ACCA FIA Financial Accounting (FFA FA) Teaching Slides 2020

Foundations in
Accountancy/ACCA
Financial Accounting (FFA/FA)
For exams from 1 September 2020 to 31 August 2021
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Key to icons
Syllabus Real world example
Technical content Case study
Question to consider Diagram
Answer Key concept
Past exam question Tackling the exam
Answer to past exam Summary

question
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Syllabus
A The context and purpose of financial reporting

B The qualitative characteristics of financial information
C The use of double entry and accounting systems
D Recording transactions and events
E Preparing a trial balance
F Preparing basic financial statements
G Preparing simple consolidated financial statements
H Interpretation of financial statements
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Exam format
Exam format
35 questions for 2 marks each 70
2 questions for 15 marks each 30
Total 100
Two hour exam – all questions are compulsory.

The Specimen Exam for FA/FFA can be found at:
www.accaglobal.com/gb/en/student/exam-support-
resources/fundamentals-exams-study-resources/f3/past-pilot-papers.html
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Tackling multiple choice questions 1
The MCQs in your exam contain four possible answers, you

have to choose the option that best answers the question.
• The three incorrect options are called distracters, these

are included to test your understanding of the syllabus.
• The following slides detail how best to avoid the common
pitfalls that most students fall into.
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Steps to follow when attempting MCQs:
Step 1: Skim read all MCQs and identify what appear to be

the easier questions.
Step 2: Attempt each question:

• Start with the easier questions
• Read the question thoroughly
• Try to work out the answer before looking at the options
OR you may prefer to look at the options at the beginning
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Step 3: Read the four options and see if one matches your
own answer.
Be careful with numerical questions as the distracters are

designed to match answers that incorporate common errors.
Check your calculation is correct.

Have you followed the requirement exactly?
Have you included every stage in the calculation?
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Step 4: What to do if your answer does not match the

options?
• Re-read the question to ensure that you understand it and

are answering the requirement
• Eliminate any obviously wrong answers
• Consider which of the remaining answers is the most likely
to be correct and select the option
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Step 5: If you are still unsure make a note and continue to

the next question.
Step 6: Revisit unanswered questions. When you come back

to a question after a break you often find you are able to
answer it correctly straight away.
If you are still unsure have a guess. You are not penalised
for incorrect answers, so never leave a question
unanswered!
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After extensive question practice and revision of MCQs you

may find that you recognise a question when you sit the
exam.
Be aware that the detail and/or requirement may be different.

If the question seems familiar read the requirement and
options carefully – do not assume that it is identical.
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Chapter 1 • The purpose of financial reporting
• Types of business entity
Introduction to • Users
accounting • Governance
• The main financial statements
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Syllabus learning outcomes 1
• Define financial reporting and understand the nature,

principles and scope of financial reporting.
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• Identify and define the different business entities of: sole

trader, partnership and limited liability company and
recognise the legal differences between them.
• Identify the advantages and disadvantages of operating as
each of the three types of business entity.
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• Identify the users of financial statements and state and

differentiate between their information needs.
• Understand and identify the purpose of each of the main
financial statements.
• Define and identify assets, liabilities, equity, revenue and
expenses
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• Explain what is meant by governance specifically in the

context of the preparation of financial statements.
• Describe the duties and responsibilities of directors and
other parties covering the preparation of financial
statements.
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Overview
Statement of financial
Statement of profit or loss
position
Users of financial
Financial statements
information
Governance Introduction
to accounting
Types of business
entities
Limited liability
Sole trader Partnership
company
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The purpose of financial reporting 1
• Financial reporting is a way of recording, analysing

and summarising financial data.
• Financial data is the name given to the actual
transactions carried out by a business eg sales of goods.
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The purpose of financial reporting 2
• Financial data is recorded in the books of prime entry.

• Transactions are analysed in the books of prime entry
and the totals are posted to the ledger accounts.
• The transactions are summarised in the financial
statements.
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Types of business entity 1
What is a business?
• A business of whatever size or nature exists to make a
profit.
• Profit occurs when income exceeds expenses.
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Types of business entity 2
Types of business entity

• Sole traders – refers to ownership, sole traders can have
employees
• Partnerships – two or more people working together to
earn profits
• Limited liability company – owners have liability limited
to the amount they pay for their shares.
• A limited liability company has a separate legal identity
from its owners.
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Users
Users of accounts
• Managers of the company
• Shareholders of the company
• Trade contacts
• Providers of finance to the company
• Taxation authorities
• Employees of the company
• Financial analysts and advisors
• Government and their agencies
• The public
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Tackling the exam
Exam focus point:

The needs of users can be easily examined.
For example, you could be given a list of types of information
and asked which user group would be most interested in this
information.
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Discussion question
Required
What information would these users of financial information
be interested in?
(a) Investors
(b) Employees
(c) Lenders
(d) Suppliers
(e) Customers
(f) Governments and their agencies
(g) Public
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Answer to discussion question
Users of financial information

(a) Investors
— Profitability
— Future prospects
— Likely risk and return
— Chance of capital growth
— Ability to pay dividends
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Answer to discussion question (cont'd)
(b) Employees
— Profitability
— Long-term growth
— Security of their job
— Likelihood of bonus
— Number of employees
— Ability to pay retirement benefits
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(c) Lenders
— Whether return on finance will continue to be met
— Other providers and security of their debt
— Likelihood of repayment of capital amount
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(d) Suppliers
— Likelihood of payment on time
— Likelihood of payment at all
— Whether they should continue to supply
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(e) Customers
— Ability of entity to continue supplying
— Profitability as a measure of value for money of
goods bought
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(f) Governments and their agencies

— Statistics
— Size of company
— Growth rates
— Average payment periods
— Foreign trade
— Profits made
— Corporate income tax liability
— Sales tax liability
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(g) Public
— Contribution to local economy
— Information about trends in the prosperity of the
entity
— Range of activities provided
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The main financial statements 1
• The statement of financial position is a list of all the

assets owned and all the liabilities owed by a business
at a particular date.
• An asset is a resource controlled by an entity as a
result of past events and from which future economic
benefits are expected to flow to the entity.
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• A liability is a present obligation of the entity arising

from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying
economic benefits.
• Equity is the residual interest in the assets of the entity
after deducting all its liabilities.
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• A statement of profit or loss is a record of income

generated and expenditure incurred over a given
period.
• Income is increases in economic benefits during the

accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that
result in increases in equity, other than those relating to
contributions from equity participants.
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• Expenses are decreases in economic benefits during

the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result
in decreases in equity, other than those relating to
distributions to equity participants.
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Governance
Directors
• Main aim – to create wealth for shareholders.
• Have a duty of care to show reasonable competence;
may have to indemnify the company against loss
caused by their negligence.
• Are in a fiduciary position in relation to the company
which means that they must act honestly in what they
consider to be the best interests of the company and in
good faith.
• Are responsible for the preparation of the financial
statements of the company.
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Chapter Summary 1
1 Accounting
▪ Accounting is a way of recording, analysing and
summarising a business's transactions.
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Chapter Summary 2
2 Accounting records
▪ All businesses must keep sufficient accounting records in
order to be able to produce accurate information about the
entity's activities.
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Chapter Summary 3
3 The concept of business entity

▪ The business entity concept states that a business is a
separate entity from its owners.
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Chapter Summary 4
4 Types of business entities

▪ There are three main types of businesses. For sole traders
and partnerships the owners have unlimited liability and
bear all the risks and reap all the rewards of being in
business. For a limited liability company the shareholders'
liability is limited to the extent of their investment.
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Chapter Summary 5
5 Users of financial information

▪ Financial statements are used by a wide variety of users,
each with different information needs. Satisfying the
investors' needs will mean that the majority of other users'
needs are also met.
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Chapter Summary 6
6 Proforma financial statements

▪ Companies must follow a prescribed format when
producing their financial statements, there is however no
set format for a sole trader's statement of profit or loss and
statement of financial position.
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Chapter Summary 7
7 Governance
▪ Corporate governance is the process by which businesses
are directed and controlled by those responsible for
running the business.
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Chapter 2 • The regulatory system
• IASB
The regulatory
framework
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• Understand the role of the regulatory system including the

roles of the:
— International Financial Reporting Standards Foundation
(IFRSF)
— International Accounting Standards Board (IASB)
— International Financial Reporting Standards Advisory
Council (IFRSAC)
— International Financial Reporting Standards
Interpretations Committee (IFRSIC)
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• Understand the role of International Financial Reporting

Standards (IFRS)
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Overview
Regulatory
framework
IFRSF
IFRS AC IASB IFRS IC
Issue IFRS
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The regulatory system 1
• Financial statements are produced by an entity's

managers in order to show its owners how the entity has
performed over a period of time.
• Company financial statements particularly need to show a
true and fair view.
• This means a system of regulation is necessary to ensure
that financial statements are produced to a high standard
and are comparable across different companies.
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Influences upon financial accounting

• National law – form and content of accounts may be
regulated by national legislation. 'Fair presentation'.
• Accounting standards – IASB produces standards.
• Accounting concepts and individual judgement can

lead to subjectivity; accounting standards developed to
address subjectivity.
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Influences upon financial accounting (cont'd)

• GAAP – Generally Accepted Accounting Principles –
drawn from: local company law, accounting standards,
statutory requirements in other countries and stock
exchanges
• Other international issues
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IASB 1
• The IASB develops International Financial Reporting

Standards (IFRSs).
• The parent entity of the IASB is the IFRS Foundation.
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IASB 2
• The main objectives of the IFRS Foundation are to:

— Develop a single set of high quality, understandable,
enforceable and globally accepted IFRSs through
standard-setting body IASB
— Promote use and rigorous application of these
standards
— Take account of the needs of emerging economies and
SMEs
— Bring about convergence of national accounting
standards and IFRSs to high quality solutions
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IASB 3
Monitoring board
IFRS Foundation
IFRS Advisory
IASB
Council
Appoints
IFRS Interpretations
Reports to Committee (IFRSIC)
Advises
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Lecture example 1
Which body oversees the work of the International

Accounting Standards Board?
A The IFRSIC
B The IFRSF
C The IASB
D The IFRSAC
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Answer to lecture example 1
B The IFRSF
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Lecture example 2
Which of the following bodies is involved is trying to achieve

convergence of global accounting standards?
A The IASB
B The IFRSIC
C The IFRSF
D The IFRSAC
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A The IASB is trying to achieve convergence by getting

greater acceptance of IFRSs globally.
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Lecture example 3
International Financial Reporting Standards are prepared by:

A The IFRS Foundation
B The IASB
C The IAASB
D The accounting bodies of each country
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B IFRSs are prepared by the IASB.
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Lecture example 4
Which of the following best describes the role of the

International Financial Reporting Standards Interpretations
Committee?
A Issues International Financial Reporting Standards
B Provides advice on the development of standards
C Interprets International Financial Reporting Standards
D Investigates listed companies to ensure they comply
with International Financial Reporting Standards
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C IFRSIC interprets International Financial Reporting

Standards
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Chapter summary 1
1 Regulatory system
▪ Financial statements are relied on by many different user
groups to make economic decisions. A system of
regulation is therefore necessary to ensure that the
information produced is of a high standard.
▪ The IFRSF appoints members to the IASB, IFRSIC and
IFRSAC.
▪ The IASB issues International Financial Reporting
Standards.
▪ The IFRSIC issues guidance on how to apply accounting
standards.
▪ The IFRSAC advises the IASB on its agenda.
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Chapter summary 2
2 The role of international financial reporting standards

▪ International financial reporting standards give guidance
as to how transactions should be recorded in the
accounts.
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Chapter 3 • The IASB's Conceptual
Framework
• Qualitative characteristics of
The qualitative financial information
characteristics of
financial information
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Syllabus learning outcomes
• Define, understand and apply qualitative characteristics.

• Define, understand and apply accounting concepts
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Overview
The qualitative characteristics of

financial information
The objective of
Underlying assumption
financial statements
IASB Conceptual Framework
Qualitative characteristics Elements of financial

of financial information statements
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The IASB's Conceptual Framework 1
Underlying assumption
Going concern
• The financial statements are normally prepared on the
assumption that an entity is a going concern and will
continue in operation for the foreseeable future.
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Not an underlying assumption but accounts should be

prepared on an accruals basis:
Accruals basis
• The effects of transactions and other events are
recognised when they occur (and not as cash or its
equivalent is received or paid) and they are recorded in
the accounting records and reported in the financial
statements of the periods to which they relate.
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Qualitative characteristics
Two fundamental qualitative characteristics:
• Relevance
• Faithful representation
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Relevance
• Information is relevant when it influences decisions of
users, affected by nature and materiality.
• Materiality: information is material if its omission or
misstatement could influence the economic decisions of
users taken on the basis of the financial statements.
Faithful representation
• Financial information must faithfully represent the
underlying economic phenomena.
• Complete, neutral, free from error.
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Enhancing characteristics
• Comparability
• Verifiability
• Timeliness
• Understandability
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Comparability
• Users must be able to compare financial statements
through time and with other entities
• Disclose accounting policies
• Disclose corresponding information for comparative
periods
Verifiability
• Information that can be independently verified
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Timeliness
• Information is available in time to be capable of
influencing decisions
Understandability
• Users must be able to understand financial statements
• Users assumed to have some economic, business and
accounting knowledge
• Complex matters should not be left out if relevant
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Other concepts
Business entity concept

• In accounting, the business is treated as separate to its
owners. Not the same as limited liability!
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Fair presentation
• Financial statements are required to present fairly in all
material respects the financial results and position of the
business.
• Compliance with IFRSs will achieve this.
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Consistency
• Presentation and classification of items should remain
consistent from one period to the next.
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Tackling the exam
Exam focus point:
Always read the question carefully before answering. Make

sure that you understand the requirement and have picked
out the main points of the question. This may sound obvious
but the FA/FFA examiner regularly comments that students
have failed to read the question.
The syllabus shows that you must understand and be able to

apply both qualitative characteristics and accounting
concepts. Do not neglect this section.
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Specimen exam question
Source: ACCA FA/FFA Financial Accounting Specimen Exam
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Specimen exam answer
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Chapter summary 1
1 The IASB's Conceptual Framework

▪ Financial statements should present fairly the activities of
an entity for a particular period.
▪ The IASB's Conceptual Framework provides a set of
principles on which financial accounting is based.
▪ The objective of financial statements is to provide
information on an entity's financial position, financial
performance and financial adaptability. The accruals
basis requires that transactions are recognised when they
occur rather than when any cash is received or paid.
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Chapter summary 2
▪ The going concern basis assumes that the entity will

continue in operation for the foreseeable future.
▪ In order for the information in the financial statements to
be useful it should possess the fundamental
characteristics of relevance and faithful representation
and the enhancing characteristics of comparability,
verifiability, timeliness and understandability.
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Chapter 4 • Statement of financial position
• Statement of profit or loss
Sources, records • The role of source documents
and books of prime • Sales and purchase day books

• Cash books
entry
• Controlling petty cash – the
imprest system
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• Identify and explain the function of the main data sources

in an accounting system
• Understand how the accounting system contributes to
providing useful information and complies with
organisational policies and deadlines.
• Outline the contents and purpose of different types of
business documentation, including: quotation, sales order,
purchase order, goods received note, goods despatched
note, invoice, statement, credit note, debit note, remittance
advice, receipt.
• Identify the main types of business transactions, for
example, sales, purchases, payments and receipts.
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• Identify the main types of ledger accounts and books of

prime entry, and understand their nature and function.
• Record sale, purchase and cash transactions in the ledger
accounts
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• Understand the need for a record of petty cash

transactions.
Note. The following slides introduce the accounting terms

Statement of financial position and Statement of profit or loss.
These will be explained fully as we progress through the
later chapters.
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Overview
position
Sources, records and

books of prime entry
Books of prime entry Memorandum ledgers
Sales day Purchase day Petty cash

Cash book Journal book
book book book
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Lecture example 1
Required
List out everything you own and owe.
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Own
— Examples:
(i) House
(ii) Bicycle
(iii) Cash
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Answer to lecture example 1 (cont'd)
Owe
— Examples:
(i) Mortgage
(ii) Bank loan
(iii) Credit card
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Statement of financial position
For a business, this list is formalised as a statement of

financial position and shows the entity's assets and
liabilities.
• Asset: is a resource controlled by the entity as a result
of past events and from which future economic
benefits are expected to flow to the entity.
• Liability: is a present obligation of the entity arising
from past events, the settlement of which is expected
to result in an outflow of economic benefits.
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Key features 1
• Always headed 'as at', for the date of the statement of

financial position.
• Non-current assets – assets held and used in the
business over the long-term (ie more than one year).
• Current assets – not non-current assets! Conventionally
listed in increasing order of liquidity (ie closeness of assets
to cash).
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Key features 2
• Capital: what the business owes the proprietor/owner. In

this case the sole trader owns all of the business, ie its
total net worth.
• Don't include a caption (item heading) if there isn't a value
for it.
The statement of financial position is a snapshot of the

business at one point in time.
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Statement of profit or loss 1
A statement of profit or loss for a sole trader will have the

following key features:
• Headed up with the period for which the income and
expenses are being included.
• The top part is the trading account which records sales,
less cost of sales, to arrive at the gross profit.
• Expenses (rent, electricity, wages and salaries etc) are
deducted from the gross profit to arrive at the profit for
the year.
• Do not include nil value captions.
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Profit is the excess of total income over total expenditure. If

expenditure exceeds income, the business has made a loss.
The statement of profit or loss is a summary of the

business's performance over a period of time.
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The role of source documents 1
Types of source documents

• Quotation
• Sales order
• Purchase order
• Invoice
• Credit note
• Debit note
• Goods received note
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Books of prime entry

• The source documents are recorded in books of prime
entry.
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The main books of prime entry

• Sales day book
• Purchase day book
• Sales returns day book
• Purchase returns day book
• Journal
• Cash book
• Petty cash book
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Sales and purchase day books 1
Sales day book

• The sales day book is used to keep a list of all invoices
sent out to credit customers each day.
Sales day book

The sales day book is used to keep a list of all invoices sent
out to credit customers each day. Here is an example.
SALES DAY BOOK
Date Invoice number Customer Rec'bles ledger ref. Total invoiced
$
3.3.X9 207 ABC & Co SL 12 4,000
208 XYZ Co SL 59 1,200
5,200
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Sales and purchase day books 2
Purchase day book

• This is used to keep a record of invoices which a business
receives for credit purchases.
Purchases day book

This is used to keep a record of invoices which a business
receives for credit purchases. Here is an example.
PURCHASES DAY BOOK
Date Supplier Payables ledger ref. Total invoiced
$
3.4.X9 RST Co PL31 215
10.4.X9 JMU Inc PL19 1,804
15.4.X.9 DDT & Co PL24 758
2,777
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Cash books 1
Cash book
• Cash receipts and payments are recorded in the cash
book.
Cash receipts are recorded as follows, with the total column
analysed into its component parts.
CASH RECEIPTS
Date Narrative Total Rec'bles ledger Cash sales Sundry

$ $ $ $
3.3.X9 Cash sale 150 150
ABC & Co 1,000 1,000
1,150 1,000 150 –
• Cash payments are recorded in a similar way.
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Cash books 2
Petty cash book

• Petty cash payments and receipts are recorded in a petty
cash book.
Most businesses keep a small amount of cash on the

premises for small payments, eg stamps, coffee.
PETTY CASH BOOK
RECEIPTS PAYMENTS
Date Narrative Total Date Narrative Total Stationery Coffee etc
$ $ $ $ $ $
3.3.X9 Bank 50 3.3.X9 Paper 10 10
Coffee 5 5
50 15 10 5
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Cash books 3
Petty cash imprest system

• Under the 'imprest system':
Cash still held in petty cash X
Plus voucher payments X
Must equal the agreed sum or float X
• Reimbursement is made equal to the voucher payments to

bring the float back up to the imprest amount.
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Controlling petty cash – the imprest system
An imprest system acts as an accounting control by having a

set amount of petty cash.
• Pre-set limit, say $50

• Voucher filled in when money is taken out to pay
expenses
• At any time, vouchers + cash = pre-set limit
• At the end of the week/month, the petty cash book is filled
in from the vouchers
• The amount needed to bring the balance back up to the
pre-set limit = money spent
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Tackling the exam
Exam focus point:
You will not get numerical questions on the imprest system in

your exam. However, you do need to be aware of how the
imprest system works.
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Chapter summary 1
1 Statement of financial position

▪ The statement of financial position shows the assets and
liabilities of a business at a particular point in time.
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Chapter summary 2
2 The statement of profit or loss

▪ The statement of profit or loss shows its performance over
a period.
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Chapter summary 3
3 The relationship between the statements of financial

position and profit or loss
▪ The statement of profit or loss largely explains the
movement between the business's assets and liabilities at
the beginning of the year and at the end of the year.
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Chapter summary 4
4 From business transactions to financial statements

▪ A business will enter many transactions during the year. All
of these need to be recorded and summarised to produce
the entity's financial statements.
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Chapter summary 5
5 Books of prime entry

▪ The business's transactions must first be categorised into
the books of prime entry. The cash book records money
paid in to and out of the bank account; the sales day book
records credit sales; the purchase day book records
credit purchases; the petty cash book records
transactions made in petty cash and the journal book is
used to correct errors and make other adjustments such
as accruals and prepayments. The totals on these books
are then summarised in the nominal ledger.
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Chapter 5 • The nominal ledger
• The accounting equation
Ledger accounts • Double entry bookkeeping
and double entry • The journal

• Day book analysis
• The receivables and payables
ledgers
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• Understand and apply the concept of double entry

accounting and the duality concept.
• Identify the main types of ledger account understand their
nature and function
• Illustrate how to balance and close a ledger account
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• Understand and illustrate the uses of journals and the

posting of journal entries into ledger accounts.
• Identify correct journals from given narrative.
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• Record credit sale; credit purchase and cash transactions

in ledger accounts and day books.
• Understand and record sales and purchase returns.
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Overview
Ledger accounts
and double entry
Ledger accounts Double entry
Balancing off Debit Credit
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The nominal ledger 1
Ledger accounting and double entry

• Method used to summarise transactions in the books of
prime entry
• A ledger account or 'T' account looks like this:
NAME OF ACCOUNT
$ $
DEBIT SIDE CREDIT SIDE
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The nominal ledger

• Is an accounting record which summarises the financial
affairs of a business
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Accounts within the nominal ledger include the following.

• Plant and machinery (non-current asset)
• Inventories (current asset)
• Sales (income)
• Rent (expense)
• Total payables (current liability)
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The accounting equation 1
The accounting equation

• CAPITAL + LIABILITIES = ASSETS
Capital
• Investment of funds with the intention of earning a return
Drawings
• Amounts withdrawn from the business by the owner
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The accounting equation 2
The accounting equation is based on the principle that an

entity is separate from the owner, ie the business entity
concept.
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Double entry bookkeeping 1
Basic principles
• Double entry bookkeeping is based on the same idea as
the accounting equation.
• Every accounting transaction has two equal but opposite
effects.
• Equality of assets and liabilities is preserved.
• In a system of double entry bookkeeping every accounting
event must be entered in ledger accounts both as a debit
and as an equal but opposite credit.
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A debit entry will:

• Increase an expense
• Increase an asset
• Decrease a liability
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A credit entry will:

• Decrease an asset
• Increase a liability
• Increase income
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Double entry bookkeeping

• The rules of double entry bookkeeping are best learnt by
considering the cash book.
• A credit entry indicates a payment made by the business;
the matching debit entry is then made in an account
denoting an expense paid, an asset purchased or a liability
settled.
• A debit entry in the cash book indicates cash received by
the business; the matching credit entry is then made in an
account denoting revenue received, a liability created or
an asset realised.
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Lecture example 1
Required
What is the double entry for each of the following?
Explain each entry in terms of the general rules above.
(a) Sales for cash
(b) Sales on credit
(c) Purchase for cash
(d) Purchase on credit
(e) Pay electricity bill
(f) Receive cash from a credit customer
(g) Pay cash to a credit supplier
(h) Borrow money from the bank
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Lecture example 2
Douglas
• Douglas had the following transactions during January:
(1) Introduced $5,000 cash as capital
(2) Purchased goods on credit from Richard, worth $2,000
(3) Paid rent for one month, $500
(4) Paid electricity for one month, $200
(5) Purchased car for cash, $1,000
(6) Sold half of the goods on credit to Tish for $1,750
(7) Drew $300 for his own expenses
(8) Sold goods for cash, $2,100
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Lecture example 2 (cont'd)
Required
Post transactions (1) to (8) to the relevant ledger
accounts.
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Lecture example 3
The following information has been posted to the cash

account below.
Required
Balance off the cash account to determine the amount of
cash held at the end of January.
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The journal
The journal
• Book of prime entry
• Keeps a record of unusual movements between accounts
• Format of journal entries is as follows:
Date Debit Credit
$ $
DEBIT A/c to be debited X
CREDIT A/c to be credited X
Narrative to explain transaction
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Tackling the exam
Exam focus point:
An examination question might ask you to 'journalise'

transactions which would not in practice be recorded in the
journal at all. If you are faced with such a problem, you
should simply record the debit and credit entries for every
transaction.
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Day book analysis 1
Day book analysis

• Entries in the day books are totalled and analysed before
posting to the nominal ledger.
• Note that day books are often analysed as in the following
extract (date, customer name and reference not shown).
Total invoiced Calculator sales Book sales
$ $ $
340 160 180
120 70 50
600 350 250
Total 1,060 580 480
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Day book analysis 2
• To identify sales by product, total sales would be entered

('posted') as follows.
$ $
DEBIT Receivables a/c 1,060
CREDIT Sales: Calculators 580
Sales: Books 480
• Other books of prime entry are analysed in a similar way.
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The receivables and payables ledgers 1
Trade account receivable

• A customer who buys goods without paying for them
straight away (an asset)
• Also known as a debtor
Trade account payable

• A person to whom a business owes money (a liability)
• Also known as a creditor
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Receivables and payables ledgers

• To keep track of individual customer and supplier balances
it is common to maintain subsidiary ledgers called the
receivables ledger and the payables ledger. Each
account in these ledgers represents the balance owed by
or to an individual customer or supplier.
• These receivables and payables ledgers are usually kept
purely for reference and are therefore known as
memorandum records. They do not form part of the
double entry system.
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• However, some computerised accounting packages treat the

receivables and payables ledgers as part of the double entry
system, in which case separate control accounts are not
kept.
Entries to the receivables ledger are made as follows:
• When making an entry in the sales day book, an entry is then
made on the debit side of the customer's account in the
receivables ledger.
• When cash is received and an entry made in the cash book,
an entry is also made on the credit side of the customer's
account in the receivables ledger.
• The payables ledger operates in much the same way.
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Flow of information
Assorted transactions
Categorised in books of
prime entry
TOTALS
double entry
Posted to nominal ledger
FINANCIAL STATEMENTS
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Chapter summary 1
1 Introduction
▪ In Chapter 4 the totals on the books of prime entry were
summarised in the nominal ledger. These amounts are
posted to the nominal ledger using double entry.
▪ The principles of double entry work on the basis that for
each debit entry there must be a credit entry. This is also
known as the dual effect.
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Chapter summary 2
2 Ledger accounts
▪ A debit entry increases assets, expenses and drawings
and a credit entry increases liabilities, income and capital
– this can be remembered as DEAD CLIC.
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Chapter summary 3
3 Flow of information
▪ A business' transactions are categorised in the books of
prime entry and the totals are then posted to the nominal
ledger. A trial balance (Chapter 6) can then be extracted
from the balances on the nominal ledger accounts and the
statement of financial position and statement of profit or
loss produced.
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Chapter summary 4
4 Balancing off the ledger accounts

▪ At the end of each period the nominal ledger accounts
(T accounts) are 'balanced off' to determine the closing
balance on each account.
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Chapter summary 5
5 Memorandum ledgers
▪ There are two memorandum ledgers: the receivables
ledger and the payables ledger. The receivables ledger
shows how much the business is owed by each
individual customer at a point in time and the payables
ledger shows how much it owes to each individual
supplier at any point in time.
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Chapter 6 • The trial balance
• Statement of profit or loss
From trial balance to • Statement of financial position
financial statements • Preparing financial statements
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• Identify the purpose of a trial balance

• Extract ledger balances into a trial balance
• Prepare extracts of an opening trial balance
• Identify and understand the limitations of a trial balance
• Understand and apply the accounting equation
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Overview
Trial balance
From trial balance

to financial statements
position
Accounting equation
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The trial balance 1
Balancing ledger accounts

• At the end of an accounting period a balance is struck on
each ledger account.
• Total all debits and credits
• Debits exceed credits = debit balance
• Credits exceed debits = credit balance
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The trial balance 2
• An example of balancing a ledger account is shown below
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The trial balance 3
Trial balance
• The balances are then collected in a trial balance. If the
double entry is correct, total debits = total credits.
• An example of a trial balance, incorporating the above
receivables balance, is shown on the next slide.
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The trial balance 4
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Lecture example 1
• Douglas
Cash
$ $
Capital 5,000 Rent 500
Sales 2,100 Electricity 200
Car 1,000
Drawings 300
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Capital
$ $
Cash 5,000
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Trade payables
$ $
Purchases 2,000
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Purchases
$ $
Trade payables 2,000
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Rent
$ $
Cash 500
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Electricity
$ $
Cash 200
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Car
$ $
Cash 1,000
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Drawings
$ $
Cash 300
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Trade receivables
$ $
Sales 1,750
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Sales
$ $
Trade receivables 1,750
Cash 2,100
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Required
Balance off the ledger accounts for Douglas
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Cash
$ $
Capital 5,000 Rent 500
Sales 2,100 Electricity 200
Car 1,000
Drawings 300
Bal c/d 5,100
7,100 7,100
Bal b/d 5,100
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Capital
$ $
Bal c/d 5,000 Cash 5,000
5,000 5,000
Bal b/d 5,000
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Trade payables
$ $
Bal c/d 2,000 Purchases 2,000
2,000 2,000
Bal b/d 2,000
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Purchases
$ $
Trade payables 2,000 Bal c/d 2,000
Bal b/d 2,000
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Rent
$ $
Cash 500 Bal c/d 500
Bal b/d 500
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Electricity
$ $
Bal b/d 200
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Car
$ $
Cash 1,000 Bal c/d 1,000
Bal b/d 1,000
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Drawings
$ $
Bal b/d 300
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Trade receivables
$ $
Sales 1,750 Bal c/d 1,750
Bal b/d 1,750
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Sales
$ $
Bal c/d 3,850 Trade receivables 1,750
Cash 2,100
3,850
3,850 Bal b/d 3,850
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Lecture example 2
Douglas
• Refer to Lecture example 1 where the ledger accounts
were balanced off.
• Using the ledger accounts for Douglas, prepare the trial
balance as at the end of January.
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Trial Balance
Debit Credit
Cash $ $
Capital 5,100
Purchases 2,000
Rent 2,000
Electricity 500
Car 200
Drawings 1,000
Trade receivables 300
Sales 1,750
3,850
10,850 10,850
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• First open up a ledger account for the statement of profit or
loss. Continuing our example for ABC Traders this ledger
account is shown below, together with the rent account to
illustrate how balances are transferred to it at the end of
the year.
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ABC TRADERS
STATEMENT OF PROFIT OR LOSS
FOR THE YEAR ENDED 30 JUNE 20X7
$ $
Sales 35,000
Cost of sales (here = purchases) 13,000
Gross profit 22,000
Expenses
Rent 4,000
Sundry expenses 3,500
Loan interest 1,000
8,500
Net profit 13,500
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Statement of profit or loss 3 – Transferring
Rent
$ $
Cash 4,000 Bal c/d 4,000
Bal b/d 4,000 SPL 4,000
SPL
Rent 4,000
NB: The remaining profit or loss account balances are also then
transferred to the statement of profit or loss account as
illustrated above.
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Lecture example 3
• Douglas
Refer to Lecture example 2.
Required
Prepare a statement of profit or loss in ledger account form.
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Purchases
$ $
Creditors 2,000 Bal c/d 2,000
Bal b/d 2,000 SPL 2,000
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Rent
$ $
Bal b/d 500 SPL 500
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Electricity
$ $
Bal b/d 200 SPL 200
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Sales
$ $
Bal c/d 3,850 Trade receivables 1,750
Bal b/d 200 Cash 2,100
3,850 3,850
SPL 3,850 Bal b/d 3,850
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$ $
Purchases 2,000 Sales 3,850
Gross profit c/d 1,850 0
3,850 3,850
Rent 500 Gross profit b/d 1,850
Electricity 200
Net profit c/d 1,150 0
1,850 1,850
Net profit b/d 1,150
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Statement of financial position 1

• The statement of financial position is prepared by following
these steps.
• Balance off the accounts relating to assets and liabilities.
• Transfer the balances (per ABC Traders) on the drawings
account and the statement of profit or loss ($13,500) to the
capital account as follows:
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DRAWINGS
$ $
Cash 5,000 Capital 5,000

$ $
Rent 4,000
Sundry expenses 3,500
Loan interest 1,000
Capital a/c 13,500
35,000 35,000
CAPITAL
$ $
Drawings 5,000 Capital 10,000
Balance c/d 18,500 SPL 13,500
23,500 23,500
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• This gives us the statement of financial position as follows:
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Lecture example 4
• Douglas
Refer to Lecture example 2 and Lecture example 3.
Required
Draw up a statement of profit or loss for the period and a
statement of financial position at the end of January.
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DOUGLAS
STATEMENT OF PROFIT OR LOSS FOR THE MONTH OF JANUARY
$ $
Sales 3,850
Less cost of sales:
Purchases 2,000
2,000
Gross profit 1,850
Less expenses:
Rent 500
Electricity 200
(700)
Net profit 1,150
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DOUGLAS
STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY
$ $
NON-CURRENT ASSET
Motor Vehicle 1,000
CURRENT ASSETS

Cash 5,100
6,850
7,850
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$ $
PROPRIETOR'S INTEREST
Capital introduced on 1 January 5,000
Profit for the year 1,150
Less: drawings (300)
Balance 31 January 5,850
CURRENT LIABILITIES
7,850
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Lecture example 5
• Douglas
Required
Transfer the profit and drawings to the capital account.
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Drawings
$ $
Bal b/d 300 Capital 300
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$ $
Gross profit c/d 1,850 0
3,850 3,850
Rent 500 Gross profit b/d 1,850
Electricity 200
Net profit c/d 1,150 0
1,850 1,850
Capital 1,150 Net profit b/d 1,150
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Capital
$ $
Bal c/d 5,000 Cash 5,000
Drawings 300 Bal b/d 5,000
Bal c/d 5,850 Net profit 1,150
6,150 6,150
Bal b/d 5,850
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Lecture example 6
• Douglas
Required
Prepare the accounting equation for Douglas.
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Assets = capital + (profit – drawings) + payables
7,850 = 5,000 + (1,150 – 300) + 2,000
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Preparing financial statements
Accounting process overview
Receipt/
Invoice Payment Invoice
Receivables Sales day Purchase Payables

Cash book
ledger book day book ledger
Dr Cr
Dr Dr
General
ledger
Cr Cr
Preliminary trial balance

Journal
Dr
eg closing
inventory Cr
Clear income and expenditure
balances to SPL
Clear profit and drawings

balances to capital account
Prepare statement of financial position
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Tackling the exam
Exam focus point:
Practising the techniques illustrated in this chapter is

essential in preparing for the FA/FFA exam.
You are likely to get a question requiring you to calculate a

figure for the statement of financial position or statement of
profit or loss from a trial balance, particularly the 15 mark
questions.
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Chapter summary 1
1 Introduction
▪ Once a business's transactions have been categorised in
the books of prime entry and summarised in the nominal
ledger accounts the next step is to extract a trial balance.
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Chapter summary 2
2 The trial balance

▪ The trial balance consists of a list of the balances
brought down on each ledger account.
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Chapter summary 3
3 The statement of profit or loss

▪ The balances on all of the income and expenditure ledger
accounts are transferred to the statement of profit or loss.
▪ As we will see later the statement of profit or loss will be
affected by certain adjustments that will affect profit (such
as closing inventory).
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Chapter summary 4
4 The statement of financial position

▪ The statement of financial position lists out the balances
on all of the asset and liability ledger accounts.
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Chapter summary 5
5 The accounting equation

▪ The accounting equation expresses the statement of
financial position as an equation:
▪ Assets = capital + profit – drawings + payables
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Chapter 7 • Cost of goods sold
• Accounting for opening and closing
inventories
Inventory
• Counting inventories
• Valuing inventories
• IAS 2 Inventories
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• Recognise the need for adjustments for inventory in

preparing financial statements.
• Record opening and closing inventory.
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• Identify the alternative methods of valuing inventory.

• Understand and apply the IASB requirements for valuing
inventories.
• Recognise which costs should be included in valuing
inventories.
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• Understand the use of continuous and period end

inventory records.
• Calculate the value of closing inventory using 'first in, first
out' and 'average cost' (both periodic weighted average
and continuous weighted average).
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• Understand the impact of accounting concepts on the

valuation of inventory.
• Identify the impact of inventory valuation methods on profit
and on assets.
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Overview
Accounting adjustments
Inventory
Valuation Effects on profit
Cost Net realisable value
Methods of estimating cost
FIFO AVCO
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Cost of goods sold 1
• Formula for the cost of goods sold

$
Opening inventory value X
Add: purchases (or production costs) X
X
Less: closing inventory value (X)
Cost of goods sold X
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Carriage inwards
• Cost paid by purchaser of having goods transported to his
business
• Added to cost of purchases
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Carriage outwards
• Cost to the seller, paid by the seller, of having goods
transported to customer
• Is a selling and distribution expense
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Accounting for opening and closing inventories 1
Entries during the year

• During the year, purchases are recorded by the following
entry.
DEBIT Purchases $ amount bought

CREDIT Cash or payables $ amount bought
• The inventory account is not touched at all.
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Entries at year-end
• The first thing to do is to transfer the purchases account
balance to the statement of profit or loss:
DEBIT Statement of profit or loss $ total purchases

CREDIT Purchases $ total purchases
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• The balance on the inventory account is still the opening

inventory balance. This must also be transferred to the
statement of profit or loss:
DEBIT Statement of profit or loss $ opening inventory

CREDIT Inventory $ opening inventory
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• The exact reverse entry is made for the closing inventory

(which will be next year's opening inventory):
DEBIT Inventory $ closing inventory

CREDIT Statement of profit or loss $ closing inventory
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Counting inventories 1
Counting inventories
• In order to make the entry for the closing inventory, we
need to know what is held at the year-end. We find this out
not from the accounting records, but by going into the
warehouse and actually counting the boxes on the
shelves.
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Counting inventories 2
• Some businesses keep detailed records of inventory

coming in and going out, so as not to have to count
everything on the last day of the year. These records are
not part of the double entry system.
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Valuing inventories 1
Valuation
Inventories must be valued at the lower of:
• Cost
• Net realisable value (NRV)
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Cost
Can use per IAS 2:
• FIFO (First In First Out)
• Average cost (both periodic weighted average and
continuous weighted average)
• LIFO (Last In First Out) is not permitted
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NRV
Expected selling price X
Less: costs to get items ready for sale (X)
selling costs (X)
X
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• Inventory forms a major part of the assets of some

companies.
• So the value placed on the inventory can make a big
difference to the profit or loss reported.
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IAS 2 Inventories
IAS 2
• Inventories should be measured at the lower of cost and
net realisable value – the comparison between the two
should ideally be made separately for each item.
• Cost is the cost incurred in the normal course of business
in bringing the product to its present location and
condition, including production overheads and costs of
conversion.
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IAS 2 Inventories 2
IAS 2
• Inventory can include raw materials, work in progress,
finished goods, goods purchased for resale.
• FIFO and average cost (both periodic weighted average
and continuous weighted average) are allowed.
• LIFO is not allowed.
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IAS 2 Inventories 3
Inventories are assets:

• Held for sale in the ordinary course of business;
• In the process of production for such sale; or
• In the form of materials or supplies to be consumed in the
production process or in the rendering of services.
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IAS 2 Inventories 4
Net realisable value is the estimated selling price:

• In the ordinary course of business less the estimated costs
of completion and the estimated costs necessary to make
the sale
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Tackling the exam
Understanding IAS 2 is a very important and you will be

expected to apply it in the exam.
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Lecture example 1
According to IAS 2 Inventories, which of the following

should not be included in determining the cost of the
inventories of an entity?
(1) Labour costs
(2) Transport costs to deliver goods to customers
(3) Administrative overheads
(4) Depreciation on factory machine
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A All four items

B 1 only
C 2 and 3 only
D 2, 3, and 4 only
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C
Transport costs to deliver goods to customers are an
example of carriage outwards and should not be included.
Administrative overheads do not relate to production and
cannot therefore be included.
The depreciation of the factory machine is a production
overhead and should be included.
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Lecture example 2
Jessie is trying to value her inventory. She has the

following information available:
$
Selling price 35
Costs incurred to date 20
Cost of work to complete item 12
Selling costs per item 1
Required
What is the net realisable value of Jessie's inventory?
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Net realisable value is:

$
Estimated selling price 35
Less: costs of completion (12)
Less: selling costs (1)
22
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Lecture example 3
On 1 January 20X7 a company held 200 units of finished

goods valued at $10 each. During January the following
transactions took place:
Date Units purchased Cost per unit
10 January 300 $10.85
20 January 350 $11.50
25 January 250 $13.00
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Sales during January were as follows:
Date Units sold Cost per unit

14 January 280 $18.00
21 January 400 $18.00
28 January 80 $18.00
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Required
Determine the valuation of closing inventories and cost of
sales using:
(a) FIFO
(b) Weighted average cost (continuous)
(c) Weighted average cost (periodic)
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(a) Closing inventories (FIFO)

Purchases
Opening 10 Jan 20 Jan 25 Jan
inventories
200 300 350 250
Sales
14 Jan (200) (80)
21 Jan (220) (180)
26 Jan (80)
Nil Nil 90 250
@ $11.50 @ $13.00
= $1,035 = $3,250
$4,285
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Cost of sales (FIFO)

$
Opening inventories (200 × $10) 2,000
Purchases 10,530
12,530
Less: closing inventories (4,285)
8,245
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(b) Closing inventories and cost of sales (AVCO – continuous)
Average Total Cost of
Units Cost Unit Cost Cost Sales
$ $ $ $
1.1.X2 b/f 200 10.00 2,000
10.1.X2 Purchase 300 10.85 3,255
500 (W1) 10.51 5,255
14.1.X2 Sales (280) 10.51 (2,943) 2,943
220 2,312
20.1.X2 Purchase 350 11.50 4,025
570 (W2) 11.12 6,337
21.1.X2 Sales (400) 11.12 (4,448) 4,448
170 1,889
25.1.X2 Purchase 250 13.00 3,250
420 (W3) 12.24 5,139
28.1.X2 Sale (80) 12.24 (979) 979
340 4,160 8,370
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(W1) $5,255/500 = $10.51

(W2) $6,337/570 = $11.12
(W3) $5,139/420 = $12.24
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(c) Closing inventories and cost of sales (AVCO – periodic)
Total
Units Units Cost Value
$ (opening +
purchases)
$
1.1.X2 b/f 200 10.00 2,000
10.1.X2 Purchases 300 10.85 3,255
14.1.X2 Sales (280)
20.1.X2 Purchases 350 11.50 4,025
21.1.X2 Sales (400)

25.1.X2 Purchases 250 13.00 3,250
28.1.X2 Sales (80)

1,100 (760)
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(c) Closing inventories and cost of sales (AVCO - periodic)
$
Opening inventories ($200 × $10) 2,000
Purchases (3,255 + 4,025 + 3,250) 10,530
12,530
Average cost for the period = $12,530 ÷ 1,100 = $11.39
Closing inventory value = (1,100 – 760) × $11.39 = $3,873
Cost of sales $
Opening inventories 2,000
Purchases 10,530
12,530
Less closing inventories (3,873)
8,657
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Chapter summary 1
1 Introduction
▪ Inventories can be a significant figure in an entity's
accounts and will impact both the profit figure and the net
asset position. It is important therefore that it is recorded
correctly.
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Chapter summary 2
2 Accounting adjustment
▪ As seen in Chapter 6 the statement of profit or loss
matches the sales revenue earned in a period with the
cost of sales incurred to generate that revenue. There
are therefore two inventory adjustments: the opening
inventory adjustment and the closing inventory
adjustment.
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Chapter summary 3
3 Valuation
▪ Inventories should be valued at the lower of cost and
net realisable value.
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Chapter summary 4
4 Cost
▪ The cost of inventory includes the cost of purchase,
costs of conversion and any other costs necessary
to bring the inventory to its present location and
condition.
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Chapter summary 5
5 Net realisable value (NRV)

▪ Net realisable value is the estimated selling price less
the costs to completion and any selling and
distribution costs.
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Chapter summary 6
6 Theoretical methods of estimating cost

▪ Methods available to estimate the cost of inventories are
first in, first out (FIFO) and average cost. Under FIFO
the inventories held at the year end are the most recent
purchases but under average cost the cost of all
inventories purchased is weighted to produce an
average figure.
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Chapter summary 7
7 Valuation effects on profit

▪ In times of rising prices, using FIFO will mean the
financial statements show higher inventory values and
higher profits.
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Chapter 8 • Capital and revenue expenditure
• IAS 16 Property, plant and
equipment
Tangible non current
• Depreciation
assets
• Non-current asset disposals
• Revaluations
• Disclosure
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• Define non-current assets and recognise the difference

between current and non-current assets.
• Explain the difference between capital and revenue items
and classify expenditure accordingly.
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• Prepare ledger entries to record the acquisition, disposal,

depreciation and accumulated depreciation of noncurrent
assets.
• Calculate and record profits or losses on disposal of
non-current assets in the statement of profit or loss,
including part-exchange transactions.
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• Record the revaluation of a non-current asset and

calculate its subsequent depreciation and profit or loss on
disposal.
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• Explain the purpose and function of an asset register.
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• Understand and explain the purpose of depreciation.

• Calculate the charge for depreciation using the straight
line and reducing methods, identifying when each is
appropriate.
• Calculate the adjustments to depreciation necessary if
changes are made in the estimated useful life and/or
residual value of a non-current asset.
• Record depreciation in the statement of profit or loss and
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Overview
Capital versus revenue
Cost
expenditure
Tangible non-current
assets
Revaluations Depreciation Disposals
Straight line Reducing balance

method method
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Capital and revenue expenditure 1
What is capital expenditure?

• Capital expenditure results in the acquisition of non-
current assets, or an increase in their earning capacity.
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Capital and revenue expenditure 2
What is revenue expenditure?

• Revenue expenditure is incurred for the purpose of trade
or to maintain the existing earning capacity of the
non-current assets.
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Tackling the exam
It is highly likely that some questions in your exam will focus

on the distinction between capital and revenue expenditure.
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IAS 16 Property, plant and equipment 1
IAS 16
• Initial measurement – at cost
• Components of cost
— Purchase price (including import duties, excl trade
discount, recoverable sales tax)
— Initial estimate of dismantling and restoration costs
— Directly attributable costs, eg site preparation, delivery
and handling costs installation, assembly costs, testing
and professional fees
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Tackling the exam
Exam focus point:

Only staff costs arising directly from the construction or
acquisition of the asset can be capitalised as part of the cost of
the asset.
The costs of training staff to use a new asset cannot be

capitalised because it is not probable that economic benefits
will be generated from training the staff as we can't guarantee
that those staff will stay and use the asset. The costs of training
staff should be expensed.
Watch out for this in your exam!
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IAS 16 Property, plant and equipment 2
• Subsequent expenditure
— Added to carrying amount if improves condition
beyond previous performance
• Repairs and maintenance costs are expensed
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Depreciation 1
Depreciation – accruals concept

• Is a process of spreading the original cost of a non-current
asset over the accounting periods in which its benefit will
be felt
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Depreciation 2
Two methods
• Straight line
depreciation = cost – residual value
useful life
• Reducing balance
depreciation = cost × reducing balance%
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Depreciation 3
• The double entry for depreciation is as follows:
DEBIT Depreciation expense (SPL)

CREDIT Accumulated depreciation (SOFP)
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Depreciation 4
Change in expected life

• If after a period of an asset's life it is realised that the
original useful life has been changed, then the
depreciation charge needs to be adjusted.
• The revised charge from that date becomes:
Carrying amount at revised date

Remaining useful life
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Tackling the exam
Exam focus point:

If an exam question gives you the purchase date of a
non-current asset which is part way through an accounting
period, you should generally assume that depreciation
should be calculated in this way as a 'part year' amount,
unless the question states otherwise.
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Non-current asset disposals 1
Disposal
• On disposal of an asset a profit or loss will arise
depending on whether disposal proceeds are greater or
less than the carrying value of the asset.
• If proceeds > CV = profit
• If proceeds < CV = loss
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Double entry for a disposal

• Eliminate cost
DEBIT Disposals
CREDIT Non-current assets
• Eliminate accumulated depreciation

DEBIT Provision for depreciation
CREDIT Disposals
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• Account for sales proceeds

DEBIT Cash
CREDIT Disposals
or if part exchange deal
DEBIT Non-current assets
CREDIT Disposals
with part exchange value
• Transfer balance on disposals account to the statement of

profit or loss.
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Revaluations 1
IAS 16 allows a choice between

• Keeping asset at cost
• Revaluing to fair value
Fair value may give fairer view on business.
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Revaluations 2
Accounting for a revaluation

A revaluation is recorded as follows:
DEBIT Non-current asset

(revalued amount less original cost)
DEBIT Accumulated depreciation
(total depreciation to date)
CREDIT Revaluation surplus
(revalued amount less carrying value)
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Disclosure
Disclosure
With regard to disclosure, a proforma non-current asset note is shown here.
Land and Plant and
Total buildings equipment
$'000 $'000 $'000
Cost or valuation
At January 20X7 160 100 60
Revaluation surplus 20 20 –
Additions in year 50 30 20
Disposals in year (45) (15) (30)
At 31 December 20X7 185 135 50
Depreciation
At 1 January 20X7 30 20 10
Charge for year 7 5 2
Eliminated on disposals (3) – (3)
At 31 December 20X7 34 25 9
Carrying value
At 31 December 20X7 151 110 41
At 1 January 20X7 130 80 50
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Tackling the exam 1
Exam focus point:
There was a question on revaluations in the December 2012

exam. This asked for the depreciation charge and balance
on the revaluation surplus at the end of the financial year,
following a revaluation at the beginning of the year.
The examiner commented that this was one of the questions

with the lowest pass rates that session. Students correctly
calculated the balance on the revaluation surplus but failed
to identify the correct depreciation charge for the year.
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Tackling the exam 2
As the revaluation took place at the beginning of the year, a

whole year's depreciation had to be calculated using the
revalued amount over the remaining useful economic life.
The remaining useful life needed to be calculated by working

out the original depreciation charge and comparing this to
the accumulated depreciation brought forward to find out
how long the asset had been held.
Students who answered the question wrongly had used the

original useful economic life rather than the remaining useful
economic life figure.
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Lecture example 1
Required
What examples of tangible non-current assets can you
identify?
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• Examples include:
(a) Land and buildings
(b) Plant and equipment
(c) Motor vehicles
(d) Furniture and fittings, computers
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Lecture example 2
On 10 December 20X7 an entity bought a machine.

The breakdown on the invoice showed:
$
Cost of machine 20,000
Delivery costs 200
One-year maintenance contract 900
21,100
Further installation costs of $500 were also incurred.
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Required
At what amount should the machine be capitalised in the
entity's records?
A $20,000
B $20,700
C $20,200
D $21,600
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B
The cost capitalised should include the purchase price
($20,000) plus all directly attributable costs (delivery and
installation).
The cost of the maintenance contract should be shown as

an expense in the statement of profit or loss.
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Lecture example 3
A business buys a machine for $2,500. It is expected to

have a useful life of three years after which time it will
have a scrap value of $250.
Required
(a) Calculate the annual depreciation charge.
(b) Calculate the cost, accumulated depreciation and
carrying amount (CA) for each year of the asset's life.
Note. CA = cost – accumulated depreciation to date.
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Straight line method:
2,500 ─ 250
Depreciation charge= = $750 per
3 years annum
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Accumulated
Year Cost CA
depreciation
1
2,500 750 1,750
2
2,500 1,500 1,000
3
2,500 2,250 250
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Graphical representation
CA
$
2,500
250
Year
0 3
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Lecture example 4
A business buys a machine costing $6,000. The depreciation

rate is 40% on a reducing balance basis.
Required
Calculate depreciation expense, accumulated depreciation
and carrying amount of the asset for the first three years.
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Dep'n Dep'n Acc'd

Year CA
rate expense dep'n
1
40% 2,400 2,400 3,600
2
40% 1,440 3,840 2,160
3
40% 864 4,704 1,296
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Graphical representation
CA
$
6,000
3,600
2,160
1,296
Year
1 2 3 4 5
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Lecture example 5
Required
Using the information in Lecture example 3, show:
(a) The journal entry which would have been written at
the end of the first year.
(b) The treatment of depreciation for all years in the
relevant ledger accounts.
(c) The relevant statement of profit or loss and statement
of financial position extracts for each year.
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(a) Journal entry

Debit Credit
$ $
Depreciation expense 750
Accumulated depreciation 750
Being annual depreciation charged on machine
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(b) Accounting for depreciation:

Machine (SOFP)
$ $
Cash 2,500 Bal c/d 2,500
2,500 2,500
Bal b/d 2,500
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Depreciation expense (SPL)

$ $
Year 1 Accumulated dep'n 750 Year 1 SPL 750
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Accumulated depreciation (SOFP)

$ $
Bal c/d 750 Year 1 Depreciation expense 750
Bal c/d 1,500 Year 2 Bal b/d 750
Depreciation expense 750
Bal c/d 1,500 1,500
2,250 1,500
Year 3 Bal b/d 750
2,250 Depreciation expense 2,250
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STATEMENT OF PROFIT OR LOSS (extracts):

Year 1 Year 2 Year 3
$ $ $
Expenses
Depreciation 750 750 750
STATEMENT OF FINANCIAL POSITION (extracts):
Accumulated Net Book
Cost Depreciation Value
$ $ $
(Year 1) Machine 2,500 (750) 1,750
(Year 2) Machine 2,500 (1,500) 1,000
(Year 3) Machine 2,500 (2,250) 250
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Lecture example 6
The machine costing $6,000 in Lecture example 4 is sold

in Year 3 for $3,000. No depreciation is charged in the
year of disposal.
Required
(a) Calculate the profit or loss on disposal of the machine.
(b) Complete the ledger accounts to show how the
disposal would be accounted for.
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(a)
$
Sales proceeds 3,000
CA at end of year 2 (2,160)
840
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(b)
Machine (SOFP)
$ $
Bal b/d 6,000 (a) Disposal account 6,000

$ $
(b) Disposal account 3,840 Bal b/d 3,840
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Disposal account (SPL)

$ $
(a) Machine 6,000 (c) Cash 3,000
Balance = profit 840
on disposal (SPL) (b) Accumulated dep'n 3,840
6,840 6,840
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Lecture example 7
Assume in Lecture example 6 that instead of cash

proceeds of $3,000, there is a part exchange allowance of
$3,000 on a replacement machine costing $10,000.
Required
(a) Calculate the profit or loss on disposal of the machine.
(b) Calculate the amount of cash paid for the new
machine.
(c) Complete the ledger accounts to show both the
disposal and the acquisition.
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(a) The profit on disposal is still $840, the only difference is

that the proceeds were not received in cash, but in the
form of a part exchange allowance.
(b) Cash paid for the new machine is $7,000 ($10,000 –
$3,000)
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Old machine (SOFP)

$ $
Bal b/d 6,000 (a) Disposal account 6,000

$ $
(b) Disposal account 3,840 Bal b/d 3,840
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New machine (SOFP)

$ $
(c) Disposal account 3,000 Bal c/d 10,000
Cash 7,000
10,000 10,000
Bal b/d 10,000
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Disposal account (SPL)

$ $
(a) Machine 6,000 (c) New machine (part 3,000
Profit disposal (SPL) 840 exchange)
6,840 (b) Accumulated 3,840
depreciation
6,840
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Lecture example 8
A building costing $100,000 on which depreciation of

$20,000 has been charged is to be revalued to $150,000.
Required
(a) Show the double entry to record the revaluation and
make the postings to the ledger accounts.
(b) What would be the depreciation charge for the year if
the building has a remaining useful life of 40 years?
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(a) The double entry is

$ $
Dr Non-current asset – building (150 – 100) 50,000
Dr Accumulated depreciation – building 20,000
Cr Revaluation surplus 70,000
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Building (SOFP)
$ $
Bal b/d 100,000
revaluation surplus 50,000 Bal c/d 150,000
150,000 150,000
150,000
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$ $
Revaluation surplus 20,000 Bal b/d 20,000
Revaluation surplus (SOFP)

$ $
Building 50,000
Revaluation surplus 70,000 Accumulated 20,000
depreciation
70,000 70,000
Bal b/d 70,000
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(b) Depreciation charge is

$150,000/40 years = $3,750
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Lecture example 9
1.1.X1 Asset cost $40,000

Estimated useful life five years
No residual value
1.1.X3 Total useful life revised to four years.
Required
Calculate the depreciation charge, accumulated
depreciation and CA for each year of the asset's life (year
end 31 December).
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Review of useful life:

Year Depreciation Accumulated
charge depreciation CA
$ $ $
20X1 40,000/5 = 8,000 8,000 32,000
20X2 40,000/5 = 8,000 16,000 24,000
20X3 24,000/2 = 12,000 28,000 12,000
20X4 24,000/2 = 12,000 40,000 0
40,000
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Lecture example 10
1.1.X1 Asset cost $40,000

Residual value $1,500
Useful life five years
Depreciation: 25% reducing balance
1.1.X3 Change depreciation method to straight line
Required
Calculate the depreciation charge, accumulated
depreciation and CA for each year of the asset's life (year
ended 31 December).
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Change in method of depreciation:

Dep'n Accumulated
charge depreciation CA
$ $ $
20X1 40,000 × 25% 10,000 10,000 30,000
20X2 30,000 × 25% 7,500 17,500 22,500
20X3 (22,500 – 1,500)/3 7,000 24,500 15,500
20X4 7,000 31,500 8,500
20X5 7,000 38,500 1,500
38,500
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Chapter summary 1
1 Introduction
▪ Expenditure on non-current assets is often significant
and it is important therefore that it is accounted for
appropriately.
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Chapter summary 2
2 Non-current assets
▪ Capital expenditure results in a non-current asset
being shown on the statement of financial position.
Revenue expenditure, such as repairs and maintenance,
is shown as an expense in the statement of profit or loss.
▪ Tangible non-current assets should initially be recorded
at cost. This includes the purchase price of the item
plus any directly attributable costs to bring the item
to its intended location and ready to use.
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Chapter summary 3
3 Depreciation
▪ Depreciation is an expense charged in relation to the
asset each year to reflect the using up of the asset. Land
usually has an unlimited useful life and so is not
depreciated.
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Chapter summary 4
4 Methods of depreciation
▪ Depreciation is usually calculated on a straight line or
reducing balance basis.
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Chapter summary 5
5 Straight line method

▪ This method is suitable for assets which are used up
evenly during their life time. The depreciation expense is
the same each year.
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Chapter summary 6
6 Reducing balance method

▪ This method is suitable for assets which generate more
revenue in the earlier years of their life. The depreciation
expense is higher in the initial years.
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Chapter summary 7
7 Accounting for depreciation

▪ Depreciation is recorded by way of a journal entry. The
expense is recorded as a debit entry and reduces profit.
The credit is made to the accumulated depreciation
account and reduces the carrying value of the asset in
the statement of financial position.
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Chapter summary 8
8 Disposal of non-current assets

▪ On disposal of a non-current asset the sales proceeds
are compared to the carrying amountof the asset in order
to calculate the profit or loss on disposal. Where an
asset is given in part exchange for another asset, the
part exchange allowance takes the place of the sales
proceeds.
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Chapter summary 9
9 Revaluations
▪ An entity may choose to revalue its assets rather than
hold them at cost – this is a choice of accounting
policy. Where an entity revalues, it must revalue all
assets in the same class and the depreciation charge
is based on the revalued amount.
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Chapter summary 10
10 Depreciation revisited
▪ If an entity changes the method of depreciation used
from straight line to reducing balance (or vice versa) or
revises the useful life of an asset it should write off the
asset's carrying amount using the revised method or
useful life.
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Chapter 9 • Intangible non-current assets
• Research and development costs
Intangible
non-current assets
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• Recognise the difference between tangible and intangible

non-current assets.
• Identify types of intangible assets.
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• Identify the definition and treatment of research and

development costs in accordance with IFRS.
• Calculate amounts to be capitalised as development
expenditure or to be expensed from given information.
• Calculate and account for the charge for amortisation and
explain its purpose.
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Overview
Intangible non-current
assets
Research Development expenditure
Accounting treatment
Amortisation
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Intangible non-current assets 1
Intangible non-current assets

• Non-current assets which have a value to the entity but no
physical substance.
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Examples
• Goodwill (see Chapter 24)
• Leases
• Patents and trade names
• Deferred development costs
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Amortisation
• Intangible assets must be amortised systematically over
their useful life. An intangible asset with an indefinite
useful life is not amortised but should be reviewed each
year for impairment.
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Disclosure
• Method of amortisation used
• Useful life of the assets or amortisation rate used
• Gross carrying value, accumulated amortisation and
accumulated impairment losses at beginning and end of
period
• Movements during the period
• Carrying amount of internally-generated intangible assets
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Research and development costs 1
IAS 38 Intangible assets

• Pure or basic research
• Applied research
• All costs written off as incurred
• Development expenditure must be capitalised if all criteria
stated under IAS 38 can be demonstrated.
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Research and development costs 2
IAS 38 criteria:
• P – Probable future economic benefits
• I – Intention to complete the intangible asset and use or
sell it
• R – The availability of Resources to complete the
development and use or sell
• A – Ability to use or sell
• T – Technical feasibility of completing the asset
• E – Reliable measurement of Expenditure
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Tackling the exam
Exam focus point:
The recognition criteria can be summarised by the

mnemonic PIRATE which makes it easier to learn for your
exam.
There is an article on research and development in the

Financial Reporting (FR) exam resources section of the
ACCA website. Although this article was written for FR, it is
relevant to FA/FFA and you should take a look at it.
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Lecture example 1
Z Co incurred the following costs during the year ended

31 August 20X8:
(1) $20,000 on salaries for market research staff sent out
to canvass drivers' opinions on a potential new car.
(2) $100,000 to purchase a machine to manufacture
components for the new car. It has an estimated
useful life of ten years.
(3) $25,000 on materials to manufacture a prototype and
$50,000 on salaries relating to its design and
manufacture. The new car is expected to go on sale
in 20X9.
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Required
How should each of the above items be shown in the
financial statements for the year ended 31 August 20X8?
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(1) Market research would take place at an early stage in

any development process. Its purpose is to gather
information about whether there may be interest in a
potential product. At this point in time an entity cannot be
certain that the expenditure will lead to profits and so the
costs are research costs. $20,000 should be shown as
an expense in the statement of profit or loss.
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(2) A machine is a tangible non-current asset and is

accounted for under IAS 16 regardless of its use. The
$100,000 should be capitalised as a tangible non-current
asset and depreciated over its useful life of ten years.
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(3) Material costs and design and manufacture salaries are

part of the development process. They should be
capitalised as an intangible non-current asset provided
that all of the 'PIRATE' criteria are met.
The costs should be amortised in 20X9 once the car is
available to be sold on the market.
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Lecture example 2
Development Co incurs the following expenditure in years

20X1–20X5.
Research Development
$ $
20X1 35,000 55,000
20X2 – 65,000
20X3 – –
20X4 – –
20X5 38,000 –
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The development expenditure meets the IAS 38 criteria that

require capitalisation ('PIRATE'). The item developed in
20X1 and 20X2 goes on sale on 1.1.X3 and it will be three
years from then until any competitor is expected to have a
similar product on the market.
Required
Show statement of profit or loss and statement of financial
position extracts for the years 20X1–20X5 inclusive.
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Statement of profit or loss extracts

Expenses X1 X2 X3 X4 X5
$ $ $ $ $
Research expenditure 35,000 – – – 38,000
Amortisation of – – 40,000 40,000 40,000
development expenditure
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Non-current assets X1 X2 X3 X4 X5
$ $ $ $ $
Development expenditure 55,000 120,000 120,000 120,000 120,000
Amortisation – – (40,000) (80,000) (120,000)
Net book value 55,000 120,000 80,000 40,000 –
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Chapter summary 1
1 Definition
▪ An intangible non-current asset is an identifiable
non-monetary asset without physical substance.
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Chapter summary 2
2 Research and development expenditure

▪ Some entities spend significant sums of money on
research and development it is therefore essential that
these transactions are accounted for appropriately.
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Chapter summary 3
3 Intangible assets (IAS 38)

▪ IAS 38 defines research and development. Research
expenditure is incurred where the entity is acquiring new
scientific or technical knowledge. Development
expenditure relates to the application of research
findings.
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Chapter summary 4
4 Accounting treatment
▪ Research relates to costs incurred to obtain knowledge
or understanding. There is no certainty of future profit
from this expenditure and so it should be shown as an
expense in the statement of profit or loss.
▪ Development expenditure MUST be capitalised as an
intangible non-current asset provided all of the
PIRATE criteria are met. This asset will then be
amortised over the period during which the asset’s
economic benefits are consumed by the entity.
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Chapter summary 5
5 Amortisation of capitalised development expenditure

▪ Amortisation is essentially the same as depreciation but
relates to intangibles. Where an entity has capitalised
development expenditure it should amortise the
intangible once the asset is ready for use.
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Chapter 10 • Accruals and prepayments
Accruals and
prepayments
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• Understand how the matching concept applies to accruals

and prepayments.
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• Identify and calculate the adjustments needed for accruals

and prepayments in preparing financial statements.
• Prepare the journal entries and ledger entries for the
creation of an accrual or prepayment.
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• Illustrate the process of adjusting for accruals and

prepayments in preparing financial statements.
• Understand and identify the impact on profit and net
assets of accruals and prepayments.
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Overview
Accruals and
prepayments
Accounting
treatment
Reversing out Presentation in

Year end
accruals and the statement
adjustments
prepayments of financial position
Accrued income Accounting

and deferred income treatment
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Accruals and prepayments 1
Accrual
• Expenses charged against the profits of a period even
though they have not yet been paid for
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Prepayment
• Payments made in one period but charged to the later
period to which they relate
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Prepayment
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Accruals
Expense incurred – no invoice yet
Part relating to current accounting period is an accrual

Debit SPL
Credit SOFP payables (liability)
• Remember that the financial statements are prepared

on an accruals basis.
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Lecture example 1
• Fiona set up a business on 1 January 20X7. Her cash

payments for the year to 31 December 20X7 included:
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Date paid Amount Period

$
Electricity
10.3.X7 96 2 months to 28 February 20X7
12.6.X7 120 quarter to 31 May 20X7
14.9.X7 104 quarter to 31 August 20X7
10.12.X7 145 quarter to 30 November 20X7
Rent
1.2.X7 375 3 months to 31 March 20X7
6.4.X7 1,584 12 months to 31 March 20X8
Note: On 6 March 20X8 Fiona received an electricity bill for $168 for
the quarter to 28 February 20X8.
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Required
(a) Calculate the expense incurred by Fiona for electricity
and rent for the year ended 31 December 20X7.
(b) Calculate the amount of any accruals/prepayments at
the end of the year.
(c) State the journal entry required for the year-end
adjustments.
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(a) $
Electricity expense
Cash paid: 10.3.X7 96
12.6.X7 120
14.9.X7 104
10.12.X7 145
465
December expense missing (1/3 × $168) 56
521
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$
Rent expense
Cash paid: 1.2.X7 375
6.4.X7 1,584
1,959
Less: expense relating to Jan – March × (3/12× $1,584) (396)
1,563
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(b) & (c)

Electricity accrual is $56
$ $
Dr Electricity expense (SPL) 56
Cr Accruals (SOFP) 56
Being: electricity expense accrued at 31 December 20X7.
Rent prepayment is $396

$ $
Dr Prepayments (SOFP) 396
Cr Rent expense (SPL) 396
Being: rent expense prepaid at 31 December 20X7.
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Lecture example 2
Required
Using the figures from Lecture example 1:
Complete the necessary entries in Fiona's ledger accounts
as at 31 December 20X7, then balance off the accounts.
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Electricity expense (SPL)

$ $
10.3.X7 Cash 96
12.6.X7 Cash 120
14.9.X7 Cash 104
10.12.X7 Cash 145
31.12.X7 Accruals 56 31.12.X7 Transfer to SPL
521
521 521
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Rent expense (SPL)

$ $
1.2.X7 Cash 375
6.4.X7 Cash 1,584 31.12.X7 Transfer to SPL 1,563
31.12.X7 Prepayments 396
1,959 1,959
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Accruals (SOFP)
$ $
31.12.X7 Bal c/d 56 31.12.X7 Electricity 56
56 56
1.1.X8 Bal b/d 56
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Prepayments (SOFP)
$ $
31.12.X7 Rent 396

31.12.X7 Bal c/d 396
396 396
1.1.X8 Bal b/d 396
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Lecture example 3
In 20X8 Fiona paid the following electricity bills:
Date paid Amount Period

$
12.3.X8 168 quarter to 28 February 20X8
9.6.X8 134 quarter to 31 May 20X8
12.9.X8 118 quarter to 31 August 20X8
12.12.X8 158 quarter to 30 November 20X8
During March 20X9 Fiona received an electricity bill for $189

for the quarter to 28 February 20X9.
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Required
Calculate the electricity expense and accrual for the year
ended 31 December 20X8 and complete the ledger
accounts.
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Electricity expense (SPL)

$ $
12.3.X8 Cash 168 1.1.X8 Accrual reversed 56
9.6.X8 Cash 134 31.12.X8 To statement of 585
profit or loss
12.9.X8 Cash 118
12.12.X8 Cash 158
31.12.X8 Accruals
(1/3 × 189) 63
641 641
Accruals and prepayments from the previous year
are reversed at the beginning of the next accounting
period so that the current year expense is correct.
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Accruals (SOFP)
$ $
1.1.X8 Accrual 56 1.1.X8 Bal b/d 56
reversed
31.12.X8 Bal c/d 63 31.12.X8 Electricity accrual 63
119 119
1.1.X9 Bal b/d 63
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Lecture example 4
Jimmy Co prepares its financial statements for the year to

30 June each year. The company pays for its insurance
quarterly in advance on 1 March, 1 June, 1 September and
1 December each year. The annual insurance premium was
$24,000 until 31 August 20X6, after that date it increased to
$30,000 per year.
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Required
What insurance expense and end of year prepayment
should be included in the financial statements for the year
ended 30 June 20X7?
Expense Prepayment
A $29,000 $2,500
B $29,000 $5,000
C $28,500 $2,500
D $28,500 $5,000
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B
$
Insurance expense
July X6 – August X6 ( 2/12 × $24,000) 4,000
Sept X6 – June X7 ( 10/12 × $30,000) 25,000
29,000
Prepayment
1 June X7 paid ( 1/4 × $30,000) 7,500
Less: June X7 ( 1/3 × $7,500) (2,500)
5,000
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Tackling the exam
Exam focus point:
You will almost certainly have to deal with accruals and/or

prepayments in the exam. Make sure you understand the
logic, then you will be able to do deal with whichever
question comes up.
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Chapter summary 1
1 Introduction
▪ An entity should produce its financial statements using
the accruals basis. This is an implied assumption in the
IASB Conceptual Framework.
▪ Accruals are made when expenses are paid in arrears,
whereas prepayments arise when expenses are paid for
in advance.
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Chapter summary 2
▪ Accruals increase expenses and are shown as a liability
on the statement of financial position at the year end.
▪ Prepayments reduce expenses and are an asset on the
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Chapter summary 3
3 Reversing out accruals and prepayments

▪ Accruals and prepayments from the previous year are
reversed at the beginning of the next accounting period
so that the current year expense is correct.
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Chapter summary 4
4 Accrued income and deferred income

▪ These follow a similar theory to accruals and
prepayments but relate to income.
▪ An entity will accrue income where it has earned the
income during the period but not yet invoiced for it. This
will increase income and be shown as a receivable at the
year end.
▪ Where an entity has received income in advance of it
being earned it should be deferred to the following
period. This will reduce income and be shown as a
payable at the year end.
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Chapter 11 • IAS 37 Provisions, contingent
liabilities and contingent assets
Provisions and
contingencies
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• Understand the definition of 'provision', 'contingent liability'

and 'contingent asset', distinguish between them and
classify items accordingly.
• Identify and illustrate the different methods of accounting
for provisions, contingent liabilities and contingent assets.
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• Calculate provisions and changes in provisions and

account for the movement in provisions.
• Report provisions in the final accounts.
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Overview
Accounting treatment Recognition criteria
Provisions
Provisions and
contingencies
Contingent liabilities Contingent assets
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IAS 37 Provisions, contingent liabilities and contingent assets
Provision
• A liability of uncertain timing or amount
• The amount recognised as a provision should be the best
estimate of the expenditure required to settle that present
obligation.
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IAS 37 (cont'd)
Contingent liability
• A possible obligation that arises from past events, whose
existence will be confirmed by the occurrence or
non-occurrence of future events not wholly in the entity's
control.
• A present obligation not recognised because:
— It is not probable that settlement of the obligation will be
required.
— The amount cannot be measured.
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IAS 37 (cont'd)
Contingent asset
• A possible asset that arises from past events and whose
existence will be confirmed by the occurrence of one or
more uncertain future events not wholly within the entity's
control.
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IAS 37 (cont'd)
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Lecture example 1
Grass Co is reviewing its warranty obligations. Based on sales during

20X7 it has established that if all lawnmowers sold required minor
repairs this would cost $1m whereas if major repairs were required this
would cost $6m.
Grass Co expects that 75% of lawnmowers will have no faults, 20% will
need minor repairs and 5% major repairs.
Required
(a) What provision should be made in 20X7 and what accounting
entry is needed to record it?
(b) What entry should be made in 20X8 assuming the provision
required then is $0.75m?
(c) What entry should be made in 20X9 assuming the provision
required then is $0.3m?
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(a) A provision should be made using expected values:

($1m × 20%) + ($6m × 5%) = $0.5m
Dr Warranty cost expense (SPL) $0.5m

Cr Provisions (SOFP) $0.5m
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(b) In 20X8 the provision needs to increase by $0.25m

($0.75m – $0.5m). Entry is:
Dr Warranty cost expense (SPL) $0.25m

Cr Provisions (SOFP) $0.25m
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(c) In 20X9 the provision needs to decrease by $0.45m

($0.75m – $0.3m). Entry is:
Dr Provisions (SOFP) $0.45m

Cr Warranty cost expense (SPL) $0.45m
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Tackling the exam
Exam focus point:
This subject area was highlighted by the examiner at the

2013 ACCA Learning Providers Conference as being one of
the least well answered in the exam. The examiner
commented that students were not learning key definitions
and displayed an inability to apply the theory to practical
situations. Make sure you understand this chapter fully and
attempt questions to cement your understanding.
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Chapter summary 1
1 Introduction
▪ IAS 37 provides guidance on when a provision must and
must not be made.
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Chapter summary 2
2 Provisions
▪ A provision should only be made in the financial
statements when an entity has a present obligation to
incur expenditure. It must also be more likely than not
that the expenditure will be incurred and a reliable
estimate of the amount is known.
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Chapter summary 3
3 Contingent liabilities
▪ A contingent liability should be disclosed where the
criteria for making a provision are not met, but where
there is either a possible obligation or a present
obligation but it is only possible that the expenditure
will be incurred.
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Chapter summary 4
4 Contingent assets
▪ Contingent assets should only be included in the
financial statements if it is certain to be received and
should be disclosed if probable.
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Chapter 12 • Irrecoverable debts and
receivables allowances
• Accounting for irrecoverable debts
Irrecoverable debts and receivables allowances
and allowances
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• Identify the benefits and costs of offering credit facilities to

customers.
• Understand the purpose of an aged receivables analysis.
• Understand the purpose of credit limits
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• Prepare the bookkeeping entries to write off an

irrecoverable debt, record an irrecoverable debt
• Record an irrecoverable debt recovered
• Identify the impact of irrecoverable debts on the statement
of profit or loss and on the statement of financial position.
• Prepare the bookkeeping entries to create and adjust an
allowance for receivables.
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• Illustrate how to include movements in the allowance for

receivables in the statement of profit or loss and how the
closing balance of the allowance should appear in the
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Overview
Amounts recovered
Irrecoverable debts
Irrecoverable debts
and allowances
Allowance for receivables
Allowances
Equivalent to a % of the
Specific
remaining balance
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Irrecoverable debts and receivables allowances 1
Irrecoverable debts and receivables allowances

• A receivable should only be classed as an asset if it is
recoverable.
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Irrecoverable debts
• If definitely irrecoverable, it should be written off to the
statement of profit or loss as an irrecoverable debt.
DEBIT Irrecoverable debt expense (SPL)

CREDIT Trade receivables (SOFP)
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Receivables allowances
• If uncertainty exists as to the recoverability of the debt, an
allowance should be set up. This is offset against the
receivables balance on the statement of financial position.
DEBIT Irrecoverable debt expense (SPL)

CREDIT Allowance for receivables (SOFP)
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Receivables allowances (cont'd)

• Allowances can either be specific, against a particular
receivable, or against a proportion of all receivables not
specifically allowed for.
• In this exam, the allowance is likely to be expressed as a
percentage of trade receivables, eg an allowance
equivalent to 2% of trade receivables.
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Accounting for irrecoverable debts and receivables
allowances 1
Allowances for receivables

• When calculating the allowance to be made, the following
order applies.
$
Receivables balance per receivables control account X
Less: irrecoverable debts written off (X)
amounts specifically allowed (X)
Balance on which allowance is calculated X
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allowances 2
• Note. Only the movement in the allowance needs to be

charged or credited to the SPL.
$
Allowance required X
Existing allowance (X)
Increase/(decrease) required X/(X)
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allowances 3
• If a reduction in the receivables allowance is required,

then:
DEBIT Allowance for receivables (SOFP)

CREDIT Irrecoverable debts expense (SPL)
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allowances 4
• If a increase in the receivables allowance is required, then:
DEBIT Irrecoverable debt (SPL)

CREDIT Allowance for receivables (SOFP)
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allowances 5
Subsequent recovery of debts

• If an irrecoverable debt is recovered, having previously
been written off, then:
DEBIT Cash (SOFP)

CREDIT Irrecoverable debts expense (SPL)
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Tackling the exam
Exam focus point:
In the exam it is highly likely that you will have to calculate

the increase or decrease in the allowance for receivables
and show the effect of this on the statement of profit or loss.
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Lecture example 1
Fight & Co has trade receivables at 31 December 20X7 of

$65,000. A review of customer files indicates that two
customers, Ali and Tyson, which owe $7,000 and $8,000
respectively, have gone bankrupt and their debts are
considered irrecoverable.
Required
(a) Calculate the balance c/d on the trade receivables
account at the end of the year.
(b) Calculate the irrecoverable debt expense shown in the
statement of profit or loss.
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(a) The balance c/d on the trade receivables account at the

end of the year is $50,000.
(b) The irrecoverable debt expense shown in the SPL is
$15,000.
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Workings
Trade receivables (SOFP)
$ $
31.12.X7 Bal b/d 65,000 31.12.X7 irrecoverable debt 15,000
expense
(Ali $7,000)
(Tyson $8,000)
31.12.X7 Bal c/d 50,000
65,000 65,000
Irrecoverable debt expense (SPL)

$ $
31.12.X7 Trade receivables 15,000 31.12.X7 To SPL 15,000
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Lecture example 2
A further review of Fight & Co's customer files indicates there

is some uncertainty as to whether a debt of $3,500 owed by
Bugner is recoverable.
(a) Calculate the allowance for receivables shown on the
(b) Calculate the allowance for receivables expense shown
in the statement of profit or loss.
(c) Show how the information from Lecture examples 1 and
2 would be shown in extracts from the statement of profit
or loss and statement of financial position.
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Allowance for receivables:

(a) The allowance for receivables shown on the statement of
financial position is $3,500.
(b) The allowance for receivables expense shown in the
SPL is $3,500.
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Workings
Allowance for receivables (SOFP)
$ $
Bal c/d 3,500 Allowance for receivables 3,500
expense
Allowance for receivables expense (SPL)

$ $
Allowance for receivables 3,500 SPL 3,500
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(c)
STATEMENT OF PROFIT OR LOSS (extract)

$
Expenses
Irrecoverable debts (see Lecture Example 1) (15,000)
Allowance for receivables expense (3,500)
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STATEMENT OF FINANCIAL POSITION (extract)

$
Current assets
Less: allowance for receivables (3,500)
46,500
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Lecture example 3
A business's trade receivables account showed a year end balance of

$47,440. It was decided that amounts totaling $340 should be written off
as irrecoverable, a specific allowance was to be made against an amount
of $400 due from Dodgy Co, a customer, and a further allowance for
doubtful receivables equivalent to 2% of the remaining outstanding
receivables was to be created.
Required
(a) Calculate the allowance for receivables shown in the
(b) Calculate the total receivables expense shown in the
statement of profit or loss.
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(a) The allowance for receivables shown in the statement

of financial position is $1,334.
(b) The total receivables expense (irrecoverable debt and
allowance for receivables expense) shown in the
statement of profit or loss is $1,674.
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$ $
Bal b/d 47,440 Irrecoverable debt & 340
allowance for receivables
expense
Bal c/d 47,100

47,440 47,440
Bal b/d 47,100
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$ $
Bal c/d Irrecoverable debt & 1,334
Specific 400 allowance for receivables
Further(W) 934 expense
1,334
1,334 1,334
Bal b/d 1,334
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Irrecoverable debt and allowance for receivables expense (SPL)

$ $
Allowance for 1,334 SPL 1,674
receivables
1,674 1,674
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Workings
(W) Allowance for doubtful debts:
$
Trade receivables (net of irrecoverable debts written off) 47,100
Less: specific allowance (400)
46,700 × 2%
= $934
• Total allowance = 400 + 934 = 1,334
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Lecture example 4
Fight & Co (see Lecture example 1) subsequently receive a

cheque of $7,000 from Ali.
Required
Show the treatment of this recovery in the relevant 'T'
accounts.
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Irrecoverable debts recovered

$ $
1.1.X8 Bal b/d 50,000
Irrecoverable debt expense (SPL)

$ $
SPL 7,000 Cash 7,000
Cash (SOFP)
$
Irrecoverable debt expense 7,000
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Lecture example 5
Required
Show the accounting treatment for Fight & Co if, having
made a specific allowance (see Lecture example 2), during
the next year Bugner repays his debt of $3,500 to Fight & Co
in cash?
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Specific allowance recovered

$ $
Bal b/d 50,000 (a) Cash 3,500
Bal c/d 46,500
50,000 50,000
$ $
(b) Allowance for 3,500 Bal b/d 3,500
receivables expense
Irrecoverable debt and allowance for receivables expense (SPL)
$ $
SPL 3,500 (b) Allowance for receivables 3,500
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Lecture example 6
Required
Following on from the information used in Lecture example 2,
suppose that in the next accounting period, the debt from
Bugner is considered to be irrecoverable.
What double entry would be required to record this?
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$ $
Dr Allowance for receivables 3,500
Cr Trade receivables 3,500
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Lecture example 7
The following information is available for A Co:
Year ended 31 December 20X7: Trade receivables $20,000

Year ended 31 December 20X8: Trade receivables $30,000
A Co requires an allowance equivalent to 5% of trade

receivables in each year.
Required
Show the required adjustment to the allowance for
receivables account in the year ended 31 December 20X8.
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Changes in allowance:
The allowance for receivables expense in 20X8 is $500
[(30,000 × 5%) – (20,000 × 5%)]
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Long method
$ $
(a) Allowance for 1,000 1.1.X8 Bal b/d
receivables expense ($20,000 × 5%) 1,000
(20,000 × 5%) (ii) 31.12.X8 Allowance for
Bal c/d 1,500 receivables expense 1,500
2,500 ($30,000 × 5%) 2,500

$ $
(ii) Allowance for 1,500 (a) Allowance for 1,000
receivables receivables 500
1,500 SPL 1,500
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Short method
$ $
31.12.X7Bal b/d
31.12.X8 Bal c/d ($20,000 × 5%) 1,000
($30,000 × 5%) 1,500 Allowance for receivables 500
expense (increase in
1,500 allowance) 1,500

$ $
Allowance for receivables 500 SPL 500
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Lecture example 8
At 30 September 20X7 G Co had an allowance for

receivables of $24,000.
During the year ended 30 September 20X8 G Co recovered

$2,000 from a customer whose balance was written off in
20X7 and wrote off further debts totaling $18,000. The
closing allowance for receivables is required to be $21,000.
No adjustments have been made for this information.
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Required
What amount should appear in the statement of profit or loss
for the year ended 30 September 20X8 for the above items?
A $13,000
B $15,000
C $17,000
D $23,000
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A $13,000
Allowance for Statement of
receivables profit or loss
$ $
(1) Write off recovered (2,000)
(2) Write off in 20X8 18,000
(3) Change in allowance:
At 30.9.X7 24,000
At 30.9.X8 21,000
Decrease required 3,000 (3,000)
13,000
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Chapter summary 1
1 Introduction
▪ A trade receivable is an asset of the business which
should only be shown in the financial statements if it is
believed to be recoverable.
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Chapter summary 2
2 Irrecoverable debts
▪ Bad or irrecoverable debts must therefore be written
off as an expense in the statement of profit or loss.
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Chapter summary 3
3 Allowance for receivables

▪ An allowance should be made against trade receivables
where there is concern as to whether or not a balance
will be recoverable.
▪ Specific allowances relate to particular customer
balances.
▪ A further allowance may be the equivalent of a
percentage of the receivables balance.
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Chapter summary 4
4 Effect in subsequent periods

▪ The key to being able to account for the effect in
subsequent periods is to know what accounting entries
have previously been made and then make any relevant
adjustments.
▪ For example, if cash is received from a receivable that
was previously written off then the receivable has already
been removed from the accounts.
▪ Consequently the only adjustments needed are to record
the cash received and remove the irrecoverable debt
expense recorded last year which has proved to be
unnecessary.
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Chapter 13 • Nature and collection of sales tax
• Accounting for sales tax
Sales tax
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• Understand the general principles of the operation of a

sales tax.
• Calculate sales tax on transactions and record the
consequent accounting entries.
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Overview
Output tax Input tax
Sales tax
Irrecoverable sales tax Discounts
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Nature and collection of sales tax 1
Sales tax
• Is an indirect tax levied on the sale of goods and services
• Administered by tax authorities
• Can have a number of rates, eg standard rate, reduced
rate
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Output sales tax

• Sales tax charged by the business on goods/services
Input sales tax

• Sales tax on purchases made by the business
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Output tax greater than input?

• Pay difference to tax authorities
Input tax greater than output?

• Refund due to business
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Accounting for sales tax 1
Credit sales
• Include sales tax in sales day book; analyse it separately
• Include gross receipts from receivables in cash book; no
need to show sales tax separately
• Exclude sales tax element from statement of profit or loss
• Credit sales tax control account with output sales tax
element of sales invoices
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Credit purchases
• Include sales tax in purchases day book; analyse it
separately
• Include gross payments in cash book; no need to show
sales tax separately
• Exclude recoverable sales tax from statement of profit or
loss
• Include irrecoverable sales tax in statement of profit or
loss
• Debit sales tax control account with recoverable input
sales tax element of credit purchases
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Cash sales
• Include gross receipts in cash book; show sales tax
separately
• Exclude sales tax element from statement of profit or loss
• Credit sales tax control account with output sales tax
element of cash sales
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Cash purchases
• Include gross payments in cash book: show sales tax
separately
• Exclude recoverable sales tax from statement of profit or
loss
• Include irrecoverable sales tax in statement of profit or
loss
• Debit sales tax control account with recoverable input
sales tax element of cash purchases
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Tackling the exam
Exam focus point:

A small amount of sales tax is quite likely in questions. It is
worth spending a bit of time ensuring that you understand
the logic behind the way sales tax is accounted for, rather
than trying to learn the rules by rote. This will ensure that
even if you forget the rules, you will be able to work out what
should be done.
• In the exam only one rate of sales tax will be used.

• You will be given the rate to use in the question.
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Lecture example 1
A business buys goods for $1,000 plus 15% sales tax. They then sell those
goods for $1,500 + 15% sales tax.
The purchases will cost ($1,000 × 1.15) = $1,150

The sales will raise ($1,500 × 1.15) = $1,725
The sales tax payable to tax authorities will be:
Payable on outputs (sales) (15% × $1,500) 225.00

Reclaimable on inputs (purchases) (15% × $1,000) (150.00)
Net sales tax to tax authorities 75.00
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As the business is purely collecting the sales tax for the tax authorities,
and is able to set off its sales tax suffered it does not include sales tax
as either an expense or income in the statement of profit or loss. The
sales tax is accounted for when the transaction occurs.
Required
(a) Post the double entry to the ledger account below.
$ $
Dr Purchases 1,000
Dr Sales tax control account 150
Cr Trade payables 1,150
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(b) Post the double entry to the ledger account below.
$ $
Dr Trade receivables 1,725
Cr Sales 1,500
Cr Sales tax control account 225
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Purchases
$
Trade payables
$
Purchases 1,150
Trade receivables
$
Sales 1,725
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Sales tax control a/c
$ $
Trade payables 150 Trade rec. 225
Sales
$ $
Trade rec. 1,500
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Chapter summary 1
1 Introduction
▪ A business acts as a collecting agent for the tax
authorities and charges sales tax (output tax) on its sales
and reclaims sales tax (input tax) on its purchases.
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Chapter summary 2
▪ Sales and purchases are recorded at the net amount.
▪ Sales tax may be charged at various rates, however the
rate of sales tax will always be provided in an exam
question.
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Chapter summary 3
3 Irrecoverable sales tax

▪ Sales tax may not be recoverable on certain purchases.
Where this is the case the question will state that the
sales tax is not recoverable and the cost recorded will be
the gross amount.
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Chapter summary 4
4 Sales tax and discounts

▪ The effect of discounts on sales tax is covered in
Chapter 14.
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Chapter summary 5
5 Rates of sales tax

▪ Zero rated supplies have sales tax charged on them at
0% whereas exempt supplies are not subject to sales
tax.
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Chapter 14 • What are control accounts?
• Discounts
Control accounts • The operation of control accounts

• The purpose of control accounts
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• Understand the purpose of control accounts for accounts

receivable and accounts payable.
• Understand how control accounts relate to the double
entry system.
• Prepare ledger control accounts from given information.
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• Perform control account reconciliations for accounts

receivable and accounts payable and identify errors which
would be highlighted by performing them.
• Identify and correct errors in control accounts and ledger
accounts.
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• Account for discounts allowed and discounts received.

• Account for contras between trade receivables and trade
payables.
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• Understand and record sales and purchase returns.

• Prepare, reconcile and understand the purpose of supplier
statements
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Overview
Reconciliations
Receivables ledger control account Receivables ledger

Payables ledger control account Payables ledger
Control accounts
Discounts Returns, credit notes,

Contra entries
allowed and received Refunds and over payments
Trade discounts Settlement discounts
Sales tax considerations
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What are control accounts? 1
What are control accounts?

A control account is a total account.
• Its balance represents an asset or a liability which is the
grand total of many individual assets or liabilities.
• These individual assets/liabilities must be separately
detailed in subsidiary accounting records, but their total is
conveniently available in the control account ready for
immediate use.
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Most businesses operate control accounts for trade

receivables and payables, but such accounts may be
useful in other areas too, eg sales tax, payroll taxes.
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With regard to the double entry relating to receivables

and payables, note the following:
• The accounts of individuals are maintained for
memorandum purposes only.
• Entering a sales invoice, say, in the account of an
individual receivable is not part of the double entry
process.
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Discounts 1
Two types of discount

• Trade discount – reduction in cost of goods eg regular
customers, bulk discounts
Accounting treatment for trade discounts

• Discount received: deduct from purchases
• Discount allowed: deduct from sales
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Discounts 2
• Cash/settlement discount – reduction in amount

payable, eg for cash or prompt payment
Accounting treatment for cash/settlement discount

received: include as other income
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Discounts 3
Cash/settlement discount allowed: Depends if customer

expected to take discount when they pay:
Customer expected to take the discount?
Yes, expected to take discount No, not expected to take discount
First measure revenue at price less First measure revenue at full price.
discount (ie as expected).
After, if customer then does not After, if customer then does take
take discount, recognise the rest of the discount, deduct it from
the revenue. revenue.
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Tackling the exam
Exam focus point:
Students often get confused between cash and trade

discounts. Exam questions could easily contain both types of
discount so you must be able to distinguish between them
and account for them correctly.
Remember that only cash (settlement) discounts received

are separately recorded in the books, sales and purchases
are recorded net of trade discounts.
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The operation of control accounts 1
The invoices in the sales day book are totalled periodically

and the total amount is posted as follows:
DEBIT Receivables control account

CREDIT Sales account
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Similarly, the total of cash receipts from receivables is

posted from the cash book to the credit side of the
receivables control account.
DEBIT Cash account

CREDIT Receivables control account
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In the same way, the payables control account is credited

with the total purchase invoices logged in the purchase day
book and debited with the total of cash payments to
suppliers.
DEBIT Purchases account

CREDIT Payables control account
DEBIT Payables control account

CREDIT Cash account
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The purpose of control accounts 1
Reasons for maintaining control accounts

• Check on the accuracy of the personal accounts in the
receivables ledger.
• The control accounts provide a convenient total which can
be used immediately in extracting a trial balance or
preparing accounts.
• A reconciliation between the control account total and the
receivables ledger will help to detect errors, thus providing
an important control.
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• Proforma of receivables control account
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• Proforma of payables control account
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Reconciling control a/cs with memorandum ledgers

• Step 1 – correct the total of the balances from the
memorandum ledger
• Step 2 – correct the control a/c balance
• Step 3 – the balances should now agree
Note. The corrected control a/c balance appears in the

final accounts.
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Possible reasons for credit balances on receivables ledger

accounts, or for debit balances on payables ledger accounts
• Overpayment of amount owed
• Return of goods
• Payment in advance
• Posting errors
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Lecture example 1
A Co has the following information:

• 10 January 20X6
• Sells $150 of goods to customer A
• Sells $200 of goods to customer B
• 15 January 20X6
• A Co purchases $100 of goods from supplier Y
• A Co purchases $1,300 of goods from supplier Z
• 21 January 20X6
• A Co receives full payment from customer B and this
money is used to pay supplier Y
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Required
(1) Record the above transactions in the books of prime
entry and the memorandum ledgers.
(2) Post the totals from the BOPE to the nominal ledger.
(3) Balance off nominal ledger accounts.
(4) Reconcile the memorandum ledgers to the control
accounts.
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(1) Books of prime entry

Sales day book
Date Customer Amount
10 Jan X6 Customer A 150
10 Jan X6 Customer B 200
350
Purchase day book
Date Supplier Amount
15 Jan X6 Supplier Y 100
15 Jan X6 Supplier Z 1,300
1,400
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Cash receipts book

Date Narrative Total Sales Receivables
21 Jan X6 Customer B 200 200
200 200
Cash payment book
Date Narrative Total Purchases Payables
21 Jan X6 Supplier Y 100 100
100 100
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Memorandum ledgers
Receivables ledger
Customer A
$ $
10.1.X6 Sales 150
Bal c/d 150
150 150
Bal b/d 150
Customer B
$ $
10.1.X6 Sales 200 21.1.X6 Payment 200
received
200 200
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Payables ledger
Supplier Y
$ $
21.1.X6 Payment made 100 15.1.X6 Purchases 100
100 100
Supplier Z
$ $
Bal c/d 1,300 15.1.X6 Purchases 1,300
1,300 1,300
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(2) & (3) Nominal ledger

Receivables Ledger Control Account (RLCA) (SOFP)
$ $
31.1.X6 Sales 350 31.1.X6 Bank 200
Bal c/d 150
350 350
Bal b/d 150
Payables Ledger Control Account (PLCA) (SOFP)
$ $
31.1.X6 Bank 100 31.1.X6 Purchases 1,400
Bal c/d 1,300
1,400 1,400
Bal b/d 1,300
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(2) & (3) Nominal ledger

Bank (SOFP)
$ $
31.1.X6 RLCA 200 31.1.X6 PLCA 100
Bal c/d 100
200 200
Bal b/d 100
Sales (SPL) Purchases (SPL)
$ $ $ $
31.1.X6 350 31.1.X6 1,400
RLCA PLCA
SPL 350 SPL 1,400
350
350 1,400 1,400
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(4) Reconciliation
Balance per list of balances $
Receivables ledger
Customer A 150
Customer B –
150
Balance per RLCA 150
Balance per list of balances $

Payables ledger
Supplier Y –
Supplier Z 1,300
1,300
Balance per PLCA 1,300
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Lecture example 2
(a) On 1 January 20X7 a business made a sale on credit for

$12,000. A trade discount of $2,000 was available with a
further 10% settlement discount if payment were made
within ten days. The discount is expected to be taken.
Required
Record the initial sale.
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(b) On 4.1.X7, the customer pays for the goods taking

advantage of the settlement discount. The discount will be
10% of sales value.
Required
Record the full settlement of the amount owed.
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Required
(c) What would your answer be to part (b) if the settlement
discount were not taken?
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(a)
Sales (SPL) RLCA (SOFP)
$ $ $ $
1.1X7 RCLA 9,000 1.1X7 Sales 9,000
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(b)
Bank (SOFP) RLCA (SOFP)
$ $ $ $
4.1.X7 RCLA 9,000 1.1X7 Sales 9,000 4.1.X7 Bank 9,000
9,000 9,000
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(c)
Bank (SOFP) RLCA (SOFP)
$ $ $ $
4.1.X7 RCLA 9,000 1.1X7 Sales 9,000 4.1.X7 Bank 9,000
4.1.X7 Sales 1,000
9,000 9,000
Sales (SPL)
$ $
1.1.X7 RCLA 9,000

4.1.X7 Bank 1,000
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Lecture example 3
Ryan Co purchases goods worth $5,000 from Austin Co. Ryan Co will
receive a 5% settlement discount if the goods are paid for within seven
days. Ryan Co has every intention of taking advantage of the settlement
discount.
Required
In the books of Ryan:
(a) Show the initial recording of the purchase.
(b) Record the payment for the goods assuming Ryan
pays within seven days.
(c) Record the payment for the goods if payment is made
after seven days.
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(a)
Purchases (SPL) PLCA (SOFP)
$ $ $ $
PLCA 5,000 Purchases 5,000
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(b)
Discounts received (SPL)

$ $
PLCA 250
Bank (SOFP) PLCA (SOFP)

$ $ $ $
Bank 4,750 Bank 4,750 Purchases 5,000
Discounts
Received 250
5,000 5,000
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(c)
Bank (SOFP) PLCA (SOFP)
$ $ $ $
PLCA 5,000 Bank 5,000 Purchases 5,000
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Lecture example 4
(a) Post the following transactions to and balance off the receivables
ledger control account.
(1) Opening balance $614,000
(2) Credit sales made during the month $302,600
(3) Receipts from customers $311,000
(4) Irrecoverable debts were written off $35,400
(5) Contras against amounts due to suppliers in payables
ledger $8,650
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(b) The receivables ledger list of balances totals to $563,900.

You have found the following errors:
(i) The total of the sales day book was undercast by $3,600.
(ii) A credit balance of $450 was included in the list of
balances as a debit.
(iii) A customer balance of $2,150 was left out when the
receivables ledger list of balances was totalled.
Required
Reconcile the receivables ledger control account to the receivables
ledger list of balances.
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(a) RLCA
$ $
Balance b/d 614,000 Bank 311,000
Sales 302,600 Contras(PLCA) 8,650
Irrecoverable debts 35,400
Bal c/d 561,550
916,600 916,600
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(b) Reconciliation
RLCA
$ $
Bal b/d (part (a)) 561,550
(i) Sales (SDB undercast) 3,600 Bal c/d 565,150
565,150 565,150
$
Balance per list of balances 563,900
(ii) Credit balance included as a debit
(2 × $450) (900)
(iii) Customer balance omitted 2,150
1,250
565,150
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Sale and purchase returns
• Sometimes when a business has made a sale, the customer will return
the goods. Equally when the business has purchased some goods on
credit, it may return them to the supplier.
• Sales returns are credited to the receivables ledger control account
(using a credit note). The credit balance on the control account will
either be offset against future sales, or paid back to the customer in
the form of cash.
• Purchase returns are debited to the payables ledger control account
(also using a credit note). The debit balance will either be offset
against future purchases, or a refund can be requested.
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Chapter summary 1
1 Recap
▪ The balance of the receivables ledger control account
and the payables ledger control account in the nominal
ledger show the total owed by all credit customers and
due to all credit suppliers.
▪ The purpose of the memorandum ledgers is to show the
balance on each individual customer or supplier account.
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Chapter summary 2
2 The flow of information

▪ Given that the nominal ledger and the memorandum
ledgers are updated from the same source
documentation, at any point in time the balance on the
control accounts should equal the total of all the
balances in the memorandum ledgers.
▪ Where the two balances are not the same an error must
have arisen and a reconciliation should be performed to
identify the errors (Section 5).
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Chapter summary 3
3 Other entries
▪ If an entity has a customer is also a supplier the two
parties may choose to settle their accounts by making a
contra entry. The contra is always for the lower of the
two balances.
▪ If a customer returns goods having paid for them or
overpays for goods then the entity will owe money back
to that customer and the customer will have a credit
balance on their account.
▪ If a customer is late in settling their account the entity
may decide to charge them interest on the overdue
account. This will increase the balance owed.
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Chapter summary 4
4 Discounts
▪ Sometimes a business may offer discounts to attract
custom. There are two types of discounts: trade
discounts and settlement discounts.
▪ Sales and purchases are recorded after trade discounts,
and sales are recorded based on expectation of whether
settlement discounts will be taken.
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Chapter summary 5
5 Control account reconciliations

▪ As illustrated in the chapter if the balance on the control
account does not agree to the total of all the balances on
the memorandum ledger then an error must have
occurred and a reconciliation will need to be carried out
to identify the differences.
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Chapter 15 • Bank statement and cash book
• Bank reconciliation
Bank reconciliations
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• Understand the purpose of bank reconciliations.

• Identify the main reasons for differences between the cash
book and the bank statement.
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• Correct cash book errors and/or omissions.

• Prepare bank reconciliation statements and identify the
bank balance to be reported in the final accounts.
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• Derive bank statement and cash book balances from given

information.
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Overview
Bank reconciliations
Cash book balance Bank statement balance
Differences
Timing differences Errors by the business Errors by the bank
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Bank statement and cash book 1
Bank reconciliation
• A comparison of a bank statement with the cash book.
• The bank reconciliation is an important financial control.
• The bank reconciliation will invariably show a difference.
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Bank statement and cash book 2
Differences on bank reconciliation

• Errors: more likely in the cash book
• Omissions: items on the bank statement not in the cash
book (eg bank charges)
• Timing differences: eg cheques issued and entered in the
cash book but not yet presented at the bank
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Bank reconciliation 1
Performing a bank reconciliation

Step 1: Correct the cash book
CASH ACCOUNT
Balance b/f X Dishonoured cheque X
Undercast error Bank charges X
in balance b/f X Standing orders X
Direct debits X
_ Balance c/f X
X X
Corrected balance b/f X
• The corrected cash book balance is the cash balance that

is shown in the SOFP.
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Bank reconciliation 2
Step 2: Reconcile to the bank statement

Proforma bank reconciliation
$
Balance per bank statement X
Less: outstanding cheques (X)
Plus: outstanding lodgements X
Plus/less: bank errors X/(X)
Balance per corrected cash book X
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Tackling the exam
Exam focus point:

• In the exam, you may be given a list of adjustments and
asked to select which ones will be adjusted in the cash
book and/or the bank reconciliation.
• Alternatively you may be asked to calculate the bank
balance to be reported in the SOFP (the adjusted cash
book figure).
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Lecture example 1
The cash account of Graham showed a debit balance of

$204 on 31 March 20X8. A comparison with the bank
statements revealed the following:
$
(1) Cheques drawn but not presented 3,168
(2) Amounts paid into the bank but not credited 723
(3) Entries in the bank statements not recorded
in the cash account
(i) Standing order payments 35
(ii) Interest on bank deposit account 18
(iii) Bank charges 14
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(4) Balance on the bank statement at 31 March 20X8 was

$2,618
Required
Make any necessary adjustments to the cash book
balance and complete the bank reconciliation statement as
at 31 March 20X8.
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Adjustment of cash book balance

Cash account
$ $
Balance b/d 204 Standing order (3i) 35

Bank interest (3ii) 18 Bank charges (3iii) 14
Balance c/d 173
222 222
Bank reconciliation statement

$
Balance per bank statement at 31 March 20X8 2,618
Unrecorded lodgements 723
Outstanding cheques (3,168)
Balance per cash book at 31 March 20X8 173
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Lecture example 2
Whilst preparing a bank reconciliation statement at

31 December. The following items caused a difference
between the bank statement balance and the cash book
balance.
(1) Bank interest charged to the account in error
(2) Direct debit for $500 for insurance
(3) Bank charges of $70
(4) Cheque paid to a supplier on 29 December
(5) Receipt from a trade receivable by electronic transfer
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Required
Which of these items will result in an adjustment to the
balance per the bank statement?
A (2), (3), and (5)

B (1) and (4)
C (1), (4), and (5)
D (1), (3) and (5)
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B
(1) is a bank error, (4) is an outstanding cheque (2), (3)
and (5) have all been processed correctly by the bank but
need recording in the cash account.
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Chapter summary 1
1 Introduction
▪ A business maintains a cash book to tell it how much
cash it has at a particular point in time. It should
reconcile this balance to the bank statement in order to
ensure the cash book information is accurate.
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Chapter summary 2
2 Bank statement and cash book

▪ Differences between the cash book balance and the
bank statement balance will arise for three reasons:
timing differences, errors by the business and errors
by the bank.
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Chapter summary 3
3 Preparing a bank reconciliation

▪ The bank reconciliation is produced by checking all of
the items on the bank statement to the cash book to
ensure that they have all been recorded.
▪ Any items not in the cash book will then need to be
recorded and the cash book updated.
▪ The balance per the bank statement must then be
adjusted for any timing differences (unrecorded
lodgements and outstanding cheques) or errors by the
bank.
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Chapter 16 • Types of error in accounting
• The correction of errors
Correction of errors
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• Identify the types of error which may occur in bookkeeping

systems.
• Identify errors which would be highlighted by the extraction
of a trial balance.
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• Prepare journal entries to correct errors.
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• Calculate and understand the impact of errors on the

statement of profit or loss, statement of profit or loss and
other comprehensive income and statement of financial
position.
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• Understand the purpose of a suspense account.

• Identify errors leading to the creation of a suspense
account.
• Record entries in a suspense account and make journal
entries to clear it.
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Overview
Types of error
Suspense account Adjustments to profit
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Tackling the exam
Exam focus point:
The examiner has highlighted suspense accounts and errors

as areas that students find particularly difficult. You need to
use a methodical approach as highlighted in this chapter.
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Types of error in accounting 1
The main types of error are as follows

• Errors of transposition, eg writing $381 as $318 (the
difference is divisible by 9)
• Errors of omission, eg receive supplier's invoice for $500
and do not record it in the books at all
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Types of error in accounting 2
The main types of error are as follows

• Errors of principle, eg treating capital expenditure as
revenue expenditure
• Errors of commission, eg putting telephone expenses in
the electricity expense account
• Compensating errors, eg both sales day book and
purchases day book coincidentally undercast by $500
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The correction of errors 1
• Errors can be corrected using the journal, but only those
errors which required both a debit and an (equal) credit
adjustment.
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• Example
Accountant omits to record invoice from supplier for
$2,000. This would be corrected by the following journal
entry.
DEBIT Purchases $2,000

CREDIT Payables $2,000
A transaction previously omitted.
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• Another example
Accountant posts car insurance of $800 to motor vehicles
account. Correct as follows.
DEBIT Motor expenses $800

CREDIT Motor vehicles $800
Correction of error of principle.
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A suspense account is a temporary account that is

used in the following circumstances.
• The bookkeeper knows in which account to make the debit
entry for a transaction but does not know where to make
the corresponding credit entry (or vice versa).
— The credit is temporarily posted to the suspense
account until the correct credit entry is known.
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Suspense account (cont'd)

• A difference occurs in the trial balance caused by the
incomplete recording of the double entry in respect of one
or more transactions.
— The difference is recorded in the suspense account and
included in the trial balance, so restoring equality.
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Any balance on a suspense account must be eliminated.

It is never included in the final accounts.
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Lecture example 1
Dan, the bookkeeper of Tiffany's, has made his usual mess

of things and produced the following attempt at a trial
balance for the year ended 30 April 20X7.
$ $
Property, plant and equipment
At cost 60,000
Provision for depreciation 31,000
Capital at 1 May 20X6 53,000
Inventory, at cost 14,000
Receivables ledger control account 9,600
Payables ledger control account 6,500
Balance at bank 1,640
85,240 102,800
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As chief accountant you discover the following:

(1) A rent payment of $350 in March 20X7 had been
debited in the receivables ledger control account.
(2) An irrecoverable debt of $500 during the year ended
30 April 20X7 had not been recorded in the books.
(3) No entry had been made for the refund of $2,620 made
by cheque to V Woolf in March 20X7, in respect of
defective goods returned to Tiffany. V Woolf, who had
already paid for the goods, returned them on 28
February 20X7.
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(4) The total column of the cash receipts book had been
overcast by $1,900 in March 20X7.
(5) The purchase of stationery for $1,460 cash in June 20X6
has not been posted to the appropriate expense account.
(6) Capital of $35,000 was recorded incorrectly as $53,000.
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Required
Prepare:
(a) Journal entries to correct the above errors
(b) A suspense account showing how it is cleared
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(a) Journal entries
Dr Cr
$ $
(1) Rent and rates 350
(2) Irrecoverable debts 500
(3) Trade receivables 2,620
Cash at bank 2,620
(4) Suspense account 1,900
Cash at bank 1,900
(5) Stationery and postage 1,460
Suspense account 1,460
(6) Capital 18,000
Suspense account 18,000
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(b) Suspense account

$ $
Brought forward Stationery and postage
(102,800 – 85,240) 17,560 (5) 1,460
Cash at bank (4) 1,900 Capital (6) 18,000
19,460 19,460
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Lecture example 2
Required
Prepare a statement of adjustments to profit for Lecture
example 1.
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Adjustment of profits statement for the year ended 30 April 20X7

Increases Decreases
$ $ $
Draft profit 12,300
Adjustments
Rent (1) 350
Irrecoverable debt (2) 500
Stationery (5) 1,460
Total adjustments 2,310 ( 2,310)

9,990
Revised profit
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Lecture example 3
Z Co's statement of profit or loss showed a profit of $112,400

for the year ended 30 September 20X7. The following errors
were later discovered:
(1) Sales returns of $2,700 had been recorded as a new
sale.
(2) A machine which had been held for two years and had
originally cost $15,000 was depreciated this year
using a 331/3% reducing balance basis. Z Co's policy
is to depreciate machines over four years.
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Required
What would be the net profit after adjusting for these errors?
A $103,250
B $105,750
C $105,950
D $108,450
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B
Increases Decreases
$ $ $
Draft profit 112,400
Adjustments
(1) sales returns (2 × $2,700) 5,400
(2) depreciation (W) 1,250
_ 6,650
Adjusted profit (6,650)
105,750
(W) Depreciation charge was

331/3% × ($15,000 × 2/4) = $2,500
Depreciation charge should have been
$15,000 ÷ 4 years = $3,750
Incremental depreciation to be charged $1,250
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Working:
P&L $83,600
Mis-posting $18,000 Should Dr. Asset
Depreciation ($4,500) Did Dr. Expense
($18,000 x 25%) $97,100
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Chapter summary 1
1 Introduction
▪ If the trial balance doesn't balance an error has been
made and must be corrected.
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Chapter summary 2
2 Types of error
▪ There are four types of errors: errors of omission,
commission, principle and compensating errors which
will still allow the trial balance to balance.
▪ If an error is made however where debits ≠ credits then
the trial balance will not balance.
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Chapter summary 3
3 Suspense accounts
▪ Where the trial balance does not balance a suspense
account will be inserted and the errors, once identified,
will be corrected via a journal entry.
▪ A suspense account should never appear in the final
financial statements.
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Chapter summary 4
4 Adjustments to profit
▪ Where the process of correcting errors requires changes
to income and expense accounts the business's profit
will be affected. In this case a statement of
adjustments to profit can be prepared to determine the
revised profit figure.
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Chapter 17 • Incomplete records questions
• Accounting and business
equations
Incomplete records
• Credit sales, purchases and cost
of sales
• Stolen or destroyed goods
• Cash book
• Accruals, prepayments and
drawings
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Understand and apply techniques used in incomplete record

situations:
• Use of accounting equation
• Use of ledger accounts to calculate missing figures
• Use of cash and/or bank summaries
• Use of profit percentages to calculate missing figures
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Overview
Margin Cost structures Mark-up
Incomplete records
Techniques for solving

incomplete records
Derive missing figures

from given information
Sales Purchases Drawings Inventory
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Incomplete records questions 1
Types of question
An incomplete records question may require competence in
dealing with one or more of the following.
• Preparation of accounts from information in the question
• Theft of cash (balance on the cash in hand account is
unknown)
• Theft or destruction of inventory (closing inventory is the
unknown)
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• Estimated figures, eg 'drawings are between $15 and $20

per week'
• Calculation of capital by means of net assets
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• Calculation of profit by (profit = increase in net assets plus

drawings minus increase in capital)
• Calculation of year end inventory when the inventory count
was done after the year end
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Accounting and business equations 1
Accounting equation
• An examination question may provide information about
the assets and liabilities of an entity at the beginning of a
period, leaving you to calculate capital as the balancing
figure.
• Remember:
Assets – Liabilities [net assets] = Proprietor's capital + Profit – Drawings
A–L=C+P–D
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Accounting and business equations 2
• You may need to rearrange the equation, depending on

which figure you need to calculate.
• For example if you have opening and closing net assets,
you can calculate profit for the year as follows:
Profit = Opening NAs – Closing NAs
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Credit sales, purchases and cost of sales 1
Credit sales and receivables

• The key lies in the formula linking sales, cash receipts and
receivables.
• Remember:
Opening receivables + sales – cash receipts = closing
receivables
• Alternatively put all the workings into a control account to
calculate the figure you want.
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Purchases and trade accounts payables

• Similarly you need a formula for linking purchases, cash
payments and payables:
Opening payables + purchases – cash payments =
closing payables
• Alternatively put all the workings into a control account to
calculate the figure you want.
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Gross margins and mark-ups

• Other incomplete records problems revolve around the
relationship between sales, cost of sales and gross profit.
Bear in mind the crucial formula:
$
Sales 100
Less Cost of sales 25
Equals Gross profit 75
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• Mark-up is profit as a % of cost, eg 33 ⅓% mark-up
$
Sales 133.3% 80
COS 100% (60)
Gross profit 33.3% 20
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• Margin is profit as a % of sales eg 25% margin
$
Sales 100% 80
COS 75% (60)
Gross profit 25% 20
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Stolen or destroyed goods 1
Stolen goods or goods destroyed

• The cost of goods stolen/destroyed can be calculated as
follows:
$
Cost of goods sold based on gross profit margin
or mark-up A
Cost of goods sold calculated using standard formula
(ie opening inventory plus purchases less
closing inventory) (B)
Difference (lost/stolen inventory) C
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• If no goods have been lost, A and B should be the same

and therefore C should be nil.
• If goods have been lost, B will be larger than A, because
some goods which have been purchased were neither
sold nor remaining in inventory, ie they have been lost.
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• Stolen or lost inventory is accounted for in two ways

depending on whether the goods were insured:
— If insured
DEBIT Insurance claim account (receivable)
CREDIT Cost of sales
— If not insured
DEBIT Expenses (eg Admin)
CREDIT Cost of sales
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Cash book 1
Cash book
• Incomplete records problems often concern small retail
entities where sales are mainly for cash. A two column
cash book is often the key to preparing final accounts.
• The bank column records cheques drawn on the business
bank account and cheques received from customers and
other sources.
• The cash column records till receipts and any expenses or
drawings paid out of till receipts before banking.
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Cash book 2
Debits (receipts) Credits (payments)

Cash Bank Cash Bank
$ $ $ $
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Cash book 3
• Don't forget that movements between cash and bank need

to be recorded by contra entries. This will usually be cash
receipts lodged in the bank (debit bank column, credit
cash column), but could also be withdrawals of cash from
the bank to top up the till (debit cash column, credit bank
column).
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Cash book 4
• Incomplete records problems will often feature an

unknown figure to be derived. Enter in the credit of the
cash column all amounts known to have been paid from till
receipts: expenses, withdrawals, lodgements into bank.
Enter in the debit of the cash column all receipts from cash
customers or other cash sources.
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Cash book 5
• The balancing figure may then be a large debit,

representing the value of cash sales if that is the unknown
figure.
• Alternatively it may be a credit entry that is needed to
balance, representing the amount of cash withdrawals or
of cash stolen.
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Accruals, prepayments and drawings 1
Accruals and prepayments

• When there is an accrued expense or prepayment, the
SPL charge can be calculated from the opening balance,
the cash movement and the closing balance. Sometimes it
helps to use a 'T' account, eg as follows (for a rent
payment).
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RENT
$ $
Prepayment: bal b/f 700 SPL (bal fig) 9,000
Cash 9,300 Prepayment: bal c/f 1,000
10,000 10,000
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Drawings
Note three tricky points about drawings.
• Owner pays personal income into business bank account
DEBIT Cash
CREDIT Drawings
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• Owner pays personal expenses out of business bank

account or takes goods for personal use
DEBIT Drawings
CREDIT Cash/Purchases
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Tackling the exam
• Wording of an exam question

— 'Drawings approximately $40 per week'
Therefore drawings for year = $40 × 52 = $2,080
— 'Drawings between $35 and $45 per week'
Therefore drawings are a missing number to be
calculated.
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Lecture example 1
W Co has on average a profit margin of 40%. In 20X7 sales

total $476,000.
Required
What is cost of sales?
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% $
Sales 100 476,000 ×60%
COS 60 285,600
GP 40 190,400
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Lecture example 2
Y Co operates with a standard mark-up of 30% and has the

following information available for 20X7.
$
Sales 221,000
Closing inventories 47,500
Required
What is the value for purchases in 20X7?
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% $
Sales 130 221,000 X100/130
COS 100 170,000
GP 30 51,000
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Purchases: $
Cost of sales
Opening inventory 43,000
+ Purchases 174,500
– Closing inventory 47,500

170,000
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Lecture example 3
On 1 January 20X7 J Co had inventory of $620,000. Sales

for the month amounted to $985,000 and purchases were
$700,000. At the end of January a fire in the warehouse
destroyed some inventory items. The owners salvaged
inventory valued at $180,000. J Co operates with a mark
up of 25%.
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What is the cost of inventory destroyed in the fire?

A $335,000
B $352,000
C $401,250
D $532,000
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B Cost structure: 25% mark up.

$
Sales = 125% = 985,000
∴ COS = 100% = 788,000
Gross profit 25% 197,000
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Cost of sales
$
Purchases 700,000
1,320,000
Less: cost of sales (788,000)
Closing inventories should be 532,000
Closing inventories is (180,000)
∴ inventory lost in fire 352,000
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Lecture example 4
A Co has recorded the following details relating to trade

payables:
$
Balance at 1.1.X7 38,450
31.12.X7 43,825
Cash paid from till 430
Payments from bank 167,224
Required
Based on the information above what was the value of
purchases made during the year?
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Trade payables
$ $
Bal b/d 38,450
Till 430
Bank 167,224
Balance c/d 43,825 Purchases 173,029
211,479 211,479
Dr Purchases (SPL) $173,029

Cr Trade payables $173,029
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Lecture example 5
B Co maintains a cash float of $50. In 20X7, all receipts from

credit customers were banked, after the following payments
from the till had been made:
$
General expenses 4,500
Drawings 6,250
Total bankings in the year amounted to $28,454, and

opening and closing trade receivables were $1,447 and
$1,928 respectively.
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Required
Based on the information above what was the value of
sales made during the year?
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Cash
$ $
Bal b/d 50
Receipts from General expenses 4,500
Trade receivables 39,204 Drawings 6,250
(1)
Bankings 28,454
Bal c/d 50
39,254 39,254
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Trade receivables
$ $
Bal b/d 1,447 Cash (deduced from
cash a/c) 39,204
Sales (2) 39,685
Bal c/d 1,928
41,132 41,132
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Lecture example 6
Bob owns and manages B Co although he does not keep

detailed accounting records.
All of Bob's sales are for cash. He pays certain expenses
from his till and then banks the remaining funds.
Bob maintains a $1,000 float and operates with a margin
of 20%. He has provided you with the following information.
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Lecture example 6
$
Purchases of goods (on credit) 20,000
Wages for clerical assistant (per week;
there are 52 weeks in the year) 100
Stationery 500
Electricity 1,200
Bankings 12,800
Closing inventories 3,000
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Bob is unsure of the level of drawings taken during the year

but estimates they were between $60 and $90 per week.
Required
What were Bob's drawings during the year?
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$4,050
Cost structure:
$
Sales = 100% = 23,750
∴ COS = 80% = 19,000
Gross profit 20% 4,750
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Cash
$ $
Bal b/d 1,000 Wages 5,200
Stationery 500
Sales 23,750 Electricity 1,200
Bankings 12,800
∴ drawings 4,050
Bal c/d 1,000
24,750 24,750
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Tackling the exam
Exam focus point:
Questions on incomplete records in your exam will usually

be based on short scenarios. You may also need to use the
techniques illustrated in this chapter in one of the 15 mark
questions, either on this topic or on accounts preparation.
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Chapter summary 1
1 Issue
▪ Not all businesses keep proper accounting records,
however all businesses need to know how much profit
they have made in a particular year so that they can pay
the relevant amount of tax over to the tax authorities.
▪ Where a business does not have sufficient records to
produce financial statements they need to piece together
the missing information.
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Chapter summary 2
2 Cost structures
▪ A margin is where a business expresses gross profit as
a percentage of sales.
▪ A mark-up is where gross profit is expressed as a
percentage of cost of sales.
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Chapter summary 3
3 Other techniques for solving incomplete records

▪ Other techniques that may be used in solving incomplete
records questions involve putting all known information in
to one or two ledger accounts and balancing off to derive
the required information. These questions are essentially
a test of double entry skills.
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Chapter summary 4
4 Goods drawn by proprietor

▪ A business is a separate entity from its owner which
means that any monies or goods taken out of the
business for personal use must be classified as
drawings. Drawings of goods are always recorded at
cost.
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Chapter 18 • Preparation of final accounts
• Sole traders
Preparation of
for sole traders
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• Prepare extracts of an opening trial balance.

• Prepare journal entries to correct errors.
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• Record entries in a suspense account.

• Make journal entries to clear a suspense account.
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• Prepare extracts of a statement of financial position and

statement of profit or loss from given information.
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Overview
Preparation of financial
statements for sole traders
Trial balance
Adjustments Suspense account
Statement of profit or loss and

position
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Preparation of final accounts 1
Final accounts
• You have now revised all areas necessary to prepare the
final accounts of a sole trader. Areas you should be totally
familiar with are as follows:
– Ledger accounts
– Trial balance
– Format of statement of profit or loss and statement of
financial position
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Preparation of final accounts 2
• You should be able to deal with the following adjustments:

— Depreciation
— Inventory
— Accruals and prepayments
— Irrecoverable debts
— Allowance for receivables
— Profit/loss disposal of non-current assets
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Tackling the exam
• With the change in the format of the FA/FFA exam, you

could be asked to prepare a full SPL or SOFP for a sole
trader.
• Alternatively you may be asked to prepare extracts from
both statements.
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Sole traders
Steps to follow:
(1) Prepare trial balance
(2) Do final adjustments
(3) Clear suspense account
(4) Prepare statement of profit or loss
(5) Prepare statement of financial position
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Lecture example 1
You have been given the information below and asked to prepare the
accounts of Mugg for the year ended 31 December 20X7.
Trial balance as at 31 December 20X7

Dr Cr
$ $
Capital account at 1 January 20X7 2,377
Rent 500
Inventories 1 January 20X7 510
Electricity 240
Insurance 120
Wages 1,634
Purchases 9,876
Sales 15,542
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Dr Cr
$ $
Repairs 635
Discounts received 129
Drawings 1,200
Petty cash 5
Bank 762
Motor vehicles at cost 1,740
Furniture and fixtures at cost 830
Accumulated depreciation at 1 January 20X7
— Motor vehicles 435
— Furniture and fixtures 166
Travel and entertaining 192
Trade payables 700
Suspense account 433
19,349 19,349
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The following information is also available:

(1) Closing inventories, valued at cost, amounts to $647.
(2) Mugg has drawn $10 a month and these drawings
have been charged to wages.
(3) Depreciation is to be provided at 25% on cost on
motor vehicles, and 20% on cost on furniture and
fixtures.
(4) Irrecoverable debts totalling $37 are to be written off.
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(5) $180 received from a credit customer was correctly

entered in the trade receivables account and credited
to the bank account.
(6) Mugg has taken goods from inventories for his own
use. When purchased by his business these goods
cost $63 and they would have been sold for $91.
(7) The annual rental of the business premises is $600,
and $180 paid for electricity in August 20X7 covers
the 12 months to 30 June 20X8.
(8) A trade discount of $73 was given on a sale, but entry in
sales was for the gross sale price, instead of the invoice
amount.
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Required
(a) Prepare journal entries to record items (1) – (8).
(b) Clear the suspense account.
(c) Produce a statement of profit or loss for the year
ended 31 December 20X7 and a statement of
financial position as at that date.
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Dr Cr
Dr Inventories (SOFP) 647
Cr Closing inventories (SPL) 647
Being: adj for y/e inventories
Dr Drawings (12 × $10) 120
Cr Wages 120
Being: correction of cash drawings posted as

wages
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Dr Cr
Dr Dep'n expense (SPL) 601
Cr Acc dep'n – MV ($1,740 × 25%) 435
Cr Acc dep'n – F&F ($830 × 20%) 166
Being: adj for y/e depreciation
Dr irrecoverable debt expense 37
Cr Trade receivables 37
Being: write off of irrecoverable customer

balance
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Dr Cr
Dr Bank (2 × $180) 360
Cr Suspense account 360
Being: adj to correct cash receipt from trade

receivables
Dr Drawings 63
Cr Purchases 63
Being: adj for goods drawn from business (at

cost)
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Dr Cr
Dr Rent expense (600 ─ 500) 100
Cr Accruals 100
Being: accrual of rent expense
Dr Prepayments ($180 × 6/12) 90
Cr Electricity expense 90
Being: prepayment of electricity expense
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Dr Cr
Dr Sales 73
Cr Suspense account 73
Being: adj for trade discount which was omitted
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Suspense account
b/d 433
(5) Bank 360
(8) Sales 73
433 433
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MUGG
SPL for the y/e 31.12.X7 $ $
Sales (15,542 – 73) 15,469
Less: cost of sales
Opening inventory 510
Purchases (9,876 – 63) 9,813
Less: closing inventory 647
9,676
Gross profit 5,793
Discounts received 129
5,922
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$ $
Less: expenses
Rent (500 + 100) 600
Electricity (240 – [6/12 ×180]) 150
Insurance 120
Wages (1,634 – 120) 1,514
Repairs 635
Depreciation 601
Travel and entertainment 192
Irrecoverable debts 37
3,849
Profit for the period 2,073
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MUGG Cost Acc dep'n CA
SOFP as at 31.12.X7 $ $ $
Non-current assets
Motor vehicles 1,740 870 870
Furniture and fixtures 830 332 498
2,570 1,202 1,368
Current assets
Inventories 647
Trade receivables (672 – 37) 635
Prepayments 90
Cash and bank balances (5 + 762 + 360) 1,127 2,499
3,867
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$ $
Capital
Capital as at 1 Jan 20X7 2,377
Less: drawings (1,200 + 63 + 120) 1,383
3,067
Current liabilities
Trade payables 700
Accruals 100
800
3,867
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Chapter summary 1
1 Introduction
▪ The statement of financial position and the statement of
profit or loss are the end product produced by a
business. All the business's transactions need to be
categorised into the books of prime entry and posted to
the nominal ledger. The trial balance is then extracted
and some adjustments may need to be made before the
financial statements are drawn up.
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Chapter summary 2
2 Preparation of final accounts

▪ You may or may not have to produce a statement of
financial position or statement of profit or loss (although
you could be asked to produce extracts); however this
chapter should reinforce your understanding of Chapters
1–16.
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Chapter 19 • Limited liability companies
• Shares
Introduction to • Reserves
company accounting • Bonus and rights issues
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• Understand the capital structure of a limited liability

company including ordinary shares, preference shares
(redeemable and irredeemable) and loan notes.
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• Record movements in the share capital and share

premium accounts.
• Identify and record other reserves which may appear in
the company statement of financial position
• Define a bonus issue and a rights issue, their advantages
and disadvantages and show how they are recorded in the
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• Record dividends in ledger accounts and the financial

statements.
• Calculate and record finance costs in ledger accounts and
the financial statements.
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• Recognise the legal differences between a sole trader, a

partnership and a limited liability company.
• Identify the advantages and disadvantages of operating as
a limited liability company, sole trader or partnership.
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Overview
Finance costs
Reserves Long-term borrowings Income taxes
Introduction to
company accounting
Shares
Issue at a premium Bonus issue Rights issue
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Limited liability companies 1
Features
• Limited liability companies offer limited liability to their
owners (shareholders).
If the company becomes insolvent, the maximum amount
that an owner stands to lose is his share of the capital of
the business.
This is an attractive prospect to investors. Limited liability
companies may be private or public. IAS 1 sets out a
suggested format for financial statements.
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• Owners = shareholders or members

• Large number of owners
• Owner/manager split
• Owners appoint directors to run business on their behalf
• Owners receive share of profits in form of dividends
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Disadvantages
• Compliance with national legislation
• Compliance with national accounting standards and/or
IFRSs
• Any formation or annual registration costs
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Funding
Companies are funded in the following ways:
• Retained profits
• Share capital
• Short-term liabilities (trade accounts payable etc)
• Loan notes
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Shares 1
Shares
• The proprietors' capital in a limited liability company
consists of share capital.
When a company is set up for the first time it issues
shares, which are paid for by investors, who then become
shareholders of the company.
• Shares are denominated in units of 25 cents, 50 cents, $1
or whatever seems appropriate.
This is referred to as their nominal value.
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Shares 2
Ordinary shares have the following characteristics:

• No right to fixed dividend
• Entitled to remaining profits after preferred dividend
• Entitled to surplus on repayment of capital
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Shares 3
Preferred shares are characterised as follows:

• Rights depend on articles
• Right to fixed dividend with priority over ordinary shares
• Do not usually carry voting rights
• Generally priority for capital in winding up
• May be redeemable (loan) or irredeemable (equity)
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Shares 4
Share capital
• Authorised. The maximum amount of share capital that a
company is empowered to issue.
• Issued. The amount of share capital that has been issued
to shareholders. The amount of issued capital cannot
exceed the amount of authorised capital.
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Shares 5
• Called up. When shares are issued or allotted, a company

does not always expect to be paid the full amount of the
issue price at once. It might instead call up only a part of
the issue price, and call up the remainder later.
• Paid-up. Called up capital that has been paid.
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Shares 6
• Market value. This is the price at which someone is

prepared to purchase the share value from an existing
shareholder. It is different from nominal value.
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Shares 7
The following are the main types of share issue:

• New issue at par or at a premium
• Bonus/scrip/capitalisation issue
• Rights issue
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Shares 8
Loan notes
Companies may issue loan notes. These are long-term
liabilities not capital. They differ from shares as follows:
• Shareholder = owner; note holder = payable
• Loan note interest must be paid; not so dividends
• Loan notes often secured on company assets
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Reserves 1
Reserves
Revenue reserves consist of distributable profits and can be
paid out as dividends.
• Retained earnings
• Others, as the directors decide, eg general reserve
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Reserves 2
• Share premium. Whenever shares are issued for

consideration in excess of their nominal value, such a
premium shall be credited to a share premium account.
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Tackling the exam
Exam focus point:
The share premium account cannot be distributed as a

dividend under any circumstances.
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Reserves 3
Share premium account can be used to:

• Issue bonus shares
• Write off formation expenses and premium on the
redemption of shares and loan notes
• Write off the expenses on a new issue of shares/loan
notes and the discount on the issue of loan notes
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Reserves 4
• Revaluation surplus. Created when a company revalues

one or more of its non-current assets.
• Statutory reserves. The law requires the company to set
up these.
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Bonus and rights issues 1
Bonus issue
• A bonus (or capitalisation) issue uses reserves to pay for
the issue of share capital.
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Example
• Issue of 5,000 new $1 shares
DEBIT Reserves (share premium or
retained earnings) $5,000
CREDIT Share capital $5,000
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Rights issue
• A rights issue enables existing shareholders to acquire
further shares.
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Example
• Issue of 5,000 new $1 shares at $1.50 per share
DEBIT Cash $7,500
CREDIT Share capital $5,000
CREDIT Share premium $2,500
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Lecture example 1
On 1 June 20X6 Rab Co issued a further 200,000 ordinary

shares of 50c each for 80c per share.
Required
Show how this issue of shares would be accounted for and
what the statement of financial position would look like
immediately after the issue.
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Rab Co
$ $
Dr Cash (200,000 × 80c) 160,000
Cr Share capital (200,000 × 50c) 100,000
Cr Share premium account (200,000 × 30c) 60,000
Statement of financial position (extract) as at 1 June 20X0

Equity $
Share capital – 50c ordinary shares (50,000 + 100,000) 150,000
Share premium account 60,000
210,000
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Lecture example 2
RAB CO
$
Share capital – 50c ordinary shares 150,000
Retained earnings 200,000
410,000
Several years later Rab Co is to make a bonus issue on a
1 for 4 basis.
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Required
Show how this issue of shares would be accounted for
and prepare the statement of financial position of Rab Co
immediately after the issue.
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Bonus Issue
New share capital: 300,000 ($150,000/ 0.5) / 4
×50c = 37,500
Double entry: $ $
Dr Share premium account 37,500
Cr Share capital 37,500

$
Share capital – 50c ordinary shares (150,000 + 37,500) 187,500
Share premium account (60,000 – 37,500) 22,500
410,000
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Lecture example 3
One year later, Rab Co is to make a rights issue on a 1 for 5 basis. The
rights price is $1.50. All shareholders take up their rights.
The following statement of financial position extract shows the position
before the issue:
RAB CO
$
440,000
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Required
Show how this issue of shares would be accounted for and
prepare the statement of financial position of Rab Co
immediately following the issue.
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Rights Issue $ $
New share capital: 375,000 / 5 × 50c 37,500
Share premium: 375,000 / 5 × $1 75,000
$ $
Dr Cash 112,500
Cr Share capital 37,500
Cr Share premium account 75,000
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RAB CO
$
552,500
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Lecture example 4
ABC Co has the following share capital:

100,000 6% $1 preference shares
200,000 50c ordinary shares
Retained earnings at the beginning of the year were $125,000.

During the year ended 31 December 20X7 it made the following profit:
$
Profit before tax 60,000
Income tax expense 10,000
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Dividends paid and declared during the year were as follows:

Interim dividend paid 5c per share
Final dividend declared on 20 January 20X8 10c per share
Required
Show the movement in retained earnings for ABC Co for the year ended
31 December 20X7.
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ABC Co
Reconciliation of movement in retained earnings
for year ended 31 December 20X7
$ $
Retained earnings at beginning of year 125,000
Dividends – preference 6,000
– ordinary (200,000 shares × 5c) 10,000
(16,000)
Retained earnings at end of year 159,000
Note. Dividends which have been paid are deducted from retained earnings
in the statement of financial position. Proposed dividends are not adjusted
for.
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Lecture example 5
Lauren Ltd has a year end of December.

When preparing its financial statements for the year ended
31 December 20X5, Lauren Ltd estimated that its income tax
payable would be $62,000.
Lauren Ltd settled this tax liability on 30 September 20X6,
paying $65,000. The tax estimate for the year ended
31 December 20X6 is $43,000.
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Required
(1) Record the tax entries for the years ended
31 December 20X5 and 20X6 in the ledger accounts.
(2) Prepare the tax note which relates to the statement of
profit or loss for the year ended 31 December 20X6.
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(1)
Income tax expense (SPL)
$ $
31.12.X5 Current tax payable 62,000 31.12.X5 Statement of profit 62,000
30.9.X6 Current tax payable 3,000 or loss
31.12.X6 Current tax payable 43,000
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Current tax payable (SOFP)

$ $
31.12.X5 Balance c/d 62,000 31.12.X5 Income tax expense 62,000
62,000 62,000
30.9.X6 Bank 65,000 1.1.X6 Balance b/d 62,000
30.9.X6 Income tax expense 3,000
31.12.X6 Bal c/d 43,000 31.12.X6 Income tax expense 43,000
108,000 108,000
1.1.X7 Balance b/d 43,000
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(2) Tax note for the year ended 31 December 20X6

$
Tax charge for the year 43,000
Under provision in respect of prior periods 3,000
46,000
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Chapter summary 1
1 Introduction
▪ Companies use the same method of bookkeeping to
record transactions. There are however some differences
in the terminology and the formats used.
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Chapter summary 2

▪ The format in which companies must produce their
financial statements is prescribed by the accounting
standard IAS 1.
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Chapter summary 3
3 Share capital
▪ An entity may issue two main types of shares. Ordinary
or equity shareholders have voting rights and therefore
have control over the company. Preference shareholders
are really just providers of finance to the business and
have limited rights.
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Chapter summary 4
4 Share capital: accounting treatment

▪ In a limited liability company the shareholders own the
business. A company may raise finance by issuing new
share capital. Where shares are issued at a premium to
their nominal value, the premium is recorded in the share
premium account. A bonus issue is where the company
issues shares for no cash consideration. With a rights
issue, shares are issued for cash but the price charged is
slightly lower than the current market price.
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Chapter summary 5
5 Reserves
▪ A company may have several different types of reserve
such as a share premium account, a revaluation surplus
and retained earnings.
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Chapter summary 6
6 Dividends
▪ Shareholders may receive a dividend as a return on
their investment; these are accounted for as a deduction
to retained earnings.
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Chapter summary 7
7 Long-term borrowings
▪ A company may also raise finance by issuing debt such
as loan notes or debentures.
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Chapter summary 8
8 Finance costs
▪ It will have to pay interest on any debt that it issues and
this will be shown as 'finance costs' in the statement
of profit or loss.
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Chapter summary 9
9 Current tax
▪ Companies pay corporation tax on their profits.
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Chapter summary 10
10 Comparison
▪ Sole traders and partnerships are very similar in their
nature whilst companies are quite different. You must
ensure that you are happy with both the differences and
similarities.
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Chapter 20 • IAS 1 Presentation of financial
statements
• IAS 18 Revenue
Preparation of
for companies
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• Recognise how the accounting equation and business

entity convention underlie the statement of financial
position.
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• Understand the nature of reserves and report them in a

company statement of financial position.
• Prepare extracts of a statement of financial position or
extracts from given information.
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• Understand why the heading 'retained earnings' appears

in a company statement of financial position.
• Prepare a statement of profit or loss and other
comprehensive income or extracts as applicable from
given information.
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• Understand how accounting concepts apply to revenue

and expenses.
• Calculate revenue, cost of sales, gross profit, profit for the
year and total comprehensive income from given
information and disclose items of income and expenditure
in the statement of profit or loss.
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• Record income tax in the statement of profit or loss of a

company including the over and under provision of tax in
the prior year.
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• Understand the inter-relationship between the statement of

financial position, statement of profit or loss and statement
of profit or loss and other comprehensive income.
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• Identify items requiring separate disclosure on the face of

the statement of profit or loss.
• Identify the components of the statement of changes in
equity.
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• Explain the purpose of disclosure notes.

• Draft disclosure notes for tangible and intangible
non-current assets, inventory, provisions and events after
the reporting period.
• Illustrate how non-current asset balances and movements
are disclosed in financial statements.
• Calculate the transfer of excess depreciation between the
revaluation surplus and retained earnings.
• Classify items as current or non-current liabilities in the
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Overview
position
Preparation of financial statements

for companies
Statement of Notes to the accounts

changes in equity
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IAS 1 Presentation of financial statements 1
ABC CO
STATEMENT OF FINANCIAL POSITION
AS AT 31 DECEMBER 20X2
20X2 20X1
$ $ $ $
Assets
Non-current assets
Property, plant and equipment X X
Goodwill X X
Other intangible assets X X
X X
Current assets
Inventories X X
Trade receivables X X
Other current assets X X
Cash and cash equivalents X X
X X
Total assets X X
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ABC CO
20X2 20X1
$ $ $ $
Equity and liabilities
Equity
Share capital X X
Retained earnings/(losses) X X
Other components of equity X X
Total equity X X
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ABC CO
20X2 20X1
$ $ $ $
Non-current liabilities
Long-term borrowings X X
Long-term provisions X X
X X
Current liabilities
Trade and other payables X X
Short-term borrowings X X
Current portion of long-term
borrowings X X
Current tax payable X X
X X
Total equity and liabilities X X
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ABC CO
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE
INCOME FOR THE YEAR ENDED 31 DECEMBER 20X2
20X2 20X1
$ $
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expense (X) (X)
Other expenses (X) (X)
Finance cost (X) (X)
Profit before tax X X
Income tax expense (X) (X)
Profit for the year X X
Other comprehensive income:

Gains on property revaluation X X
Total comprehensive income for the year X X
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ABC CO
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20X2
Share capital Retained earnings Revaluation surplus Total

$ $ $ $
Balance at 1 January 20X2 X X X X
Changes in equity for 20X2

Issue of share capital X X
Dividends (X) (X)
Total comprehensive income for
the year _ X X X
Balance at 31 December 20X2 X X X X
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Tackling the exam
Exam focus point:
You need to become familiar with the format of these

statements, as you may be asked to prepare extracts in the
exam.
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IFRS 15 Revenue from contracts with customers 1
IFRS 15 Revenue from contracts with customers

Revenue is recognised to depict the transfer of promised goods or
services to customers at an amount that the entity expects to be
entitled to in exchange for those goods or services (IFRS 15:IN7).
This is achieved by applying a five step model:
(1) Identify the contract(s) with a customer
(2) Identify the performance obligations in the contract
(3) Determine the transaction price
(4) Allocate the transaction price to the performance
obligations in the contract
(5) Recognise revenue when (or as) the entity satisfies a
performance obligation.
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IFRS 15 Revenue from contracts with customers 2
IFRS 15 covers revenue from:

• Sale of goods
• Rendering of services
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Lecture example 1
Using the illustration on the following slides, prepare the

statement of profit or loss and other comprehensive income
for the year ended 30 September 20X6:
(a) Showing the statement as one statement
(b) Showing the statement as two separate statements
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Below are the statement of profit or loss and statement of financial position for
Arrow Co for the year ended 30 September 20X6.
ARROW CO
FOR THE YEAR ENDED 30 SEPTEMBER 20X6
$'000
Revenue 12,740
Cost of sales (7,040)
Gross profit 5,700
Distribution costs (2,060)
Administrative expenses (2,375)
Finance costs (72)
Income tax expense (270)
Profit for the year 923
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ARROW CO
STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X6
$'000
Assets
Non-current assets
Property, plant and equipment 5,000
5,000
Current assets
Inventories 610
Cash and cash equivalents 1,170
2,780
Total assets 7,780
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Equity and Liabilities

Equity
Share capital 1,750
Share premium account 585
revaluation surplus 1,400
5,608
Long-term borrowings 1,200
1,200
Current liabilities
Trade payables 550
Other payables 72
Current tax payable 270
Short-term provisions 80
972
Total equity and liabilities 7,780
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The following information was accounted for when the

above financial statements were produced:
(1) During the year the company made a rights issue
on a 1 for 6 basis. The issue was fully subscribed
and the rights price was $1.27. Prior to the rights
issue Arrow Co had 3,000,000 50c ordinary
shares in issue.
(2) The property, plant and equipment were revalued
by $600,000 during the year.
(3) A dividend of $300,000 was paid during the year.
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(a) One single statement

AND OTHER COMPREHENSIVE INCOME
$'000
Revenue 12,740
Gross profit 5,700
Finance costs (72)
Gains on property revaluation 600
Total comprehensive income for the year 1,523
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(b) Two separate statements

$'000
Revenue 12,740
Gross profit 5,700
Finance costs (72)
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AND OTHER COMPREHENSIVE INCOME
$'000
Gains on property revaluation 600
Total comprehensive income for the year 1,523
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Lecture example 2
Arrow had the following equity balances at 1 October

20X5 (the beginning of the year):
$'000
Share premium account 200
revaluation surplus 800
3,750
Required
Using the information from the illustration in Lecture
Example 1, produce a statement of changes in equity
for Arrow for the year ended 30 September 20X6.
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Share
Share premium Revaluation Retained Total
capital account surplus earnings equity
$'000 $'000 $'000 $'000 $'000
Balance at 30.09.X5 1,500 200 800 1,250 3,750
Issue of share capital 250 385 635
Dividends (300) (300)
Total comprehensive _ _ 600 923 1,523
income
Balance at 30.09.X6 1,750 585 1,400 1,873 5,608
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Workings
Rights issue:
Issue is on a 1 for 6 basis, therefore issue
3,000,000 ÷ 6 = 500,000 shares at $1.27 each.
Record as:
Dr Bank (500,000 × $1.27) 635,000
Cr Share capital (500,000 × 50c) 250,000
Cr Share premium (500,000 × 77c) 385,000
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Chapter summary 1
1 Introduction
▪ The financial statements published by a company need
to follow the format prescribed by IAS 1.
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Chapter summary 2

▪ You may be required to produce a statement of profit or
loss or statement of financial position and should be
aware of their contents.
▪ The statement of profit or loss and other
comprehensive income is a performance statement
which brings together the realised gains and losses from
the statement of profit or loss and the unrealised gains
and losses from the statement of financial position.
▪ The statement of changes in equity shows the
movements on each of the accounts in the equity section
of the statement of financial position in a separate
statement.
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Chapter summary 3
3 Notes to the accounts

▪ The purpose of the notes to the accounts is to provide
additional information of key financial statement figures.
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Chapter 21 • IAS 10 Events after the reporting
period
Events after the

reporting period
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• Define an event after the reporting period in accordance

with International Financial Reporting Standards.
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• Classify events as adjusting or non-adjusting.

• Distinguish between how adjusting and non-adjusting
events are reported in the financial statements.
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Overview
Definition
Events after the

reporting period
Adjusting events Non-adjusting events
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IAS 10 Events after the reporting period 1
Events after the reporting period

• Occur between the reporting date and the date on which
the financial statements are authorised for issue.
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Adjusting events
• Provide additional evidence of conditions existing at the
reporting date.
Standard accounting
• Change the figures in the financial statements if the event
is material and either it is an adjusting event or the going
concern concept is no longer appropriate.
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Non-adjusting events
• Concern conditions which did not exist at the reporting
date.
Standard accounting
• Disclose non-adjusting event in a note to the financial
statements.
• Dividends proposed or declared after the end of reporting
period but before the financial statements are approved
should be disclosed in a note to the financial statements.
• A non-adjusting event that affects going concern becomes
an adjusting event.
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Events after authorisation of the accounts

• The directors should consider publishing these if material.
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Examples of adjusting events

• Non-current assets. Determination of purchase price or
proceeds of sale
• Inventories. Evidence of NRV
• Receivables. Renegotiation by or insolvency of trade
accounts receivable
• Settlement of insurance claims
• Discoveries of error or fraud
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Examples of non-adjusting events

• Issues of shares
• Purchases/sales of non-current assets and investments
• Loss or drop in value of non-current assets or inventories
occurring after the year end
• Expansion or contraction of trade
• Government action or strikes
• Dividends declared after the reporting date
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Lecture example 1
Which of the following events after the reporting period

would normally qualify as a non-adjusting event?
(1) A fall in the market price of shares held by the entity as
investments.
(2) Insolvency of a trade receivable with a balance of
$200,000 outstanding at the end of the reporting period.
(3) Declaration of the year-end dividend by the directors.
(4) Confirmation of the amount of damages awarded to an
employee who sued for unfair dismissal after being
sacked two months before the year end.
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A (2) only
B (1) and (3)
C (1), (3) and (4)
D (2) and (4)
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B (1) and (3) are non-adjusting events as the condition

did not exist at the end of the reporting period.
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Chapter summary 1
1 Definition
▪ Events after the end of the reporting period are events
which occur between the end of the reporting period and
the date the financial statements are approved for issue.
▪ There are two types: adjusting and non-adjusting.
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Chapter summary 2
2 Adjusting events
▪ Adjusting events provide evidence of conditions that
existed at the end of the reporting period. The financial
statements should be changed to include this
information.
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Chapter summary 3
3 Non-adjusting events
▪ Non-adjusting events relate to conditions which
arose after the end of the reporting period. These should
be disclosed as a note to the financial statements.
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Chapter 22 • IAS 7 Statement of cash flows
Statements of cash
flows
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• Differentiate between profit and cash flows and

understand the need for management to control cash flow.
• Recognise the benefits and drawbacks to users of the
financial statements of a statement of cash flows.
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• Classify the effect of transactions on cash flows and how

they should be treated in a company's statement of cash
flows.
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• Calculate the figures needed for the statement of cash

flows including cash flows from operating, investing and
financing activities.
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• Calculate the cash flow from operating activities using the

direct and indirect method.
• Prepare statements of cash flows and extracts from
statements of cash flows from given information.
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Overview
Cash Cash equivalents
Cash flows
Statements of
cash flows
IAS 7
Cash flows from Cash flows from Cash flows from

operating activities investing activities financing activities
Indirect method Direct method
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IAS 7 Statement of cash flows 1
Purpose
• A statement of cash flows shows the effect of an entity's
commercial transactions on its cash balance.
• It is thought that users of accounts can readily understand
cash flows, as opposed to statements of profit or loss and
statements of financial position, which are subject to
manipulation by the use of different accounting policies.
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Format
IAS 7 Statement of cash flows splits cash flows into the
following headings:
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
• The IAS requires a reconciliation of cash and cash
equivalents.
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STATEMENT OF CASH FLOWS

YEAR ENDED 20X7 (INDIRECT METHOD)
$m $m
Cash flows from operating activities
Net profit before taxation 3,390
Adjustments for:
Depreciation 450
Investment income (500)
Interest expense 400
Operating profit before working capital charges 3,740
Increase in trade and other receivables (500)
Decrease in inventories (1,050)
Decrease in trade payables (1,740)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (720)
Net cash from operating activities 1,560
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$m $m
Cash flows from investing activities
Purchase of property, plant and equipment (900)
Proceeds from sale of equipment 20

Interest received 200
Dividends received 200
Net cash used in investing activities (480)
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$m $m
Cash flows from financing activities
Proceeds from issuance of share capital 250
Proceeds from long-term borrowings 250
Dividends paid* (1,290)
Net cash used in financing activities (790)

Net increase in cash and cash equivalents 290
Cash and cash equivalents at beginning of period (Note) 120
Cash and cash equivalents at end of period (Note) 410
*This could also be shown as an operating cash flow
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• Cash and cash equivalents consist of cash on hand and

balances with banks, and investments in money market
instruments. Cash and cash equivalents included in the
cash flow statement comprise the following statement of
financial position amounts.
20X7 20X8
$m $m
Cash on hand and balances with banks 40 25
Short-term investments 370 95
Cash and cash equivalents 410 120
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• The company has undrawn borrowing facilities of $2,000,

of which only $700 may be used for future expansion.
• This proforma is for the indirect method.
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Direct method
• The direct method proforma is the same except for the first
part which appears as follows:
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Tackling the exam
• Examination questions will probably require the indirect

method.
If the direct method is required, the necessary information
will be given to you.
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Advantages
• Business survival needs cash
• Cash flow is more objective than profit
• Trade accounts payable need to know if they will be paid
• More comparability between entities
• Better basis for decision making
• Easy to understand, prepare and audit
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Disadvantages
• The disadvantages of cash flow accounting are basically
the opposite of advantages of accruals accounting.
• For example, cash flow does not match income and
expenditure in the statement of profit or loss.
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Criticisms of IAS 7
• Inclusion of cash equivalents does not reflect the way
businesses are managed.
• The requirement that a cash equivalent has to be within
three months of maturity is unrealistic.
• Management of cash equivalents is not distinguished from
other investment decisions.
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Lecture example 1
In the statements of financial position of Tacks Co as at

31 December 20X9 and 31 December 20X8 were the
following amounts for income tax payable.
31 December
20X9 20X8
$ $
Income tax payable 156,000 168,000
The statement of profit or loss tax charge for 20X9 amounted

to $104,000.
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Required
What is the amount of income taxes paid during the year?
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Income taxes paid

Income tax payable
$'000 $'000
Income tax paid 116 Bal b/d 168
Bal c/d 156 SPL 104
272 272
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Lecture example 2
On 31 December 20X8 the value of plant and equipment in

the books of Erosion Co was as follows:
$
Plant and equipment at cost 200,000
Accumulated depreciation 80,000
Plant and equipment at carrying amount 120,000
On 1 January 20X9 an item of plant was sold for $8,000

which had originally cost $20,000 when new, but had a
carrying amount of $11,000 at the time of sale. (The
statement of financial position values shown above do not
show that this sale has taken place.)
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On 31 December 20X9 the value of plant and equipment in

the statement of financial position was:
$
Plant and equipment at cost 280,000
Accumulated depreciation 111,000
Plant and equipment at carrying amount 169,000
Required
Show the relevant entries for property, plant and
equipment which would appear in a statement of cash
flows for Erosion Co in 20X9.
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Property, plant and equipment

Plant and equipment – cost
$'000 $'000
Bal b/d 200 Disposal 20
Addition 100 Bal c/d 280
300 300
Accumulated depreciation
$'000 $'000
Disposal 9 Bal b/d 80
Bal c/d 111 SPL Charge 40
120 120
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Profit/loss on disposal:
$
Carrying amount of asset sold 11,000
Sales proceeds (8,000)
Loss on sale (3,000)
The entries in the statement of cash flows for 20X9 would be:
$
(i) Cash flows from operating activities (extract)
Adjustments for
Depreciation 40,000
Loss on sale of plant 3,000
43,000
(ii) Cash flows from investing activities (extract)
Purchase of property, plant and equipment (100,000)
Proceeds from sale of plant 8,000
(92,000)
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Lecture example 3
DISTRIBUTION CO
STATEMENT OF FINANCIAL POSITION EXTRACT
FOR THE YEAR ENDED 31 DECEMBER 20X9
20X9 20X8
$'000 $'000
Dividends payable 45 35
Dividends charged to retained earnings were $60,000.
Required
What are the dividends paid during the year ended
31 December 20X9?
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Dividends paid
Dividends payable
$'000 $'000
Dividends paid 50 Bal b/d 35
Bal c/d 45 Retained earnings 60
95 95
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Lecture example 4
The summarised accounts of the Emma Co for the year ended

31 December 20X8 are as follows:
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER
20X8 20X7
$'000 $'000
Non-current assets
Property, plant and equipment 628 514
Current assets:
Inventories 214 210
Trade receivables 168 147
Cash 7 –
389 357
1,017 871
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20X8 20X7
$'000 $'000
Equity
Share capital ($1 ordinary shares) 250 200
Share premium account 70 60
revaluation surplus 110 100
Retained earnings 314 282
744 642
10% debentures 80 50
Current liabilities
Trade payables 136 121
Income tax payable 39 28
Dividends payable 18 16
Overdraft – 14
193 179
1,017 871
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$'000
Revenue 600
Cost of sales 319
Gross profit 281
Other expenses (including depreciation of
$42,000) 186
Finance costs (interest paid) 8
Profit before tax 87
Income tax expense 31
Profit for the period 56
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Movement of retained earnings

$'000
Balance at 31 December 20X7 282 282
Profit for the period 56 56
Dividends (24) (24)
Balance at 31 December 20X8 314
You are additionally informed that there have been no disposals of
property, plant and equipment during the year. The new debentures
were issued on 1 January 20X8.
Required
Produce a statement of cash flows for Emma Co for the year
ended 31 December 20X8.
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Approach to lecture example 4
(1) Read requirement and scan additional information

(2) Download SOFP
(3) Download SPL
(4) Deal with additional information
(5) Finish workings
(6) Finish statement of cash flows
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$'000 $'000
87
Profit before taxation
Adjustments for: 42
Depreciation 8
Interest expense
137
Increase in trade receivables (168 – 147) (21)
Increase in inventories (214 – 210) (4)
Increase in trade payables (136 – 121) 15
Cash generated from operations
127
(8)
Interest paid (20)
Income taxes paid (W2)
99
Net cash from operating activities
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$'000 $'000
Cash flows from investing activities
Purchase of property, plant and equipment (W1) (146)
Net cash used in investing activities (146)
Cash flows from financing activities
Proceeds from issue of shares (250 + 70 – 200 – 60) 60
Proceeds from issue of debentures (80 – 50) 30
Dividends paid (W3) (22)
Net cash from financing activities 68
Net increase in cash and cash equivalents 21

Cash and cash equivalents at beginning of year (14)
Cash and cash equivalents at end of year 7
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Property, plant and equipment (CA)

b/d 514
Reval'n 10 Dep'n 42
Additions 146
c/d 628
670 670
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Income tax payable

b/d 28
Tax paid 20 SPL 31
c/d 39
59 59
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Dividends payable
b/d 16
Divs paid 22 Divs (RE) 24
c/d 18
40 40
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Lecture example 5
Required
Using the information in Lecture example 4 produce the
'cash flows from operating activities' section of the statement
of cash flows using the direct method.
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$'000 $'000
Cash receipts from customers (W1)
Cash payments to suppliers and employees (W2)
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities
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$'000 $'000
Cash receipts from customers (W1) 579
Cash payments to suppliers and employees (W2) (452)
Cash generated from operations 127
Interest paid (8)
Income taxes paid (20)
Net cash from operating activities 99
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Trade receivables
b/d 147
Cash rec'd 579
Revenue 600
c/d 168
747 747
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Trade payables
b/d 121
Cash paid 452
Expenses W3 467
c/d 136
588 588
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$'000 $'000
Cost of sales 319
Add: closing inventories 214
Less: opening inventories (210)
Purchases 323
Other expenses 186
Less: depreciation (42)
144
467
BPP LEARNING MEDIA

BPP LEARNING MEDIA

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Tackling the exam
Exam focus point:
The examiner has repeatedly highlighted statements of cash

flows as an area that students struggle with. The examiner
recommended practising full questions on this topic as they
will help you gain a better understanding of the individual
parts of the statement of cash flows and how it links with the
statement of financial position and the statement of profit or
loss and other comprehensive income.
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Chapter summary 1
1 Purpose
▪ The statement of cash flows shows the movement
between a company's cash and cash equivalents at the
beginning and the end of the year.
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Chapter summary 2
2 Statements of cash flows (IAS 7)

▪ Cash comprises cash on hand and on demand deposits,
less bank overdrafts.
▪ Cash equivalents are short-term, highly liquid
investments such as current asset investments (shares)
which can be converted in to known amounts of cash
relatively quickly without having a major impact on the
entity's activities.
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Chapter summary 3
3 Cash flows from operating activities

▪ This section of the statement of cash flows shows the
cash and cash equivalents generated by and used in the
entity's main trading activities.
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Chapter summary 4
4 Cash flows from investing activities

▪ This section shows the cash flows related to the
acquisition and disposal of non-current assets and
returns on investments such as interest and dividends
received.
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Chapter summary 5
5 Cash flows from financing activities

▪ Cash flows from financing activities include the monies
raised from issuing shares and loans and the cash used
in the repayment of loans and the payment of dividends.
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Chapter summary 6
6 Cash flow from operating activities using the direct

method
▪ The statement of cash flows can be produced using one
of two methods: the indirect or the direct method. The
direct method provides exactly the same cash flow
information but calculates the cash flow from operating
activities using a slightly different calculation from the
indirect method.
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Chapter 23 • Overview
• Definitions
Introduction to • Associates
consolidated
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• Define and describe the following terms in the context of

group accounting:
− Parent
− Subsidiary
− Control
− Consolidated or group financial statements
− Trade/simple investment
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• Identify subsidiaries within a group structure.
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• Define and identify an associate and significant influence

and identify situations where significant influence or
participating interest exists.
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• Describe the key features of a parent-associate

relationship and be able to identify an associate within a
group structure.
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• Describe the principle of equity accounting.
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Overview 1
Concept Accounting for associates
Introduction to consolidated
Parent's separate Consolidated statement

Types of investment
financial statements of financial position
Group financial statements
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Overview 2
Overview
• Consolidation means presenting the results, assets and
liabilities of a group of companies as if they were one
company.
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Overview 3
Basic principles
• Consolidation means adding together.
• Consolidation means cancellation of like items internal
to the group.
• Consolidate as if you owned everything then show the
extent to which you do not own everything.
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Definitions 1
• A subsidiary is an undertaking in which the parent has

control.
• Control is presumed to exist when the parent owns > 50%
of the voting power (eg voting equity shares).
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Definitions 2
Even when parent owns < 50%, some situations where

control exists:
• Parent has power to govern the financial and operating
policies of the entity by statute or an agreement.
• Parent has power to appoint or remove a majority of
members of the board of directors.
• Parent has power to cast a majority of votes at meetings of
the board of directors.
• Parent has power over > 50% voting rights by agreement
with other investors.
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Definitions 3
Further definitions per IFRS 10 Consolidated financial

statements
• Control: An investor controls an investee when the
investor is exposed, or has rights, to variable returns from
its involvement with the investee and has the ability to
affect those returns through its power over the investee.
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Definitions 4
• Subsidiary: An entity that is controlled by another entity

(known as the parent).
• Parent: An entity that controls one or more entities.
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Definitions 5
• Group: A parent and all its subsidiaries.

• Non-controlling interest: The equity in a subsidiary not
attributable, directly or indirectly to a parent.
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Associates 1
• Associate: An entity in which an investor has

significant influence.
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Associates 2
Significant influence:
• The power to participate, but not to control.
• Assumed if hold > 20% of voting rights.
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Associates 3
• Associates are accounted for in consolidated accounts

using the equity method.
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Associates 4

• Show group share of associate's PAT before group profit
before tax.
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Associates 5
SOFP
Investment in associate:
Cost of investment X
Share of retained earnings/losses X
X
• Include in non-current assets
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Tackling the exam
Exam focus point:
All the definitions relating to group accounts are extremely

important. You must learn them and understand their
meaning and application. The examiner has stated that
students need to be able to identify the nature of an
investment, using the definitions of control and significant
influence. So questions in your exam may require you to
apply these definitions to scenarios.
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Lecture example 1
• J has a 40% shareholding in each of the following three

companies:
— K: J has the power to govern the financial and
operating policies of K.
— L: J has significant influence over the affairs of L.
— M: J has the right to appoint or remove a majority of
the directors of M.
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Required
Which of these companies are subsidiaries of J for
financial reporting purposes?
A None of them
B K, L and M
C K and L only
D K and M only
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D
• Both K and M are subsidiaries even though J owns less
than 50% of the ordinary shares. IAS 27 defines a
subsidiary as an entity controlled by another entity. J has
control over K because it has the power to govern K's
financial and operating policies. J has control over M
because it can appoint or remove the majority of the
directors.
• J only has significant influence over L so L is an associate
of J.
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Lecture example 2
• Pegasus acquired 100% of the share capital of Sylvester

on 1 January 20X1 for $1,300,000 in cash.
• The statements of financial position of Pegasus and
Sylvester as at 1 January 20X1 are set out as follows:
BPP LEARNING MEDIA

Pegasus Sylvester
$'000 $'000
Assets
Non-current assets
Property, plant and 20,000 900
equipment
Investment in Sylvester 1,300
21,300
Current assets
Inventories 3,200 400
Trade receivables 2,500 175
Cash 500 125
6,200 700
27,500 1,600
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Equity
Share capital 5,000 100
Retained earnings 19,450 1,200
24,450 1,300
Current liabilities
Trade payables 2,500 260
Income tax payable 550 40
3,050 300
27,500 1,600
BPP LEARNING MEDIA

Required
Prepare the consolidated statement of financial position of
the Pegasus Group as at 1 January 20X1.
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PEGASUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AT
1 JANUARY 20X1
$'000
Assets
Non-current assets 20,900
Property, plant and equipment (20,000 + 900) 20,900
Current assets 3,600

Inventories (3,200 + 400) 2,675
Trade receivables (2,500 + 175) 625
Cash (500 + 125) 6,900
27,800
BPP LEARNING MEDIA


Equity
Share capital 5,000
24,450
Current liabilities
Trade payables (2,500 + 260) 2,760
Income tax payable (550 + 40) 590
3,350
27,800
BPP LEARNING MEDIA

Workings
1 Group structure
Pegasus
1.1.X1 100%
Pre-acquisition ret'd earning $1,200k
Sylvester
2 Cancellation
$'000 $'000
Consideration (investment) 1,300
Share capital 100

Retained earnings (W1) 1,200
(1,300)
–
BPP LEARNING MEDIA

Lecture example 3
• Three years later, 31 December 20X3, the summarised

statement of financial position of Pegasus and Sylvester
are as follows.
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Pegasus Sylvester
$'000 $'000
Assets
Non-current assets
Property, plant and equipment 24,000 4,200
Investment in Sylvester 1,300
25,300 4,200
Current assets 8,500 2,100
33,800 6,300
BPP LEARNING MEDIA

Equity
Share capital 5,000 100

31,800 5,300
Current liabilities 2,000 1,000
33,800 6,300
BPP LEARNING MEDIA

Required
the Pegasus Group as at 31 December 20X3.
BPP LEARNING MEDIA

PEGASUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
AT 31 DECEMBER 20X3
$'000
Assets
Non-current assets
Property, plant and equipment (24,000 + 4,200) 28,200
Current assets (8,500 + 2,100) 10,600
38,800

Equity
Share capital 5,000
35,800
Current liabilities (2,000 + 1,000) 3,000
38,800
BPP LEARNING MEDIA

Workings
1 Group structure
Pegasus
1.1.X1 100%
Pre-acquisition ret'd earning $1,200k
Sylvester
2 Cancellation
$'000 $'000
Consideration (investment) 1,300
Share capital 100

(1,300)
–
BPP LEARNING MEDIA

3 Retained earnings
Pegasus Sylvester
$'000 $'000
Per question 26,800 5,200
Pre-acquisition retained earnigs (1,200)
4,000
Sylvester – share of post acq'n earnings 4,000
(4,000 × 100%)
30,800
BPP LEARNING MEDIA

Lecture example 4
Which of the following statements regarding associates is

true?
(1) Associates are consolidated in the group financial
statements.
(2) An associate is an entity in which the parent has
control.
(3) Associates are equity accounted in the group financial
statements.
(4) An associate is an entity in which the parent has
significant influence.
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A (1) and (4)

B (1) and (2)
C (3) and (4)
D (2) and (3)
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C
• An associate is an entity in which the parent has
significant influence. It is equity accounted in the
consolidated financial statements.
BPP LEARNING MEDIA

Tackling the exam
Exam focus point:
The examiner commented that questions on this area were

not answered very well in the December 2011 assessment
round so make sure you fully understand this chapter.
You need to ensure that you attempt the questions on this

topic, including the long questions, in the Practice & Revision
Kit for FA/FFA.
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Chapter summary 1
1 Concept
▪ Consolidated accounts are prepared for a group of
inter-related companies.
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Chapter summary 2
2 Types of investment
▪ These are three types of investment in the syllabus:
— Subsidiaries (where there is control)
— Associates (where there is significant influence)
— Trade investments (no influence)
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Chapter summary 3
3 Parent's separate financial statements

▪ An investment in a subsidiary, associate or financial
asset is shown in the parent's statement of financial
position at cost (for exam purposes). Dividends are
show as investment income in the statement of profit or
loss and other comprehensive income.
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Chapter summary 4
4 Group financial statements

▪ Group financial statements are issued to the
shareholders of the parent only, in addition to the
parent's own financial statements. They show the group
as a single business entity.
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Chapter summary 5
5 Consolidated statement of financial position

▪ Add parent and subsidiary's assets and liabilities line
by line. Show parent's share capital and share
premium only.
▪ The investment cancels with the share capital and pre-
acquisition reserves of the subsidiary.
▪ Consolidated reserves comprise the parent's reserves
plus the group share of the subsidiary's post
acquisition reserves.
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Chapter summary 6
6 Accounting for associates

▪ Associates should be equity accounted in the
consolidated financial statements.
▪ Consolidated statement of financial position:
− Investment in associate (cost + share of post acquisition
reserves – impairment)
▪ Consolidated statement of profit or loss:
− Share of associate's profit for the year
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Chapter 24 • Cancellation and part-cancellation
• Goodwill
The consolidated • Non-controlling interests
statement of financial • Intra-group trading
position
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• Define and describe the term ‘non-controlling interest’

in the context of group accounting
• Describe the components of and prepare a
consolidated statement of financial position or extracts
thereof including:
— Fair value adjustments at acquisition on land and
buildings (excluding depreciation adjustments)
— Fair value of consideration transferred from cash
and shares (excluding deferred and contingent
consideration)
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— Elimination of intra-group trading balances

(excluding cash and goods in transit)
— Removal of unrealised profit arising on intra-group
trading
— Acquisition of subsidiaries part way through the
financial year
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• Calculate goodwill (excluding impairment of goodwill)

using the full goodwill method only.
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Overview
Approach to consolidated
statement of financial Mid-year acquisition
position
Consolidated statement of
financial position
Non-controlling
Goodwill Fair values
interest
Intra-group
trading
Other reserves
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Cancellation and part-cancellation 1
Cancellation
When preparing a simple consolidated statement of financial
position:
• Take the individual accounts of the parent company and
the subsidiary and cancel out items which appear as an
asset in one company and a liability in another.
• Add together all the uncancelled assets and liabilities
throughout the group.
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Cancellation and part-cancellation 2
Part cancellation
• An item may appear at differing amounts in the parent's
and subsidiary's statement of financial position.
• The subsidiary's shares may have been acquired at a
price other than nominal value, raising the issue of
goodwill.
• The parent may not have acquired all of the shares of the
subsidiary, raising the issue of non-controlling interests.
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Goodwill 1
Goodwill
• Goodwill arises when the parent pays more for their
investment than the par value of the shares they acquire.
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Goodwill 2
• Any pre-acquisition reserves of a subsidiary company are

not aggregated with the parent company's reserves in the
consolidated statement of financial position.
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Goodwill 3
• Goodwill is recognised as an intangible asset in the

consolidated SOFP.
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Goodwill 4
Goodwill working
$ $
Fair value of consideration transferred X
Fair value of NCI at acquisition X
Less net acquisition-date fair value of
identifiable
Assets acquired and liabilities assumed:
Ordinary share capital X
Share premium X
Retained earnings at acquisition X
Fair value adjustments at acquisition X
(X)
Goodwill X
BPP LEARNING MEDIA

Tackling the exam
Exam focus point:
You are highly likely to get a question requiring the

calculation of goodwill in your exam so make sure you
understand this section fully.
The examiner has highlighted the calculation of goodwill as a

topic answered poorly in the exam.
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Non-controlling interests 1
Non-controlling interest
• Shows the extent to which net assets controlled by the
group are owned by other parties.
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• SOFP – equity
Fair value of NCI at acquisition X
Plus NCI's share of post acq'n ret'd earnings X
NCI at reporting date X
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Retained earnings
PCo SCo
$ $
Per question X X
Adjustments (unrealised profit attribute to P Co) (X)
Pre-acquisition retained earnings (X)
Y
Group share of post-acq'n ret'd Earnings S Co (Y × %) X
Group retained earnings X
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• NCI share of retained profits = Y × NCI%
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Intra-group trading 1
Intra-group trading
Unrealised profit will arise on intra-group transactions where
the inventory is still held at the reporting date:
(1) Work out which company made the profit.
(2) Calculate the provision for unrealised profit (PUP).
(3) For consolidation purposes, eliminate the profit from
inventory, consolidated retained earnings and NCI (if
required).
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• If P sells to S, the unrealised profit lies in P's books:
DEBIT Consolidated SPL (whole profit loading)

CREDIT Group inventory
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• If S sells to P, the unrealised profit lies in S's books and

must be shared between P and the NCI:
DEBIT Consolidated SPL (P's share)

DEBIT Non-controlling interest (NCI's share)
CREDIT Group inventory
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Lecture example 1
• Pogo acquired the entire share capital of Stick for $8m on

1 February 20X0 when the statements of financial position
of the two companies were as follows.
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Pogo Stick
$'000 $'000
Investment in Stick 8,000 –
Other assets 9,500 6,500
17,500 6,500
Share capital 9,000 3,000

15,000 5,000
Liabilities 2,500 1,500
17,500 6,500
BPP LEARNING MEDIA

Required
the Pogo group as at 1 February 20X0.
BPP LEARNING MEDIA

POGO GROUP
AS AT 1 FEBRAURY 20X0
$'000
Goodwill (W2) 3,000
Other assets [9,500 + 6,500] 16,000
19,000
Share capital [Pogo only] 9,000
15,000
Liabilities [2,500 + 1,500] 4,000
19,000
BPP LEARNING MEDIA

Workings
1 Group structure
Pogo
1.2.X0 100%
Pre-acquisition ret'd earnings $2m
Stick
2 Goodwill
$'000 $'000
Consideration 8,000
Non-controlling interest 0
Net assets at acquisition represented by:
Share capital 3,000
(5,000)
Goodwill arising on acquisition 3,000
BPP LEARNING MEDIA

3 Retained earnings
Pogo Stick
$'000 $'000
Pre-acquisition retained earnings (2,000)
0
Group share of post acquisition earnings:
Stick (0 × 100%) 0
6,000
BPP LEARNING MEDIA

Lecture example 2
• Pop acquired 75% of the issued share capital of Snap on

1 January 20X8 when Snap had a retained earnings
balance of $1m.
• The fair value of the non-controlling interest at that date
was $1.5m.
• One year later the two companies had the following
statements of financial position.
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Pop Snap
$'000 $'000
Investment in Snap 6,000 –
16,500 9,200
Share capital 10,000 4,000
11,500 6,200
16,500 9,200
BPP LEARNING MEDIA

Required
Produce the consolidated statement of financial position of
Pop and its subsidiary as at 31 December 20X8.
BPP LEARNING MEDIA

POP GROUP
$'000
Goodwill (W2) 2,500
Other assets [10,500 + 9,200] 19,700
22,200
Share capital [P only] 10,000

12,400
Non-controlling interest (W4) 1,800
14,200
Liabilities [5,00 + 3,000] 8,000
22,200
BPP LEARNING MEDIA

Workings
1 Group structure
Pop
1.1X8 75%
Pre-acquisition ret'd earnings $1m
Snap
2 Goodwill
$'000 $'000
Consideration 6,000
Non-controlling interest 1,500
Net assets at acquisition represented by:
Share capital 4,000
(5,000)
Goodwill arising on acquisition 2,500
BPP LEARNING MEDIA

3 Retained earnings
Pop Snap
$'000 $'000
Pre-acquisition retained earnings (1,000)
1,200
Group share of post acquisition earnings:
Snap (1,200 × 75%) 900
2,400
4 Non-controlling interest
$'000
NCI at acquisition (W2) 1,500
NCI share of post acquisition earnings ((W3) 1,200 × 25%) 300
1,800
BPP LEARNING MEDIA

Lecture example 3
X acquired 300,000 of Y's 400,000 $1 ordinary shares on

1 January 20X5 when Y's retained earnings were $500,000.
The fair value of the non-controlling interest in Y at that date
was $280,000.
The purchase consideration comprised:
• $250,000 in cash payable at acquisition
• New shares issued in X on a 1 for 3 basis
The quoted price of X's shares on the acquisition date was
$7.35.
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The fair value of Y's land and buildings at 1 January 20X5

was $160,000 but the book value was only $100,000. All
other net assets had a fair value equivalent to their book
value.
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Required
Calculate the goodwill arising on acquisition of Y.
BPP LEARNING MEDIA

Goodwill
$ $
Fair value of consideration
Cash 250,000
Shares [(1/3 × 300,000) × $7.35] 735,000
985,000
Fair value of non-controlling interest 280,000
Less: Fair value of net assets at acq'n
Share capital 400,000
Fair value adjustment (160,000 – 100,000) 60,000
(960,000)
Goodwill at acquisition 305,000
BPP LEARNING MEDIA

Workings
1 Group structure
X
1.1.X5 300/400 = 75%
Pre-acquisition ret'd earnings $500,000
Y
BPP LEARNING MEDIA

Lecture example 4
• Poach acquired 60% of the share capital of Steal on its

incorporation. The statements of financial position of the
two companies as at 31 December 20X8 are as follows.
BPP LEARNING MEDIA

Poach Steal
$'000 $'000
Non-current assets
Property, plant and equipment 200 50
Investment in Steal 6
206 50
Current assets
Inventories 22 18
Receivables – from Poach – 30
– other 96 29
Cash 4 15
122 92
328 142
BPP LEARNING MEDIA

Equity
Share capital 100 10
Retained earnings 147 73
247 83
Current liabilities
Trade payables – to Steal 30 –
– other 51 59
81 59
328 142
BPP LEARNING MEDIA

Notes
(i) The fair value of the non-controlling interest in Steal at
acquisition was $4,000.
(ii) Steal sells goods to Poach at a profit margin of 25%
on selling price. At the year end, $12,000 of the
goods that Poach had purchased from Steal remained
in inventories.
BPP LEARNING MEDIA

Required
Prepare a consolidated statement of financial position as
at 31 December 20X8.
BPP LEARNING MEDIA

POACH GROUP
$'000
Non-current assets
Property, plant and equipment (200 + 50) 250
Current assets
Inventories (22 + 18 – (W4) 3) 37
Receivables – from Poach (30 – 30) –
– other (96 + 29) 125
Cash (4 + 15) 19
181
431
Equity attributable to the owners of the parent
Share capital 100
Retained earnings (W2) 189
289
Non-controlling interest (W3) 32
321
Current liabilities
Trade payables – to Steal (30 – 30) –
– other (51 + 59) 110
431
BPP LEARNING MEDIA

Workings
1 Group structure
Poach
On incorporation 60% \non-controlling interest 40%
(\no goodwill)
Pre-acquisition ret'd earnings $0
Steal
2 Consolidated retained earnings

Poach Steal
$'000 $'000
Per question 147 73
Provision for unrealised profit (PUP) (W4) (3)
Pre-acquisition retained earnings (0)
70
Group share of post acquisition retained earnings:
Steal (70 × 60%) 42
189
BPP LEARNING MEDIA
$'000
NCI at acquisition 4
NCI share of post acquisition retained earnings ((W2) 70 × 40%) 28
32
4 Provision for unrealised profit

On consolidation:
Profit element in inventories:
$12,000 × 25% = $3,000
\ DR Steal's retained earnings $3,000
CR Group inventories $3,000
BPP LEARNING MEDIA

Lecture example 5
• Pat acquired 80% of the issued share capital of Slap on

30 September 20X7. The share price for each of the
non-controlling interest shares in Slap was $4.50 at the
acquisition date.
• At the year end 31 December 20X7 the two companies
have the following statements of financial position:
BPP LEARNING MEDIA

Pat Slap
$'000 $'000 $'000 $'000
Investment in Slap 4,000 –
14,500 6,000
BPP LEARNING MEDIA

Share capital ($1 shares) 6,000 1,000

Share premium – 500
Retained earnings
1 Jan 20X7 4,000 1,500
Profit for 20X7 2,000 1,000
6,000 2,500
12,000 4,000
14,500 6,000
BPP LEARNING MEDIA

Required
Calculate the goodwill at the date of acquisition.
BPP LEARNING MEDIA

$'000 $'000
Consideration transferred 4,000
Non-controlling interest (1,000 × 20% × $4.50) 900
Net assets at acquisition as represented by:

Share capital 1,000
Share premium 500
(3,750)
Goodwill 1,150
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Workings
1 Group structure
Pat
30.9.X7 80%
Pre-acquisition ret'd earnings – see W2
Slap
2 Slap – retained earnings 30.9.X7

$'000
Retained earnings at 1.1.X7 1,500
For the 9 months to 30.9.X7 (1,000 × 9 ) 750
12
Retained earnings at 30.9.X7 2,250
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Chapter summary 1
1 Approach to consolidated financial position

▪ In the exam, a methodical approach to consolidation is
key.
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Chapter summary 2
2 Goodwill
▪ Positive goodwill is capitalised as an intangible non-
current asset. 'Negative' goodwill (once reassessed to
ensure it is accurate) is recognised as a bargain
purchase in the profit or loss.
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Chapter summary 3
3 Fair values
▪ In order for the goodwill figure to be accurately
measured, both the consideration transferred and the
fair value of the assets acquired and liabilities assumed
must be recognised at fair value at the date of
acquisition.
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Chapter summary 4
4 Other reserves
▪ Other reserves, eg a revaluation surplus, are calculated
using the same process as retained earnings, ie only
post-acquisition reserve movements are
consolidated.
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Chapter summary 5
▪ Non-controlling interest shows the amount of the assets
and liabilities under the control of the parent, but which
are not owned by the parent's shareholders.
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Chapter summary 6
6 Intra-group trading
▪ At the year end, intra-group payables and receivables
must be eliminated.
▪ Unrealised profit in year end inventories from intra-
group trading must be eliminated by reducing
inventories and the seller's retained earnings.
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Chapter summary 7
7 Mid-year acquisitions
▪ Only post-acquisition profits are consolidated.
Therefore, if the acquisition is mid-year, a retained
earnings figure must be estimated for the goodwill and
retained earnings calculations.
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Chapter 25 • Consolidated statement of profit or
loss
The consolidated
statement of profit or
loss
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• Describe the components of and prepare a consolidated

statement of profit or loss or extracts thereof including:
(i) Elimination of intra-group trading
(ii) Removal of unrealised profit arising on intra-group
trading
(iii) Acquisition of subsidiaries part way through the
financial year
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Overview
Consolidated statement of profit or loss
Intra-group
Purpose Approach to the
trading
consolidated statement
of profit or loss
Mid-year
acquisitions
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Consolidated statement of profit or loss 1
Main points about the consolidated statement of profit

or loss
Purpose:
• To show the results of the group for an accounting period
as if it were a single entity.
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Main points about the consolidated statement of profit

or loss
• Sales revenue to profit for year – 100% P + 100% S
(excluding adjustments for intra-group transactions)
Reason:
• To show the results of the group which were controlled by
the parent company.
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Intra-group sales
• Strip out intra-group activity from both sales revenue and
cost of sales.
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Unrealised profit on intra-group sales

• Goods sold by P. Increase cost of sales by unrealised
profit.
• Goods sold by S. Increase cost of sales by full amount of
unrealised profit and decrease non-controlling interest by
their share of unrealised profit.
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Non-controlling interests
S's profit after tax X
Less: * unrealised profit (X)
X
NCI % X
* Only applicable if sales of goods made by subsidiary.
Reason:
• To show the extent to which profits generated through P's
control are in fact owned by other parties
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Tackling the exam
Exam focus point:

The treatment of intra-group trading is very likely to be tested
in an exam question on the consolidated statement of profit
or loss.
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Reserves carried forward

• As per the calculations for the statement of financial
position.
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Lecture example 1
• On 1 July 20X4 Patois acquired 90% of Slang at a cost of

$55,000. The balance on Slang's reserves was $15,000 at
that date. Patois has ordinary share capital of $100,000
and Slang $20,000 ($1 ordinary shares).
• Statements of profit or loss for both companies for the year
ended 30 June 20X9 follow:
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Patois Slang
$'000 $'000
Revenue 100 90
Cost of sales (75) (55)
Gross profit 25 35
Distribution costs (5) (6)
Administrative expenses (8) (10)
Dividend from subsidiary 4.5 –
Profit before tax 16.5 19
Income tax expense (4) (6)
Profit for the year 12.5 13
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Required
Prepare the consolidated statement of profit or loss for the
Patois group for the year ended 30 June 20X9.
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PATOIS GROUP
CONSOLIDATED STATEMENT OF PROFIT OR LOSS
FOR THE YEAR ENDED 30 JUNE 20X9
$'000
Revenue (100 + 90) 190
Cost of sales (75 + 55) (130)
Gross profit 60
Distribution costs (5 + 6) (11)
Administrative expenses (8 + 10) (18)
Profit before tax 31

Income tax expense (4 + 6) (10)
PROFIT FOR THE YEAR 21
Profit attributable to: 19.7

Owners of the parent (21 – 1.3) 1.3
Non-controlling interest (13 × 10%) 21.0
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Workings
1 Group structure
Patois
1.7.X4 90% \non-controlling interest 10%
Pre-acquisition ret'd earnings $15,000
Slang
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Lecture example 2
• Pouch acquired 75% of the issued share capital of Sack

on 1 January 20X2.
• Sack had sold goods to Pouch during the year for
$8,000,000 at a mark up of 25%. At the year end, three
quarters of these goods had been sold on to third parties.
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STATEMENTS OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20X2

Pouch Sack
$'000 $'000
Revenue 24,500 15,600
Cost of sales and expenses (14,000) (10,000)
Dividend from subsidiary 1,500 –
Profit before tax 12,000 5,600
Income tax expense (5,000) (1,600)
PROFIT FOR THE YEAR 7,000 4,000
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Required
Prepare the consolidated statement of profit or loss for the
Pouch group for the year ended 31 December 20X2.
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POUCH GROUP
$'000
Revenue (24,500 + 15,600 – 8,000) 32,100
Cost of sales and expenses (14,000 + 10,000 – 8,000 + 400 (W3)) (16,400)
Income tax expense (5,000 + 1,600) (6,600)
PROFIT FOR THE YEAR 9,100
Profit attributable to:
Owners of the parent (9,100 – 900) 8,200
Non-controlling interest (W2) 900
9,100
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Workings
1 Group structure
Pouch
Sack
PFY TCI
$'000 $'000
PUP on sales made by Sack (W3) (400) (400)
3,600 4,600
× 25% 900 1,150
3 Unrealised profit
Sack Pouch
PUP = $8m × 25/125 × ¼ in inventories = $400,000
Add $400,000 to cost of sales and as the subsidiary is the seller, adjust NCI.
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Lecture example 3
• Perilous acquired 80% of the issued share capital of Safe

on 1 January 20X5.
• The statements of profit or loss for the two companies for
the year ended 30 September 20X5 follow.
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Perilous Safe
$'000 $'000
Revenue 10,000 1,000
Cost of sales and expenses (6,000) (700)
Profit before tax 4,000 300
Income tax expense (1,400) (120)
Profit for the year 2,600 180
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• On 14 September 20X5, Perilous sold inventories to Safe

at a transfer price of $200,000, which included a profit on
transfer of $30,000.
• Half of these inventories had been sold by Safe by the
year end.
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Required
Prepare the consolidated statement of profit or loss for
Perilous Group for the year ended 30 September 20X5.
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PERILOUS GROUP
$'000
9 10,550
Revenue (10,000 + (1,000 × ) – 200)
12
9 (6,340)
Cost of sales and expenses (6,000 + (700 × ) – 200 + 15 (W3))
12
Income tax expense (1,400 + (120 x 9 )) (1,490)
12
Attributable to: 2,693

Owners of the parent 27
Non-controlling interest (W2) 2,720
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Workings
1 Group structure and timeline
Perilous
Safe
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Perilous – all wear
Safe – Profits & NCI ×9/12
PFY
$'000
Per question (pro-rated) (180 × 9/12) 135
× 20% 27
3 Unrealised profit
PerilousSafe
PUP = $30,000 × ½ in inventories = $15,000
Add $15,000 to cost of sales.
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Tackling the exam
Exam focus point:
The August 2015 edition of the Student Accountant

contained a useful article on the preparation of consolidated
financial statement. It is recommended that you read this at:
www.accaglobal.com/uk/en/student/exam-support-
resources/fundamentals-exams-study-
resources/f3/technical-articles/group-statement.html
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Chapter summary 1
1 Purpose
▪ The purpose of the consolidated statement of profit or
loss is to show the results of the group as a single
business entity.
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Chapter summary 2
2 Approach to the consolidated statement of profit or

loss
(1) Group structure
(2) Proforma
(3) Add P + 100% S's income/expenses line by line and
post S's PFY to NCI working
(4) Adjustments
(5) Complete NCI working
(6) Complete ownership reconciliation
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Chapter summary 3
3 Intra-group trading
▪ In order not to overstate group revenue and costs,
revenue and cost of sales from intra-group trading
are cancelled. Similarly, unrealised profits on year end
inventories from intragroup trading are eliminated by
increasing cost of sales (NCI working is also adjusted if
the subsidiary is the seller).
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Chapter summary 4
4 Mid-year acquisitions
▪ Where an acquisition occurs part way through an
accounting period, income and expenses are only
consolidated for the number of months that the
subsidiary is controlled by the parent.
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Chapter 26 • Information required by users
• Profitability
Interpretation of • Liquidity
financial statements • Gearing

• Limitations of ratio analysis
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• Describe how the interpretation and analysis of financial

statements is used in a business environment
• Explain the purpose of interpretation of ratios
• Calculate key accounting ratios:
— Profitability
— Liquidity
— Efficiency
— Position
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• Explain the interrelationships between ratios.
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• Calculate and interpret the relationship between the

elements of the financial statements with regard to
profitability, liquidity and efficient use of resources and
financial position.
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• Draw valid conclusions from the information contained

within the financial statements and present these to the
appropriate user of the financial statements.
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Overview
Importance and purpose of

interpretation of financial Analysis of financial
statements statements
Interpretation of financial Limitations of

statements ratio analysis
Ratio analysis
Profitability ratios Liquidity ratios Efficiency ratios Position ratios
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Information required by users 1
Purpose
Analysis of a company's financial statements is performed by
the following:
• Interested parties outside the business who are seeking to
know more about the company (potential investors)
• Management wishing to interpret their company's past
performance in order to make improvements for the future
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As well as:
• Employees – will I get paid?
• Governments – tax, regulations compliance
• Suppliers/lenders – will we get paid?
• Customers – can we rely on this company?
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• Financial statements can be assessed using ratio

analysis.
• Past trends of the same business (analysis through time)
and compare to budget
• Comparative information for similar businesses (analysis
by competitors)
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Profitability 1
Return on capital employed

PBIT PBIT
ROCE= =
Capital employed Total assets less current liabilities
• Measures overall efficiency of company in employing

resources available to it.
• Examine
— Change year to year
— Comparison to similar entities
— Comparison with current market borrowing rates
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Profitability 2
Return on equity
PAT and pref div

ROE= %
Ord share capital + reserves
• More restricted view of capital than ROCE, but same

principles
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Profitability 3
Profit margin
PBIT Gross profit

Profit margin= % Gross profit margin =
Sales Sales
• Useful to compare profit margin to profit % to investigate

movements which do not match
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Profitability 4
Asset turnover
Sales
Asset turnover =
Total assets less current liabilitie s
• Measures efficiency of use of assets
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Liquidity 1
Current ratio
Current assets
Current ratio =
Current liabilitie s
• 2:1 acceptable? 1.5:1? Depends on industry
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Liquidity 2
Quick ratio
Current assets − Inventory
Quick ratio (acid test) =
Current liabilitie s
• Eliminates illiquid and subjectively valued inventory

• Could be high if overtrading with receivables, but no cash
• 1:1 OK? But supermarkets etc on 0.3 (no receivables)
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Liquidity 3
A/cs receivable collection period
Trade receivables
 365
Credit sales
• Consistent with quick/current ratio? If not, investigate.
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Liquidity 4
Inventory turnover period

Inventory
Inventory turnover period =  365
Cost of sales
• Higher the better? But remember:
— Lead times
— Seasonal fluctuations in orders
— Alternative uses of warehouse space
— Bulk buying discounts
— Likelihood of inventory perishing or becoming obsolete
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Liquidity 5
Accounts payable payment period
Trade accounts payable

 365
Purchases
• Use cost of sales if purchases not disclosed
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Gearing 1
Debt ratio
Total debts
Debt ratio = %
Total assets
(> 50% = high)
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Gearing 2
Gearing
Total long term debt

Gearing ratio = %
Shareholders' equity + Total long term debt
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Gearing 3
Interest cover
PBIT
Interest cover =
Interest payable
• Company must generate enough profit to cover interest.

• Is 3+ safe? Consider relevance of profit vs cash.
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Limitations of ratio analysis 1
Limitations
• Comparative information is not always available.
• They sometimes use out of date information.
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Limitations (cont'd)
• Interpretation requires thought and analysis. Ratios should
not be considered in isolation.
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Limitations (cont'd)
• The exercise is subjective, for example not all companies
use the same accounting policies.
• Ratios are not defined in standard form.
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Lecture example 1
Required
How do the following users of financial statements benefit
from ratio analysis?
(a) Shareholders
(b) Potential investors
(c) Banks and other providers of loan capital
(d) Employees
(e) Management
(f) Suppliers
(g) Governments
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(a)(b) Shareholders and potential investors will use ratios to help

them come to a decision on buying or selling the shares of
the company.
(c) Banks and other providers of loan capital will assess
whether further loans should be made to the company.
(d) Employees may use them as a basis for wage negotiation.
(e) Management will use ratios to highlight weak performing
areas in order to focus their attention on these areas.
(f) Suppliers may use ratios to assess creditworthiness.
(g) Governments may use them for statistics or for assessing
the worthiness of a government grant.
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Lecture example 2
TJF is a national supermarket chain selling food, clothes and

household appliances with a 31 December year end.
The finance director would like the management accountant
to prepare some financial data and analysis to present to the
board. He has provided the management accountant with
extracts from the financial statements to assist him in his
analysis.
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EXTRACTS FROM STATEMENT OF PROFIT OR LOSS
FOR THE YEAR ENDED 31 DECEMBER 20X5 (with comparatives)
20X5 20X4
$m $m
Revenue 20,510 17,835
Cost of sales 18,970 16,835
Gross profit 1,540 1,000
Operating profit 650 530
Finance costs 200 130
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EXTRACTS FROM STATEMENT OF FINANCIAL POSITION
AS AT 31 DECEMBER 20X5 (with comparatives)
20X5 20X4
$m $m
Non-current assets 9,100 8,390

Inventories 850 1,000
Total current assets 1,570 1,610
Trade payables 2,100 2,280
Total current liabilities 2,920 2,650
Non-current liabilities 3,250 2,530
Equity 5,050 4,935
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20X4
Gross profit margin 5.6%
Operating profit margin 3.0%

ROCE 7.1%
Current ratio 0.61
Inventory holding period 22 days
Payables payment period 49 days

Interest cover 4.08
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The finance director has also supplied the following

information regarding events in the year ended 31 December
20X5:
(1) Online food home delivery increased by 25%.
(2) The number of stores grew by 10% in the year. This
was financed by long-term borrowings.
(3) In the year ended 31 December 20X5, 40% of
customers purchased at least one clothing item during
the year whereas in the year ended 31 December
20X4, only 20% of customers did.
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(4) A strong marketing campaign took place during the

year.
(5) The new strengthened Grocery Supplier Code of
Practice came into force to improve grocery retailers'
treatment of suppliers.
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Required
(a) Calculate the ratios below for the year ended
31 December 20X5, state whether it has improved or
deteriorated and provide one possible reason for the
movement in each ratio:
• Gross profit margin
• Operating profit margin
• Return on capital employed
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• Current ratio
• Inventory holding period
• Payables payment period
• Interest cover
(b) Explain why it would not be relevant to calculate

receivables collection period in this example.
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• Note. This answer is more comprehensive than was required. You were only
required to give one of the reasons listed for the movement in each ratio.
(a) Ratios
20X5 20X4 (given)
Gross profit margin = Gross profit 1,540
100% = 7.5% 5.6%
Revenue 20,510
Gross profit margin has improved.

This appears to be because:
• Online food home delivery increased by 25% in the year and it attracts a
higher margin than sales from supermarket visits due to the delivery
charge.
• There has been a change in sales mix with higher clothes sales in the
current year probably attracting a higher margin than food sales.
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Operating profit margin =

3.0%
Profit before interest and taxation 650

100% = 3.2%
Revenue 20,510
Operating profit margin has improved but not as much as the gross
margin.
This appears to be due to:
• New, one-off marketing costs incurred in the year

• Start up costs associated with the opening of the new stores
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Return on capital employed =

7.1%
100% = 7.8%
Total equity + non - current liabilities * 5,050 + 3,250
There has only been a small improvement in ROCE despite a

significant improvement in gross margin.
• The improvements in gross margin due to the higher margin on
home delivery and clothes sales have been largely offset by one off
operating costs from marketing and new store start up costs.
• Non-current liabilities have increased due to new borrowings to
open new stores. This has largely offset the improvement in
profitability.
• Any stores opened near the year end, will not yet have had a
chance to create profits.
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Current ratio =
Current assets 1,570 0.61
= 0.54
Current liabilities 2,920
The current ratio has deteriorated, meaning that TJF is finding it

harder to pay its current liabilities as they fall due.
• TJF is holding lower levels of inventories and higher current
liabilities.
Note. The current ratio is typically low for a supermarket as the
receivables are low due to cash sales, inventories are relatively low
as they majority are perishable and payables tend to be high due to
the strong bargaining power of supermarkets over their smaller
suppliers.
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Inventory holding period =

22 days
Inventories 850
× 365 days  365 days = 16 days
Cost of sales 18,970
Inventory days have decreased meaning that TJF is selling

inventories more quickly and holding lower levels of inventories.
This is good for cash flow providing TJF is holding sufficient
inventories to meet customer demand.
The decrease appears to be due to:
• An increase in sales volume as a result of the marketing
campaign, the growth in online food home delivery, increased
clothing sales and the new stores. This increase in demand
has resulted in inventory levels being depleted more quickly.
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Payables payment period = 49 days

× 365 days × 365 days = 40 days
Cost of sales 18,970
TJF are paying their suppliers more quickly. This is bad for cash flow
as TJF is not taking advantage of the free credit but good for supplier
relationships.
The decrease appears to be due to:
• The new strengthened Grocery Supplier Code of Practice coming
into force – presumably TJF is paying suppliers more quickly to
meet their credit terms and to treat suppliers more fairly in the spirit
of the code.
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Interest cover = 4.08

= 3.25
Finance costs 200
Interest cover has deteriorated. However, TJF is still easily able to pay
its finance costs out of profit.
The deterioration in interest cover appears to be due to:
• Increased borrowings to cover the financing of the new stores
opened in the year.
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(b) Why is it not relevant to calculate the receivables

collection period?
In a supermarket, customers have to pay for their

purchases immediately. The supermarket will not offer
credit to their customers. Therefore, the sales are cash
sales rather than credit sales resulting in few if any
receivables.
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Chapter summary 1
1 Importance and purpose of interpretation of financial

statements
▪ To provide users with information about financial
performance and position to enable them to make a
decision.
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Chapter summary 2
2 Analysis of financial statements

▪ Make a note of all obvious changes or trends before
calculating any ratios.
▪ If required, give reasons for the change and significance
in the future.
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Chapter summary 3
3 Ratio analysis
▪ Split into categories:
— Profitability
— Liquidity
— Efficiency
— Position
▪ Only useful if compare with:
— Previous financial periods
— Similar businesses
— Industry averages
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Chapter summary 4
4 Profitability ratios
▪ Gross profit margin
▪ Operating profit margin
▪ Return on capital employed
▪ Return on equity
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Chapter summary 5
5 Liquidity ratios
▪ Current ratio
▪ Quick ratio
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Chapter summary 6
6 Efficiency ratios
▪ Inventory holding period
▪ Receivables collection period
▪ Payables payment period
▪ Asset turnover
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Chapter summary 7
7 Position ratios
▪ Interest cover
▪ Gearing
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Chapter summary 8
8 Limitations of ratio analysis

▪ Inflation, different accounting policies, lack of information,
trading may be seasonal, year end figures not
representative, related party transactions, different ratio
definitions, different risk profiles, financial statements
manipulated to improve key ratios and a new company
has no comparatives.
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Tackling the exam
The ACCA highlight 'Five Steps to Multiple Choice Success':
(1) Question practice is key

(2) Allocate your time (1.2 minutes per mark)
(3) Read the questions carefully
(4) Avoid wasting too much time (do not spend too long
performing lots of calculations)
(5) If in doubt when attempting a question then have a
guess!
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Foundations in

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Syllabus Real world example

Technical content Case study

Question to consider Diagram

Answer Key concept

Past exam question Tackling the exam

Answer to past exam Summary

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A The context and purpose of financial reporting

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Two hour exam – all questions are compulsory.

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The MCQs in your exam contain four possible answers, you

• The three incorrect options are called distracters, these

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Steps to follow when attempting MCQs:

Step 1: Skim read all MCQs and identify what appear to be

Step 2: Attempt each question:

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Be careful with numerical questions as the distracters are

Check your calculation is correct.

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Step 4: What to do if your answer does not match the

• Re-read the question to ensure that you understand it and

BPP LEARNING MEDIA

Step 5: If you are still unsure make a note and continue to

Step 6: Revisit unanswered questions. When you come back

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After extensive question practice and revision of MCQs you

Be aware that the detail and/or requirement may be different.

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BPP LEARNING MEDIA

• Define financial reporting and understand the nature,

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• Identify and define the different business entities of: sole

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• Identify the users of financial statements and state and

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• Explain what is meant by governance specifically in the

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BPP LEARNING MEDIA

• Financial reporting is a way of recording, analysing

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• Financial data is recorded in the books of prime entry.

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BPP LEARNING MEDIA

Types of business entity

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Exam focus point:

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BPP LEARNING MEDIA

Users of financial information

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BPP LEARNING MEDIA

BPP LEARNING MEDIA

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(f) Governments and their agencies