,500) (454,500) (757,500) (1,211,250)
NBV 1,513,500 1,210,500 907,500 453,750
Current Assets
VAT Claimable 36,000 - - -
Treatment of depreciation
Depreciation reflect the economic benefit attributable to specific period of utilizing an item of
prop plant and eq (PPE).Its treatment depends on how the asset is employed.
It can be classified broadly into 3 categories:-

67
(i) Charge as an expense in the income statement
Classified depending on the usage of the asset.e.g office equipment charge for depreciation is
classified as administration cost.
(ii) Inventory cost – equipment used in the production of inventory, the related depreciation
charge is included as a manufacturing cost. Only the cost of inventory sold during the
period is included in the cost of sale, the cost of unsold inventory is recognized as an
asset.
(iii)Capitalizing to cost of a fixed asset – Where an item of PPE is employed in construction
or assembling of another fixed assets. Depreciation charge relating to that item is part
of the initial cost of that fixed asset.
NB:
Provision for depreciation should be made as long as the asset is in a condition ready
for intended use unless the usage method is applicable.
Provision for depreciation should stop at the earliest of any of the following events.
1) Recognition on disposal.
2) Reclassification to either investment property or fixed asset held for sale.
3) Fully depreciated i.e. NBV = residual value.
4.1.3 Revaluation of property, plant and equipment (PPE)
Revaluation refers to restating the historical cost of an item of PPE to the current
value. Some items of PPE have a long life span over which prices may be changing as
a result the historical cost do not form any reliable basis of making any decision.
Such in tern is also called irrelevant and uncomparable.Accounting of PPE on the
basis of historical cost tend to overstate the operating performance of an entity,
because it compares current revenue with historical costs and this can result into is
leading interpretation.
On that basis revaluation of PPE is justified. Where current values are either defined
on their market value or replacement basis.

68
The revaluation reserve recognized is the difference between the current value and the
carrying amount.
Revaluation reserve = current value/market value/replacement – carrying amount
(NBV)
.Revaluation reserve is a deferred holding gain on to the extends to indicates to PPE and should
be recognized directly to equity.
The restatement of the carrying amount of the asset is accounted for as a change in estimate
prospectively. Where the current value is depreciated over the remaining useful life of the asset.
The revaluation reserve is realized through continued use or through eventual disposal.
Realized revaluation reserve should be transferred to the retained earnings through the statement
of changes in equity and it is equal to the depreciation on the basis of current value and
depreciation on the basis of historical cost.
Realized revaluation reserve = Depreciation at current value – Depreciation at historical cost.
Revaluation can be affected in the financial statements in two ways – writing back the account
depreciation
All the provision for depreciation to date relating to the items being revalued is transferred to the
revaluation account and the cost of the asset is reset to the asset value.
Dr. – Accumulated depreciation
Cr. – Revaluation
Dr. /Cr. – plant at cost

69
Proportionate restatement of historical values to current values.
The original cost of the asset is restated using the price index to reflect the gross replacement
value, the appreciation to reflect the equivalent at current price.
Dr. – plant cost
Cr. – Acc depreciation
Cr – Revaluation
Example 2
A ltd acquired a specialized equipment on 1st
July 05 at a cost of 240,000.
Depreciation is provided on book value at 20%.On 30th June, 07 the current value of the
equipment is sh.210, 000.All the other factors unchanged and account prepared on 31st
June each
year.
Required:-
Compute revaluation reserve of 30th
June 07
Compute the excess depreciation for the year ended 30th
June 08
Prepare the journal entry for each of the year 2007 and 2008
2008
Prepare the income statement and balance sheet extract for each of the year 2007 and
Solution
(a) On June 2006 - 240000 x 20% = 48,000
Current value 210,000
Less book value 240.000 x (0.8 x0.8) (153,600)
Revaluation reserve 56,400
(b) Excess depreciation = Revaluation realized
Depreciation current value (20% x 210,000) 42,000

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Depreciation Historical value (20% x 153,600) (30,720)
Revaluation reserve realize 11,280
Dr. Cr.
30th
June, 2007 Depreciation expense 38,400
Provision for depreciation 38,400
Provision for depreciation 86400
Equipment a/c 30000
Revaluation a/c 56400
30th
June,2008 Depreciation expense 42000
Provision for depreciation 42000
Revaluation reserve 11,280
Retained profit 11280
A ltd
Income statement

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For the year ended 30th
June, 2007 30th
June, 2008
Cost of sales
Depreciation 384,000 42,000
A ltd
Financial Position Statement As At
30th
June, 200 30th
June, 2008
Non – Current Assets
210,000
Property, plant and equipment 240,000
Acc.depreciation (86,400) (42,000)
Revaluation 400 -
NBV 210,000 168,000
Equity and reserves
Revaluation reserves 56400 45120
4.2 Accounting Intangible Assets (IAS 38)
4.2.1 Introduction
IAS 38 covers the accounting treatment of many intangible assets. The objective of IAS 38 is to
prescribe the accounting treatment for intangible assets that are not dealt with specifically in
another IAS.The standard requires an enterprise to recognize an intangible asset if, and only if,
certain criteria are met. The standard also specifies how to measure the carrying amount of
intangible assets and requires certain disclosures regarding intangible assets.
4.2.2 Scope

72
IAS 38 applies to all intangible asset other than financial assets, mineral rights and exploration
and development costs incurred by mining and oil and gas companies, intangible assets
converted by another IAS, such as intangibles held for sale, deferred tax assets, lease assets,
assets arising from employee benefits, and goodwill. Goodwill is covered by IFRS 3.
Key definitions
Intangible Asset: - An identifiable non monetary asset without physical substance. An asset is a
resource that is controlled by the enterprise as a result of past events (for example, purchase or
self - creation) and from which future economic benefits (inflows of cash or other assets) are
expected. Thus, the three critical attributes of an intangible asset are:-
(i) Identifiably
(ii) Control (power to obtain benefits from the asset)
(iii) Future economic benefits (such as revenues or reduced future costs)
Identifiably: An intangible asset is identifiable when it is separable (capable f being
separated and sold, transferred, licensed rented, or exchanged, either individually or as part of a
package) or arises from contractual or other legal rights, regardless of whether those rights are
transferable or separable from the entity or from other rights and obligations.
Examples of possible intangible assets include: -
Intangibles can be acquired
1) By separate purchase
2) As a part of business combination
3) As a government grant
4) By exchange of assets
5) By self – creation (internal generation)
4.2.3 Recognition -
Recognition criteria.
IAS 38 requires an enterprise to recognize an intangible asset, whether purchased or self – created
(at cost) if, and only if it is probable that the future economic benefits that are attributable to the

73
asset will flow to the enterprise: and the cost of the asset can be measured reliably.
This requirement applies whether an intangible asset is acquired externally or generated
internally. AS 38 includes additional recognition criteria for internally generated intangible
assets (see below)
The probability of future economic benefits must be based on reasonable and supportable
assumptions about conditions that will exist over the life of the asset. [IAS 38.22] The probability
recognition criterion is always considered to be satisfied for intangible assets that are acquired
separately or in a business combination.
If recognition criteria not met- If an intangible item does not meet both the definition of and the
criteria for recognition as an intangible asset. AS 38 requires the expenditure on this item to be
recognized as an expense when it is incurred.
Business combinations - There is a refutable presumption that the fair value (and therefore the
cost) of an intangible asset acquired in a business combination can be measured reliably. An
expenditure (included in the cost of acquisition) on an intangible item that does not meet both the
definition of and recognition criteria for an intangible asset should form part of the amount
attributed to the goodwill recognized at the acquisition date.IAS 38 notes, however, that non-
recognition due to measurement reliability should be rare:]
The only circumstances in which it might not be possible to measure reliably the fair value of an
intangible asset acquired I a business combination are when the intangible asset arises from legal
or other contractual rights and either:
a) is not separable; or

4.2.5 Initial Recognition: Computer software
74
b) is separable, but there is no history or evidence of exchange transactions for the same
or similar assets, and otherwise estimating fair value would be dependent on immeasurable
variables.
Reinstatement: The Standard also prohibits an enterprise from subsequently reinstating as an
intangible asset, at a later date, an expenditure that was originally charged to expense. This
simply means that a firm cannot write back an intangible asset that had been initially written off.
Initial Recognition: Research and Development Costs
Charge all research cost to expense.
Development costs are capitalized only after technical and commercial feasibility of the asset for
sale or use has been established. This means that the enterprise must intend and be able to
complete the intangible asset and their use it or sell it and be able to demonstrate how the asset
will generate future economic benefits.
If an enterprise cannot distinguish the research phase of an internal project to create an intangible
asset from the development phase, the enterprise treats the expenditure for that project as if it
were incurred in the research phase only.
Initial Recognition: in – process Research and Development Acquired in a Business
Combination
A research and development project acquired in a business combination is recognized as an asset
at cost, even if a component is research. Subsequent expenditure on that project is accounted for
as any other research and development cost (expensed except to the extend that the expenditure
satisfies the criteria in IAS 38 for recognizing such expenditure as an intangible asset).
4.2.4 Initial Recognition: internally Generated Brands, Mastheads, Titles, and Lists
Brands, Mastheads, publishing titles, customer lists and items similar in substance that are
internally generated should not be recognized as assets.

76
Purchased: capitalize
Operating system for hardware: include in hardware cost
Internally developed (whether for use or sale)
:charge to expense until technological feasibility, probable future benefits, intent and ability to
use or sell the software, resources to complete the software, and ability to measure cost.
Amortization: over useful life, based on pattern of benefits (straight - line is the default.)
4.2.6 Initial Recognition: Certain other Defined Types of costs
The following items must be charged to expense when incurred.
Internally generated goodwill
Start – up, pre – opening, and pre – operating costs
Training cost
Advertising cost
Relocation cost Initial
measurement
Intangible assets are initially measured at cost.
4.2.7 Measurement Subsequent to Acquisition: Cost model and Revaluation Modeling
Allowed.
An entity must choose either the cost either the cost model or the revaluation model for each
class of intangible asset.
Cost model after initial recognition the bench mark treatment is that intangible assets should be
carried at cost less any amortization and impairment losses)
Revaluation model: Intangible assets may be carried at a revalued amount (based on fair value)
less any subsequent amortization and impairment losses only fair value can be determined by

77
reference to an active market. Such active markets are expected to be uncommon for intangible
assets]
Examples where they might exist:
Milk quotas
Stock exchange seats
Taxi medallions
Under the revaluation model, revaluation increases are credited directly to “revaluation surplus”
within equity except to the extend that it reverses a revaluation decrease previously recognized in
profit and loss. If the revalued intangible has a finite life and is, therefore, being amortized (see
below) the revalued amount is amortized.
4.2.8 Classification of intangible Assets Based on Useful Life
Intangible assets are classified as:
Indefinite life: No foreseeable limit to the period over which the asset is expected to generate net
cash inflows for the entity.
Finite Life: A limited period of benefit to the entity.
Measurement Subsequent to Acquisition: Intangible Assets with Finite Lives
The cost less residual value of an intangible asset with a finite useful life should be amortized
over that life: [IAS 38.97].
The amortization method should reflect the pattern of benefits. If the patterns cannot be
determined reliably, mortise by the straight line method. The amortization charge is recognized
in profit or loss unless another IFRS requires that it be included in the cost of another asset. The
amortization period should be reviewed at least annually.
The asset should also be assessed for impairment in accordance with IAS 36.
Measurement Subsequent to Acquisition: Intangible Assets with Indefinite Lives

78
An intangible asset with an indefinite useful life should not be amortized.
Its useful life should be reviewed each reporting period to determine whether events and
circumstances continue to support an indefinite useful life assessment for the asset. If they do
not, the change in the useful life assessment from indefinite to finite should be accounted for
as a change in an accounting estimate.
The asset should also be assessed from impairment in accordance with IAS 36.
Subsequent Expenditure
Subsequent expenditure on an intangible asset after its purchase or completion should be
recognized as an expense when it is incurred, unless it is probable that this expenditure will
enable the asset to generate future economic benefits in excess of its originally assessed standard
of performance and the expenditure can be measured and attributed to the asset reliability.
[IAS 38.60].
Disclosure
For each class of intangible asset, disclose:
Useful life or amortization rate
Amortization method
Gross carrying amount
Accumulated amortization and impairment losses
Line items in the income statement in which amortization is included
Reconciliation of the carrying amount at the beginning and the end of the period showing:
Additions (business combinations separately)
Assets held for sale
Retirements and other disposals

79
Revaluations
Impairments
Reversals of impairments
Amortization
Foreign exchange differences
Basis for determining that an intangible has an indefinite life
Description and carrying amount of individually material intangible assets
Certain special disclosures about intangible assets acquired by way of government grants
Information about intangible assets whose title is restricted
Commitments to acquire intangible assets
Additional disclosures are required about: intangible assets carried at revalued amounts [IAS
38.124].
The amount of research and development expenditure recognized as an expense in the current
period.
4.3 Accounting for goodwill
Goodwill is the term by an accountant de describes the difference between the value placed upon a
company and the sum of the values of the identifiable net asset of that company. Goodwill is said
to exist only when an enterprise is earning profit over and above the normal earnings of other
similar enterprises in the same Goodwill has therefore been defined as the present value of a
company anticipated to excess earnings.
Factors which determine Goodwill

80
 Location of the enterprise
 Nature of the company’s products
 Repetition of the company’s services
 Staff personality
 Possession of valuable contracts e.g. complete or part monopoly
 Reputation of management
 Possession of trade mark partners or home of known business
 Continued advertisement campaigns
4.3.1 Accounting treatment for Goodwill
Goodwill can be negative or positive under IFRS 3.A negative acquired goodwill should be
recognized immediately as an income in the income statement, in the same year of recognition.
For positive goodwill with IFRS 3 requires it to be recognized as an asset and should not be
amortised. Instead it should be tested for impairment annually or more frequently.
If the changes in indicate that their might be impairment.Rem: IAS3S – Impairment of assets.
4.3.2 Goodwill computation on Purchased Goodwill.
Goodwill with the positive or negative is worked as follows:-
Sh.
Fair value of consideration given xxx
Fair value of interest acquired (xx)
Goodwill (xx)
When a company purchases another company – it has to pay something. This is called
Consideration.
This consideration can be:-

80
a) Cash
b) Shares
c) Debentures
d) Future economic benefits in their present value
e) Debtors etc
The fair value of interest acquired is got from the net assets.
If the company has bought the whole of another company the net assets become the interest
acquired. If the company has got part of the other company then a part of the net assets becomes
the interest acquired.
Net assets can be worked in two ways:-
1. Net assets = Total assets – Total liabilities
sh.
2. Ordinary Shares at the point of acquisition xx
Retained profits at the point of acquisition xx
xx
Example

81
ABC ltd acquires XYZ as at 31st
January, 2010.At that date the assets and liabilities of
XYZ were as follows:-
Item sh. (in million)
Land and building 30
Motor vehicle 5
Furniture and Fittings 0.8
Debtors 0.2
Cash at Bank/Bank Overdraft (0.3)
Creditors (3.1)
Bank Loans (4.0)
ABC ltd paid a consideration of 40 and acquired 80% of XYZ ltd.
Required:-
i) Value of net assets
ii) Goodwill on acquisition of XYZ
Solution
i) Working for net assets of XYZ ltd.
Item sh. (in million)
Motor vehicle 5
Furniture and Fittings 0.8
Debtors 0.2
Cash at Bank/Bank Overdraft (0.3)
Creditors (3.1)
Bank Loans (4.0)
Net assets 28.6
ii) Working for Goodwill

82
Fair value of consideration paid sh. 40million
Fair value of Interest acquired (80% x 28.6) (22.88)
Goodwill 17.12
Example
Below is a financial position statement of Wachira Kenya ltd as at 31st
Dec, 2010.
Wachira Kenya ltd
Statement of financial position as at 31st
Dec 2010
Non – Current Assets sh. (in million)
Motor vehicle 5
Equipment 3
Furniture and Fittings 4
32
Current Assets
Stock 2.2
Debtors 1.6
Cash at Bank 0.7
4.5
Current Liabilities
Trade Creditors 0.8

83
Other Creditors 0.5
1.3
Net Current Assets 3.2
Total Net Assets 35.2
Financed by
Ordinary shares 30
Retained Earnings 9
Shares Premium 6.2
35.2
For the last three years the company has suffered a continuous financial distress. As a result they
resolved to sell the company as a going concern. They approach Songa Mbele Kenya ltd who
paid a consideration of 28.4m.
The book value of value of net assets was equal to market value, and was paid from the
following items:-
i) Land and Building had a fair value of adjustment to the excess of 0.4m.
ii) Debtors needed a provision for bad debts at a rate of 5%.
Required:-
a) Determine the fair value of net assets acquired by Songa Mbele.
b) Determine the goodwill
c) How the goodwill got is in business above
Financial statements of Songa (K) ltd accounted for.
Solution
a) For value of net assets sh. (m)

84
Total net assets as per the statement 35.2
Add
Fair value adjustments (land and building) 0.4
Less
Prior for bad debts (5% x 1.6) (0.08)
35.52
Or equity party
Ordinary shares
sh.
20
Returned earnings 9
Share premium at the date of adjustment 6.2
35.2
Add for adjustment 0.4
Less prior for bad debts (0.08)
35.52
b) Goodwill on acquisition of Wachira (k) ltd
Consideration paid 28.4
Fair value of net asset acquired (35.52)
Goodwill (negative) (7.12)
c) Since Goodwill in negative is it should be recognized as an Income in the books of
Songa Mbele in the year of acquisition.

85
(i) Songa Mbele (K) ltd
Financial statement as at 31st
Dec, 2010 (extract)
Other Incomes sh.
Goodwill on acquisition 7.12
(ii) Songa Mbele (K) ltd Statement of
Financial position as at
31st
Dec, 2010
Non – Current Assets sh.
Investment in wachilia 28.4
Example 3
Sungura (k) ltd acquired 5, 00,000 ordinary shares of Paka (K) ltd as at 1st
July 2010.The ordinary
shares of Paka ltd were 800,000 issued and paid at a price of shs.20 per share. As at 31st
Jan, the
retained profits and share preference of Paka ltd were sh.400, 000 and sh.150, 000 respectively.
The profits of Paka ltd as at 31st
Dec, 2010 were sh.180, 000 and they assumed to have accrued
evenly throughout the year. Sungura paid a consideration of sh.13, 000.
Required:-
a) Percentage Interest acquired by Sungura in Paka (K) ltd
b) Fair value of net assets acquired by Sungura ltd
c) Goodwill on acquisition of Paka ltd
d) Assuming that the goodwill if any is impaired over a period of 5years.Prepare financial
extracts to show how it will appear.
Solution
a) Interest acquired = n o . of shares acquired x100

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Total no. of ordinary shares
= 500,000 x 100
800,000
= 62.5%
b) Fair value
Profit = sh.180, 000
1st
Jan, 2010 1st
July, 2010 31st
Dec, 2010
Retained profit Date of purchase
Sh.400, 000
Share premium
Shs.150, 000
Sh.’000’
Ordinary share capital 800,000 @sh.20 16,000
Share premium 150
Pre – acquisition bal b/d 400
Profit for ½ a year. Jan – June (1/2 x 180,000) 90
Fair value of Interest acquired 62.5% x 16,640 = 10,400
Goodwill on acquisition shs.’000’
Consideration paid 13,000

87
Less interest acquired (10,400)
Goodwill (positive) 2,600
c) Financial extracts
i)
Sungura (K) ltd
Statement of comprehensive Income as at
31st
Dec, 2010 (extract)
Other expenses sh. (000) s h . (000) sh. (000) sh. (000) sh. (000) sh. (000)
Years 10 11 12 13 14 15
Goodwill impairments (260) (520) (520) (520) (520) (260)
Impairment of goodwill = 2,600,000 /5 = 520,000
For 2010 = 2,600,000/5 x 1/2 = 260,000
Sungura (K) ltd
Statement of financial position
As at 31st
Dec, 2010

88
Non – Current Assets sh. (000) sh. (000) sh. (000) sh. (000) sh. (000) sh. (000)
Years 10 11 12 13 14 15
Intangible assets
Good will – Cost 2600 2600 2600 2600 2600 2600
Acc – Impairment
Loss (260) (780) (1300) (1,820) (2,240) (2,600)
NBV 2,340 1,820 1,300 780 360 0
4.3.3 Non – Purchased Goodwill
It is inherently generated and meet subject of acquisition. It arises also out of a subjective
valuation, but not through a transaction.
It should be recognized in financial statement.
4.4 Accounting for Financial Instruments
Accounting for financial instruments is covered by the following IASs: -
i) IAS 32 –presentation
ii) IAS 39 –recognition and measurement
iii) IFRS 7 – disclosure
A financial instrument is any contract that gives rise to a financial asset of one enterprise and a
financial liability or equity instrument o f another enterprise. A financial asset is any asset that is
i) Cash or

89
ii) Contractual right to exchange financial instruments with another enterprise under
conditions that are potentially favorable or
iii) An equity instrument of another enterprise
4.4.1 Recognition and Measurement
An entity should initially recognize a financial asset in his books immediately it becomes a
party to the contractual arrangement creating the financial instrument. The initial recognition is
at cost. Subsequent recognition depends on the categories. An entity should eliminate a
Financial asset from the books immediately it ceases to have right or obligation in the contractual
arrangement creating the financial asset.
4.4.2 Subsequent Measurement
For purposes of subsequent measurement, IAS 39 classified financial assets into four categories
i) Financial assets at fair value through profit and loss.
ii) Loans and receivables originated by the enterprise
iii) Held to maturity financial asset
iv) Available for sale financial asset
Financial assets at fair value through profit and loss.
These are financial assets held for trading and whose fair value can be determined.
They are initially recognized at cost, and subsequently at fair value, with changes in fair
value (although unrealized) taken to profit and loss account. Trading means held with
the intention of being disposed in the near future or simply held for speculation.
Loans and receivables originated by the enterprise.

90
Arise from an entity directly selling goods or services on credit or entity advancing money
(loans and services). They are initially recognized at cost, and subsequently at amortized cost
using the effective rate of interest.
Held to maturity financial assets
These are financial assets that:-
i) Have a fixed rate of return
ii) Have fixed or determinable maturity period
iii) An entity has an intention and ability to hold the financial asset to maturity.
They are recognized at cost and subsequently at mortised cost using effective rate of interest.
Available four sale financial assets
These are financial assets that can be disposed off any time and does not belong to any of the
other three categories above. They are initially recognized at cost .Subsequently recognized
Depending on whether fair value can be determined reliably or not
Thus: - i) if measurable subsequently measured at fair value with fair value changes taken to
reserves.
ii) If non -measurable, subsequently measured at cost.
Example 4
Y ltd purchased a debt security for sh.5m at a discount for sh.4,670,000 on 1st
Jan,2004.The debt
is repayable in 5yrs time at an interest rate of 6% p.a payable annually in arreas. The ERI of the
investment is approximately 7.65%.This is a discount rate that will give a present value of the
future cash flow that equal to the price i.e. the internal rate of return implied in the contract.
Required:

91
Using amortized cost method, show the subsequent measurements assuming that the investment
was classified as held to maturity.
Amortization schedule:
Solution
Year principal sum at Interest earned Interest received Amount at
Beginning period end
2004
(a)
4670
(b)
357
(c)
300
d=a+b-c
4727
2005 4727 362 300 4855
2006 4789 366 300 4855
2007 4855 371 300 4926
2008 4926 374 300 5000
Ledger entries – Books of investor (y ltd)

92
Investment a/c - Debt security
Show show
1/Jan/2004 Bank a/c 4670
31/Dec Interest income 57 31/ Dec Bal c/d 4727
4727 4727
2005
1/Jan Bal b/d 4727
4789 4789
2006
1/Jan Bal b/d 4789
4855 4855
2007
1/Jan Bal b/d 4855
4926 4926
2008

93
1/Jan Bal b/d 4926
5000 5000
Interest income A/c
2004
31/Dec P & L 357 Bank a/c 300
Invest a/c 57
357 357
2005
31/Dec P & L 362 Bank a/c 300
Invest a/c 62
362 362
2006
31/Dec P & L 366 Bank a/c 300
Invest a/c 66
366 366
2007
31/Dec P & L 371 Bank a/c 300
Invest a/c71

94
371 371
2008
31/Dec P & L 374 Bank a/c 300
Invest a/c 74
374 374
4.4.3 Financial Instruments Disclosures – IFRS7
The nature of financial instruments is such that they are exposed to many risks. The objective of
IFRS is to require entities to disclose in the notes to accounts
a) The various risks that its Financial assets are exposed to and
b) Strategies that the management has adopted to identify and manage those risks.
Note:
IFRS7 requires the management to disclose these risks from the same point of view that the
risks are dealt with internally i.e. the internal reporting and structure for the risks should be
the same pattern used in the disclosures e.g. If the risk centers are products, markets,
competition etc, include the disclosure in the published accounts using the same risk centers
as used in the management accounts.
Types of financial instruments

95
1. Market risk
2. Credit risk
3. Liquidity risk
4. Cash flow risk
1. Market Risk
This refers to the possibility that the value of a Financial asset might go up or down. Market risk
is further sub-classified into 3 risks:-
a) Currency risk
This is the risk that the value of a financial instrument will fluctuate because of changes in forex
rates.
b) Interest Rate Risk
This is the risk that the value of a financial instrument will fluctuate due to changes in market
interest rates. E.g. On fixed interest bonds whose value is influenced by interest rates levels.
c) Price Risk
This refers to other factors that affect the value of a financial instrument. They may be specific to
a certain industry or general e.g. the weather may affect value of investments in agriculture
industry stocks.
2. Credit Risk
This is the risk that one party to a financial instrument fails to discharge its obligations causing a
financial loss to the other party e.g. default on loans in a bank.
3. Liquidity Risk (Funding Risk)

96
This is the risk that an enterprise will be unable to meet its commitments due to liquidity
problems.
4. Cash flow Risk
This is the risk that future cash flows associated with a financial instrument will fluctuate in
amount. E.g. Interest paid or received on a floating rate loan whose interest is dependent on
some other fluctuating factor like interest rate on government bills or bonds.
? Review questions
1. What do we mean by PPE?
2. Outline examples which may constitute the cost of a PPE.
3. Define and give examples of intangible assets.
4. Differentiate between purchased goodwill and internally generated goodwill.
5. What is the financial instrument asset?
6. ABC Ltd is a media developer. On 1st
Jan 2004 the company imported specialized electronic equipment from Japan.
The following costs were incurred

98
Mount Kenya University
UNIVERSITY EXAMINATION 2010/2011
SCHOOL OF BUSINESS AND PUBLIC MANAGEMENT
DEPARTMENT OF ACCOUNTING AND FINANCE
BACHELOR OF COMMERCE
UNIT CODE: BAF3101 TITLE: ACCOUNTING FOR ASSETS DATE:
APRIL 2011 MAIN TIME: 2HRS
Instructions
Answer question ONE which is compulsory and any other two questions
QUESTION ONE.
a) Define the following terms.
i.
ii.
Journal
Source documents
(2mks)
(2mks)
iii.
iv.
Accounting cycle.
Accounting theory
(2mks)
(2mks)
b) Discuss the effect of the following in a business
i. Too much cash (3mks)
ii. Too little cash (3mks)
c) Outline any three (3) costs which would be included as part of total cost of property plant and
equipment. (4mks)

99
d) Define the term intangible assets. Explain the critical attributes of an intangible asset.
(6mks)
e) In your own words explain the importance of assets to any business organization.
(6mks)
QUESTION TWO
On 1st
July 2004 Bidco (k) Ltd acquired a power generator from Japan in relation to the power
generation and the following cost was incurred.
i. Purchase price (marked price) – sh 3m 2.5% trade discount was guaranteed
ii. Insurance and freight – sh 860,000
iii. Non claimable duty – 150,000
iv. VAT sh 60,000 (claimable VAT)
v. Re – commencement testing which included abnormal losses of sh 20,000) sh 200,000
The equipment was put into use on 2nd
July 2004 and has a estimated useful life of 10 years and
residual values of NK life of 5years and residual values of NK
Account is prepared on 31st
December and depreciation on a straight line with proportionate
charge in the year of acquisition.
Required:
a) Compute the limited cost of the equipment. (5mks)
b) Depreciation charge for each of the year end 31 December 2004, 2005, and 2006.
(5mks)
c) Prepare extracts of the income statement and balance sheet. (10mks)
QUESTION THREE
Jeha & Rahu Ltd balance sheet for the year ended 30th September, 2008 and 30 September,
2007
Prepare a cash flow statement.

100
2008 sh‘000’ 2007 sh ‘000’
Non - current assets
Fixed assets 8,500,000 7000
Current assets
Stock 6,000 5,000
Debtors 1,750 1,800
Bank balance 2,630 1550
10,380 8350
Current liabilities
Creditors 1400 1300
Tax 1200 1100
Proposed dividends 400 350
3000 2750
Net current assets 7380 5600
Net assets 15880 12,600
Financed by:
Equity & reserves
Ordinary share capital 9000 7000
Retained earning 3880 3200
Debentures loan 3000 2400
15880 12600

101
The following additional information in given
i. During the year ended 30th
September, 2008 fixed assets were purchased at a cost of sh
2700,000 while fixed assets where original cost was sh 1000,000 were disposed for sh
750. The net book value of the assets disposed were sh 400,000 and the profit on sale of
the fixed asset has been included in retained profits
ii. Accumulated depreciation at 30 the September 2008 was sh 250,000 and sh 2300,000 at
September 2007.
QUESTION FOUR
The balance sheet of Matabu (k) Ltd as at 31st
December 2008 was as below
Non - current assets sh ‘000’
Equipment 80,000
Current assets
Stock 50,000
Debtors 10,000
Cash 15,000
75,000
155,000
Equity & reserves
Ordinary share 100,000
Retained earning 30,000
Current liabilities
Account payable 25,000
155,000

102
At the value date, the company was acquired by Maisha (K) Ltd for sh 330 m.
The balance sheet values are assumed to be fair market values except the items equipment and
debtors.
Equipment needed a fair value adjustment of sh 5m.
Debtor needed a provision for doubtful to the extent of 5%
Required:
a. Fair value of net assets acquired (5mks)
b. Goodwill on acquisition (3mks)
c. In the books of Aisha Ltd goodwill acquired will be impaired over 4 years show how it
will appears in the financial statements for the years ended 31 December 2009 December
2010 December 2011 and December 2012. (12mks)
QUESTION FIVE
What is a cash flow statements (2mks)
i. Describe the basic classifications of cash flow’s items (6mks)
ii. Identify the users of cash flow statement and how they benefit from the information.
(6mks)
b) Other then goodwill gives three (3) examples of intangible assets. (3mks)
6. For the year ended 31 December Mt Kenya University had rented house in Eldoret for sh
300, 000 per month. The agreement provided payment of 3 year rent in advance
You are required top show how appropriate adjustment will be made in the book of Mt Kenya as
at year end. (5mks)

ACCOUNTING FOR ASSETS

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